Understanding prohibited activities is essential, but not every conflict of interest results in a prohibition. Many conflicts are manageable through proper disclosure. This final section covers the conflict-disclosure framework that applies to broker-dealers and agents.
BD Conflict Disclosure (Regulation Best Interest)
Under SEC Regulation Best Interest, a broker-dealer that recommends a securities transaction to a retail customer must disclose the material facts relating to conflicts of interest associated with the recommendation, must establish and enforce policies to address those conflicts, and must not place its own interest ahead of the customer's. (Reg BI is covered in the Compensation unit.)
Exam Tip: Gotchas
- Reg BI is a best-interest standard, not a suitability standard. A recommendation can be suitable but still violate Reg BI if a better option existed for the client. Suitability only asked "is this appropriate?" Reg BI asks "is this in the client's best interest?"
BD Control Relationship Disclosure
Under NASAA BD Dishonest Practices 1t:
- Must disclose control relationships with issuers before entering into any transaction with the customer
- If oral disclosure is given first, it must be supplemented by written disclosure at or before completion of the transaction
- Control relationships include: controlled by, controlling, affiliated with, or under common control with the issuer
Standard of Care: BD vs. IA
Know the high-level distinction in standards:
- A broker-dealer making a recommendation to a retail customer is held to Regulation Best Interest (a best-interest standard).
- An investment adviser is held to a fiduciary duty, the higher standard.
Practical Examples of Conflicts Requiring Disclosure
- A BD that earns revenue-sharing payments from mutual fund companies whose products it recommends
- An agent who receives higher commissions for selling proprietary products versus third-party products
- A BD that has a control relationship with the issuer of a security it recommends to customers