Quick Answer
Reg BI requires broker-dealers and their associated persons to act in a retail customer's best interest when making a recommendation, without putting the firm's interest first. NASAA has incorporated Reg BI compliance into its Statement of Policy, so it is enforceable as both a federal and a state dishonest-practice standard.
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. For the Series 63, what matters is the standard itself and how NASAA has made it enforceable at the state level.
Who Does Reg BI Apply To, and What Does It Require?
- 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 the legal representative of that person) who receives the recommendation and uses it primarily 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
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 separate fiduciary standard. Do not confuse the two standards on the exam.
What Four Obligations Satisfy the Best-Interest Standard?
Reg BI's best-interest obligation is satisfied only when the broker-dealer meets all 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; consider reasonably available alternatives; have a reasonable basis to believe it is in the customer's best interest given the customer's investment profile |
| Conflict of Interest | Establish written policies and procedures to identify, disclose, and mitigate (or eliminate) conflicts of interest; eliminate sales contests, sales quotas, bonuses, and non-cash compensation tied to selling specific 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 |
The Disclosure Obligation's compensation piece requires disclosing the sources and types of direct and indirect compensation the broker-dealer receives, including conflicts from proprietary products, third-party payments, and compensation arrangements. A specific dollar figure is not required, but the disclosure must still be full and fair, which can mean disclosing the general magnitude of the compensation.
Why Does NASAA Incorporation Matter for the Series 63?
- NASAA's Statement of Policy on Dishonest or Unethical Business Practices incorporates Reg BI at the state level
- The statement specifically provides that it is a dishonest practice to fail to comply with Regulation Best Interest when making recommendations to retail customers
- This makes Reg BI compliance enforceable as a state law obligation in jurisdictions that have adopted the NASAA statement
- Violations can trigger both federal and state enforcement action
Exam Tip: Gotchas
- Reg BI applies to broker-dealers only. Investment advisers have a separate fiduciary standard.
- NASAA has adopted Reg BI, making it testable as both a federal and state requirement.
What Should You Check on Exam Day?
- Reg BI applies only to broker-dealers and associated persons recommending to retail customers; investment advisers stay on the fiduciary standard.
- The best-interest obligation requires all four components: Disclosure, Care, Conflict of Interest, and Compliance. Care includes considering reasonably available alternatives, not just the recommended product in isolation.
- The Conflict of Interest obligation must eliminate (not just disclose) sales contests, quotas, bonuses, and non-cash compensation tied to specific-security sales within a limited period.
- Compensation disclosure covers the sources and types of compensation; the exact dollar amount is not required, but the disclosure must be full and fair.
- NASAA has adopted Reg BI, so noncompliance is enforceable as both a federal violation and a state dishonest practice.