Which Standard Applies to a Recommendation

Because the two standards can produce different tests for the same recommendation, identify which one applies before analyzing anything else about the customer or the product.

How Do You Know Which Standard Applies?

• Regulation Best Interest (Reg BI): a Securities and Exchange Commission (SEC) rule that applies whenever a broker-dealer or its associated person recommends a securities transaction or investment strategy, including an account recommendation, to a retail customer.
• Retail customer: a natural person, or that person's legal representative, who receives the recommendation and uses it primarily for personal, family, or household purposes. This is Regulation Best Interest's own definition; other rules use a similarly named term with a different test, so confirm which rule a question is testing.
• The suitability rule: applies to a recommended transaction or investment strategy wherever Regulation Best Interest does not, including a recommendation to an institutional account held by an entity or to a customer using the account for business rather than personal, family, or household purposes.
• The two standards do not stack. FINRA's own rule text says the suitability rule does not apply to a recommendation already subject to Regulation Best Interest.

Exam Tip: Gotchas

• A recommendation to a natural person does not automatically mean Regulation Best Interest applies. The retail-customer test also asks what the account is used for; a natural person's business-purpose account stays under the suitability rule.
• An institutional account is not always an entity's account. The institutional-account definition has a catch-all branch that reaches any person with at least $50 million in total assets, and that includes a natural person. If such a person uses the recommendation primarily for personal, family, or household purposes, Regulation Best Interest governs and the suitability rule steps aside.
• "Retail customer" is Regulation Best Interest's own term. It is close to, but not identical to, Form CRS's "retail investor" test, and it is the opposite shape of the communications rules' "retail investor" test. Match the term to the rule the question names.

How Does the Institutional Exemption Work Under the Suitability Rule?

• The suitability rule exempts an institutional account from customer-specific suitability if two conditions are both met:
  • The member or the associated person has a reasonable basis to believe the institutional customer can evaluate investment risk independently, in general and for the specific transaction or strategy. The rule gives this condition to either one, not to the firm alone.
  • The institutional customer affirmatively indicates it is exercising independent judgment in evaluating the recommendation.
• That affirmative indication can be given trade by trade, asset class by asset class, or for all potential transactions in the account. See the institutional-account lesson in an earlier unit for what qualifies an account as institutional in the first place, including the $50 million catch-all threshold.
• Where the institutional customer has delegated decision-making authority to an agent, such as an investment adviser or a bank trust department, both conditions are applied to the agent, not to the underlying institutional customer.

Exam Tip: Gotchas

• The institutional exemption removes only customer-specific suitability. Reasonable-basis suitability and quantitative suitability still apply to a recommendation made to an institutional account.
• When an agent, such as an investment adviser or a bank trust department, exercises delegated authority, test the agent's ability to evaluate risk independently and the agent's affirmative indication, not the underlying institutional customer's.

What Should You Check on Exam Day?

• Confirm who holds the account and what it is used for before picking a standard. An institutional account is usually an entity's, but the catch-all branch reaches a natural person too, and that person's personal-purpose account still falls under Regulation Best Interest.
• Do not treat the institutional exemption as removing all of suitability. Reasonable-basis and quantitative suitability survive it.
• When a fact pattern names an agent acting for an institutional customer, test the agent, not the institutional customer, against both exemption conditions.
• Remember Regulation Best Interest and the suitability rule never both govern the same recommendation.