Regulation Best Interest (Reg BI)

With the FINRA suitability rule as your foundation, you can now understand the SEC's higher standard: Regulation Best Interest (Reg BI). Reg BI does not replace the suitability rule; it layers on top of it for a specific category of customers.

What You'll Learn

• Who Reg BI applies to (retail customers vs. institutional investors)
• The four component obligations that make up the best interest standard
• How Reg BI differs from FINRA suitability
• The role of Form CRS (Relationship Summary) in Reg BI compliance

Scope and Application

• Reg BI applies to recommendations made to retail customers by broker-dealers (BDs)
• A "retail customer" is a natural person (or legal representative of a natural person) who uses the recommendation primarily for personal, family, or household purposes
• Reg BI does not replace the FINRA suitability rule. The suitability rule continues to apply to recommendations made to institutional investors and entities
• Reg BI imposes a higher standard than suitability: the recommendation must be in the best interest of the retail customer

Think of it this way: Suitability asks "Is this product appropriate for the customer?" Reg BI goes further and asks "Is this the best option for the customer, considering costs and alternatives?" Both standards can apply to the same BD, depending on the customer type.

Exam Tip: Gotchas

• Reg BI does NOT replace the suitability rule. Both can apply simultaneously: Reg BI for retail customers, FINRA suitability for everyone (including institutional).
• A pension fund is an institutional customer. If the exam describes a recommendation to a pension fund, apply FINRA suitability, not Reg BI.

The Four Component Obligations

Reg BI's best interest standard is satisfied by complying with four component obligations:

• Disclosure: Provide full and fair written disclosure of all material facts about the relationship and conflicts of interest, before or at the time of the recommendation
• Care: Exercise reasonable diligence, care, and skill in making the recommendation; understand potential risks, rewards, and costs; have a reasonable basis to believe the recommendation is in the customer's best interest and does not place the BD's interests ahead of the customer's
• Conflict of Interest: Establish, maintain, and enforce written policies and procedures to identify, disclose, and mitigate or eliminate conflicts of interest
• Compliance: Establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI

Exam Tip: Gotchas

• The Disclosure and Conflict of Interest obligations have no direct parallel in FINRA suitability. These are unique to Reg BI.
• All four obligations require written documentation. Disclosure requires written disclosure; Care requires documented diligence; Conflict of Interest and Compliance both require written policies and procedures.

Form CRS (Relationship Summary)

As part of Reg BI, the SEC requires BDs to deliver Form CRS (Customer Relationship Summary) to retail investors. Form CRS is a brief document (no more than 2 pages for a BD) that describes:

• The types of services offered (brokerage vs. advisory)
• Fees and costs associated with those services
• Conflicts of interest
• The standard of conduct that applies (best interest for BDs)
• Disciplinary history (and where to find more information)

BDs must deliver Form CRS before or at the earliest of: a recommendation, placing an order, or opening an account.

Exam Tip: Gotchas

• Form CRS is a Reg BI requirement, not a FINRA suitability requirement. It applies only to retail customers.
• Form CRS is limited to 2 pages for a BD. The brevity is intentional so retail customers actually read it.

Key Distinctions from FINRA Suitability

These distinctions are frequently tested:

The Care Obligation in Detail

The Care Obligation under Reg BI encompasses all elements of FINRA suitability plus two additional requirements:

1. Cost comparison: The BD must consider costs among reasonably available alternatives. Not just whether the product is suitable, but whether a less expensive alternative achieves the same objective.
2. No firm-first: The recommendation must not place the BD's interest ahead of the customer's interest.

Exam Tip: Gotchas

• "Best interest" is a higher standard than "suitable." Suitable is necessary but not sufficient under Reg BI.
• Cost comparison is required under Reg BI but not under FINRA suitability. If two mutual funds achieve the same objective but one has lower expenses, the BD must consider the lower-cost option under Reg BI.

The Conflict of Interest Obligation in Detail

The Conflict of Interest Obligation does not force a firm to remove every conflict. It draws a line between conflicts that can be mitigated (managed through disclosure, supervision, and design controls) and conflicts that must be eliminated outright:

• Mitigate (with disclosure plus reasonable supervision): Many compensation-driven conflicts can be addressed rather than banned. A firm may pay representatives on total production or pay differential commissions across product types, provided it identifies, discloses, and mitigates the conflict through written policies, supervisory review, and controls so the conflict does not distort recommendations.
• Eliminate (cannot be cured by disclosure): Sales contests, sales quotas, bonuses, and non-cash compensation tied to the sale of a specific security or a specific type of security within a limited period are conflicts the firm must eliminate, not merely mitigate. Disclosure alone does not cure them because they create a direct, security-specific incentive to push one product.

The dividing line is whether disclosure plus reasonable mitigation and supervision can adequately address the conflict. Broad, non-security-specific incentives can usually be mitigated; narrow incentives aimed at a particular security or product type cannot, so they must be eliminated.

• Revenue sharing, preferred lists, and payments from fund families: When a firm receives revenue-sharing payments from certain fund families, or those families' funds appear on the firm's preferred list, the payments are material conflicts of interest. The firm must identify them, disclose them, and mitigate them through written policies and procedures (for example, objective preferred-list criteria and supervisory review of recommendations into participating funds) so the firm's interest in the revenue is not placed ahead of the customer's interest.

Exam Tip: Gotchas

• Security-specific sales contests must be ELIMINATED, not mitigated. A contest, quota, or bonus tied to a particular security (or a specific type of security) over a limited period cannot be cured by disclosure. Broader, non-security-specific incentives (such as total-production pay) may be permitted if appropriately mitigated.
• Revenue sharing is a conflict to identify, disclose, and mitigate. It is not automatically prohibited, and disclosure in a fund prospectus does not satisfy the firm's own obligation to disclose and mitigate the conflict.

The Disclosure Obligation in Detail

The Disclosure Obligation operates recommendation by recommendation, not just once at account opening:

• New conflicts trigger fresh disclosure. A material conflict that arises after the initial disclosure (for example, the firm enters a new revenue-sharing arrangement) must be disclosed in writing before or at the time of the next recommendation that the new conflict could affect. The initial disclosure does not insulate the firm from later disclosure duties.
• The disclosure must be in writing. Full and fair disclosure of all material facts about the relationship and conflicts of interest must be written.

The Disclosure Obligation is non-waivable:

• A retail customer cannot waive written disclosure. Even if the customer asks the representative to skip the paperwork, the firm must still provide the required written disclosure before or at the time of the recommendation.
• A verbal summary does not substitute for the required writing, and handing over a prospectus does not substitute either. The prospectus is product-level disclosure from the issuer or fund; it does not cover the firm's own relationship and conflict facts.

Exam Tip: Gotchas

• A new material conflict requires fresh written disclosure before the next affected recommendation. Disclosure is per recommendation, not a one-time event at account opening.
• The retail customer cannot waive written disclosure. A verbal summary or a prospectus does not replace the firm's own written disclosure of relationship and conflict facts.