Regulation Best Interest (Reg BI) is a rule adopted by the U.S. Securities and Exchange Commission (SEC) to improve protections for retail investors in their dealings with broker-dealers. Effective June 30, 2020, Reg BI imposes a standard of conduct that requires brokers to act in the best interest of their clients when making recommendations about securities transactions or investment strategies. This standard is stricter than the previous "suitability" standard, which only required that a recommendation align with a client’s financial situation and goals, without prioritizing the client’s interests over the broker’s.
Reg BI is a General Obligation that is satisfied by complying with four component obligations, as detailed in 17 CFR § 240.15l-1:
- The Disclosure Obligation,
- The Care Obligation,
- The Conflict of Interest Obligation, and
- The Compliance Obligation.
The Disclosure Obligation requires broker-dealers to make a written, “full and fair” disclosure of 1) any material fact relating to broker-dealers’ relationship with their retail clients, and 2) any material fact relating to conflicts of interest that are associated with broker-dealers’ recommendations. The disclosure obligation must be satisfied prior to or at the time of a broker-dealer’s recommendation.
The Care Obligation requires broker-dealers to exercise reasonable diligence, care, and skill in making the recommendation. The Care Obligation imposes duties on broker-dealers to: Identify the risks, rewards, and costs that attend a particular investment; form a reasonable belief that their recommendations are appropriate for retail customers given retail customers’ investment profile; and evaluate investment advice in a holistic manner.
The Conflict of Interest Obligation requires broker-dealers to institute and maintain written policies relating to conflicts of interest. These policies must enable the detection and disclosure of conflicts of interest relating to broker-dealers’ recommendations, operational constraints such as an inability to offer products that are not proprietary, and any sales contests, sales quotas, bonuses, or non-cash compensation tied to the sale of specific securities.
The Compliance Obligation requires broker-dealers to institute and maintain written policies relating to compliance with Reg BI. The extent of this obligation will vary with the regulated broker-dealer. The SEC looks to the totality of broker-dealers’ circumstances when determining what compliance measures are reasonable.
Reg BI was introduced in response to longstanding concerns about conflicts of interest in the broker-dealer industry. Under the suitability standard, brokers could recommend products that were suitable but might not be the most advantageous option for the client, particularly when the broker stood to earn higher commissions or incentives. Reg BI seeks to address these conflicts by requiring broker-dealers to put their clients' interests ahead of their own financial gain. The rule also fills a regulatory gap left after the Department of Labor’s Fiduciary Rule for retirement accounts was vacated in 2018. See: Chamber of Commerce of the U.S. v. U.S. Dep't of Labor, 885 F.3d 360 (5th Cir. 2018). The SEC sought to raise broker-dealers’ standard of care while preserving the viability of the broker-dealer business model. However, investor advocates have criticized Reg BI as insufficiently distinct from the Suitability Rule and posing similar risks to retail investors.
Reg BI applies specifically to broker-dealers and their registered representatives when making recommendations to retail customers—individuals using investment recommendations for personal, family, or household purposes. The rule governs both securities transactions and investment strategies.
Reg BI does not apply to investment advisers, who are regulated under the Investment Advisers Act of 1940 and subject to an even higher standard of care: a fiduciary duty. Unlike the best interest obligation under Reg BI, which applies primarily to specific recommendations, an investment adviser's fiduciary duty is ongoing and requires advisers to place their clients' interests above their own in all aspects of the advisory relationship. This fiduciary standard encompasses duties of loyalty and care, demanding transparency, avoidance of conflicts of interest where possible, and full disclosure when conflicts cannot be avoided. Because investment advisers already operate under this stringent framework, their regulatory obligations surpass the requirements of Reg BI and application of Reg BI may be unnecessary in instances where one acts solely as an investment adviser and not as a broker.
Reg BI also does not apply to institutional investors, such as large financial institutions, hedge funds, or sophisticated corporate entities. These investors are presumed to possess the knowledge, experience, and resources necessary to evaluate recommendations and act in their own best interests. The exclusion of institutional investors reflects a long-standing principle in securities regulation that sophisticated parties, often with access to internal legal and financial expertise, require less regulatory protection than retail investors. Institutional investors are considered capable of identifying and negotiating conflicts of interest, assessing investment risks, and determining the suitability of transactions without the need for the heightened protections provided by Reg BI. However, this assumption has been criticized as lacking empirical grounding and for incentivizing poor broker-dealer conduct toward institutional clients.
Lastly, Reg BI does not apply to unsolicited transactions, which occur when a customer independently initiates a trade without a recommendation from a broker-dealer. Since the rule is specifically designed to regulate the conduct of broker-dealers when making recommendations, it logically excludes scenarios where the broker-dealer plays no advisory role.
For more information, see: Reg BI and Form CRS, and SEC FAQ on Reg BI
[Written in December of 2024 by the Cornell Law School Securities Law Clinic]