- What Is Regulation Best Interest (BI)?
- Regulation BI Background
- Reg BI vs. DOL Fiduciary Rule
- Criticism of Regulation BI
- Details of Regulation BI
- Which Regulation BI Obligations Apply Solely to the Broker-Dealer Entity?
- When Did Regulation BI Go Into Effect?
What Is Regulation Best Interest (BI)?
Regulation Best Interest (BI) is a Securities and Exchange Commission (SEC) rule that requires broker-dealers to only recommend financial products to their customers that are in their customers’ best interests, and to clearly identify any potential conflicts of interest and financial incentives the broker-dealer may have for the sale of those products. It is related to the U.S. Department of Labor’s (DOL) fiduciary rule. The Regulation BI rule falls under the Securities and Exchange Act of 1934 and establishes a standard of conduct for broker-dealers when recommending any securities transaction or investment strategy.
- Regulation Best Interest (BI) is a Securities and Exchange Commission (SEC) rule to help safeguard investors and standardize the conduct standards for broker-dealers and financial advisors.
- Similar in some ways to the Department of Labor’s proposed fiduciary rule, Regulation Best Interest states that financial professionals must make investment recommendations that serve the client first and foremost.
- Previously, brokers were only held to the suitability standard—meaning that when brokers advised their clients, they only had to recommend investments that were suitable but not necessarily in their clients’ best interest.
Regulation BI Background
Regulation BI was approved by the SEC in a 3-to-1 vote on June 5, 2019. The regulation was first proposed on April 18, 2018, and the SEC collected comments and held hearings on the proposal for the following five months. In a press release issued by the SEC, the commission said, “Regulation Best Interest will enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.”
An investment must meet the suitability standard requirements outlined by the Financial Industry Regulatory Authority (FINRA) prior to being recommended to a client. This standard asks the question, “Is this investment appropriate for my client?” Suitability standards are not the same as fiduciary requirements, which require that the recommendation not only be suitable but also in the client’s best interest.
Broker-dealers’ responsibilities have shifted over the past two decades from simply executing clients’ trades for stocks and other securities to providing broader investment advice. Unlike financial advisors, who act as fiduciaries for their clients, broker-dealers have not always been required to disclose potential conflicts of interest when recommending investment products or strategies.
Reg BI vs. DOL Fiduciary Rule
In 2017, the DOL proposed what is known as the fiduciary rule, which would have required that all financial professionals who work with retirement plans or provide retirement planning advice—advisors, broker-dealers, and insurance agents—be legally bound by the fiduciary standard, meaning they would be required to put their clients’ interests first.
The DOL’s fiduciary rule would have prevented professionals giving retirement advice from concealing any potential conflicts of interest and would have required them to disclose all fees and commissions in simple dollar terms to their clients to ensure full transparency. Fiduciaries are also required to present investment options that are not only suitable but beneficial for the client. The difference could eliminate many commission-based investments.
The fiduciary rule would also change the requirements of who had to abide by it. Prior to the rule, only paid advisors had to be deemed fiduciaries. After the rule, any professional making a recommendation, whether paid or not, must be transparent and work toward the benefit of the investor.
Regulation FD, as it became known, was originally scheduled to be phased in from April 10, 2017, to Jan. 1, 2018, but it was opposed by the Trump administration and SEC chair Jay Clayton. On June 21, 2018, the U.S. Fifth Circuit Court of Appeals officially vacated the rule, effectively killing it.
Once Regulation FD was killed, Regulation BI became the best hope for investors. With a similar focus on the best interest over suitability and eliminating conflicts of interest, it creates a more transparent landscape for investors. Regulation BI was put in place in 2020.
Criticism of Regulation BI
Some critics see Regulation BI as a weak replacement for Regulation FD. In 2019, Michael Kitces and Alan Moore, co-founders of the XY Planning Network for independent advisors, filed a lawsuit against the SEC in the U.S. District Court for the Southern District of New York, in the hopes of blocking Regulation BI.
That lawsuit was filed a day after seven states and the District of Columbia filed a similar lawsuit against the SEC in the same court in hopes of blocking the rule’s implementation. Those states, like XY Planning Network, argue that Regulation Best Interest evaded the guidelines that the Dodd-Frank Act set out for broker conduct.
On the other side, the Securities Industry Financial Markets Association (SIFMA), which represents the brokerage industry, defended Regulation BI, insisting that it offers stronger provisions than Regulation FD. “Not even the so-called fiduciary standard under the Investment Advisers Act includes the obligation to eliminate or mitigate conflicts,” said SIFMA President and CEO Kenneth E. Bentsen, Jr. in a press release. “It is undeniable that this rule will directly enhance investor protection and contribute to increased professionalism among financial service providers.”
Details of Regulation BI
Regulation BI addresses several issues that affect retail investors and their professional relationship with financial professionals, such as disclosures about products and services, the conduct of broker-dealers, and how information is given. The goal is to help retail investors make better, informed decisions.
A disclosure obligation would require broker-dealers to disclose material facts about the relationship and recommendations of the products and services they provide. A care obligation means that a broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand potential risks, rewards, and costs associated with the recommendation.
The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and—at a minimum—disclose or eliminate conflicts of interest. Policies and procedures must:
- Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest, or the interests of the firm, ahead of the retail customer’s interest
- Prevent material limitations on offerings—such as a limited product menu or offering only proprietary products—from causing the firm or its financial professional to place his or her interest or the interests of the firm ahead of the retail customer’s interest
- Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time
In an enhancement from the original proposal, broker-dealers must establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole. All registered broker-dealers must now comply with Regulation BI.
Which Regulation BI Obligations Apply Solely to the Broker-Dealer Entity?
Conflict-of-interest and compliance obligations apply to the broker-dealer, but the disclosure and care obligations apply to the broker-dealer and associated persons.
When Did Regulation BI Go Into Effect?
Regulation BI went into effect…