Regulation Best Interest (Reg BI) - SEC Rule 15l-1
With the foundation of compensation types and fairness standards in place, Reg BI represents the overarching standard that governs how broker-dealers must act when making recommendations to retail customers.
Overview and Applicability
- Reg BI applies to broker-dealers and their associated persons when making a recommendation to a retail customer
- A retail customer is a natural person (or their legal representative) using the recommendation for personal, family, or household purposes
- Reg BI requires that broker-dealers act in the best interest of the retail customer at the time a recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the customer's interest
- Reg BI is satisfied only if the broker-dealer complies with four component obligations
Exam Tip: Gotchas
Reg BI applies only to broker-dealers and their associated persons. It does not apply to investment advisers, who are held to a fiduciary standard under the Investment Advisers Act. Do not confuse the two standards on the exam.
The Four Component Obligations
| Obligation | Key Requirements |
|---|---|
| Disclosure | Before or at the time of recommendation, disclose in writing: the capacity in which the BD is acting; all material fees, costs, and charges; the type and scope of services; all material facts relating to conflicts of interest |
| Care | Exercise reasonable diligence, care, and skill; understand the potential risks, rewards, and costs of the recommendation; have a reasonable basis to believe the recommendation is in the customer's best interest; consider reasonably available alternatives |
| Conflict of Interest | Establish and maintain written policies to identify, disclose, and mitigate (or eliminate) conflicts; eliminate sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities or types of securities within a limited period |
| Compliance | Establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole |
Compensation Disclosure Under Reg BI
The Disclosure Obligation has specific requirements related to compensation:
- Disclose all material fees and costs relating to the customer's transactions, holdings, and accounts
- Disclose the sources and types of direct and indirect compensation the broker-dealer receives
- The specific dollar amount of compensation need not be disclosed, but disclosure must be full and fair and may require disclosing the general magnitude of compensation
- Disclose conflicts arising from proprietary products, third-party payments, and compensation arrangements
Conflict of Interest Obligation - Compensation Rules
The Conflict of Interest Obligation targets specific compensation practices:
- Broker-dealers must eliminate (not just disclose or mitigate):
- Sales contests
- Sales quotas
- Bonuses tied to the sale of specific securities
- Non-cash compensation based on selling specific securities or types of securities within a limited period
Think of it this way: Most conflicts under Reg BI can be addressed through disclosure and mitigation. But sales contests and quotas must be eliminated entirely.
NASAA Incorporation of Reg BI
- NASAA's Statement of Policy on Dishonest or Unethical Business Practices (as amended 2022) incorporates Reg BI at the state level
- Section 1.d specifically states that it is a dishonest practice to fail to comply with Regulation Best Interest obligations when making recommendations to retail customers
- This means Reg BI compliance is enforceable as a state law obligation in jurisdictions that have adopted the NASAA statement
- Violations can trigger both federal SEC enforcement and state administrator action
Exam Tip: Gotchas
- Reg BI applies to broker-dealers only. Investment advisers have a separate fiduciary standard.
- Sales contests must be eliminated, not just disclosed or mitigated.
- NASAA has adopted Reg BI, making it testable as both a federal and state requirement.