Regulation Best Interest: A rule to protect investors

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Reg BI prioritizes the retail customer.

© Olivier Le Moal/stock.adobe.com

Imagine you’re eating lunch with a friend who knows that you’re lactose intolerant. Your friend cares about you, so she recommends a non-dairy dessert instead of the ice cream. Regulation Best Interest provides similar protection for your investment portfolio—it ensures that your broker-dealer recommends only what’s best for you. Reg BI, as the rule is often called, is one reason that your broker sends you so much paperwork.

A broker-dealer acting in your financial best interest can be a great resource for your investment portfolio.

Regulation Best Interest is a directive mandating that broker-dealers (BDs) and their associated persons (APs) must act in the best interests of their client when suggesting an investment strategy. The regulation was enacted with the goal of preventing broker-dealers from putting their interests—such as commissions, marketing agreements, or other financial incentives—first.

Regulation Best Interest “enhances the broker-dealer standard of conduct beyond existing suitability obligations,” according to the U.S. Securities and Exchange Commission (SEC), the federal agency that enacted the regulation in 2019. Regulation BI also aligns standards of conduct for broker-dealers “with retail customers’ reasonable expectations.”

Reg BI was adopted—and became effective June 30, 2020—under the Securities Exchange Act of 1934. The regulation is crafted based on key principles of the Investment Advisers Act of 1940, which sets out rules for wealth managers to ensure that they act in their clients’ best interests.

Regulation Best Interest applies to any type of financial recommendation by a broker-dealer, including:

Regulation BI for broker-dealers is a lot like the Hippocratic oath for doctors. Just as every doctor must vow to do no harm, every broker-dealer must prioritize the financial objectives of their clients.

Regulation Best Interest requires broker-dealers to:

Broker-dealers must fulfill four specific obligations related to disclosure, care, conflicts of interest, and compliance:

Reg BI isn’t merely a rule; complying with Reg BI is an ongoing practice that requires sustained commitment by broker-dealers. It establishes a standard of conduct that cannot be met simply by creating additional paperwork.

Here’s how a broker-dealer might comply with Reg BI.

1. Establish the client relationship. The broker-dealer’s first step with a new client is to establish the relationship in a way that makes the broker-dealer’s responsibilities clear. The broker-dealer must explain their obligation to act in the client’s best interest.

2. Provide Form CRS. The broker-dealer immediately provides the client with a Form CRS—short for Customer Relationship Summary. This disclosure document explains in detail the services that the broker-dealer offers and the types of relationships that the broker-dealer maintains with clients.

Form CRS also discloses:

Form CRS must be promptly updated and redelivered to the client if there are any changes to the information.

3. Understand your investment goals. Your broker-dealer’s next step is to gather information about your financial needs and objectives. The broker-dealer should seek to understand your current investment portfolio and ask what you would like to accomplish by using their services.

4. Make customized investment recommendations. The broker-dealer can then recommend investment options that are customized to your financial goals. Regulation Best Interest requires the broker-dealer to exercise reasonable diligence, care, and skill to understand the potential risks and rewards associated with any investment recommendation.

5. Disclose all material information. At the same time that a broker-dealer makes an investment recommendation, they must also disclose in writing all material facts about the investment opportunity, including information about any potential conflicts of interest.

6. Address conflicts of interest. The broker-dealer is expected to make reasonable efforts to address any conflicts of interest. The broker-dealer under Reg BI must maintain written, formal policies that specify how conflicts of interest are handled.

7. Implement compliance measures. Broker-dealers are required to establish and enforce policies on an ongoing basis that ensure their consistent compliance with Regulation Best Interest. Investors may routinely receive disclosures or other notices that enable a broker-dealer to stay compliant with this SEC rule.

There are several major advantages and disadvantages to Regulation Best Interest.

Pros. Investors have a lot to love about Reg BI:

Cons. As with any regulation, Reg BI has a few drawbacks:

Getting investment recommendations from a professional can seem overwhelming. It helps to know that your broker-dealer, at a minimum, is acting on your behalf every time you receive a portfolio recommendation. Regulation Best Interest aims to protect your financial interests and those of every other retail investor.