June 30, 2020 was the deadline for compliance with new standards of conduct for broker-dealers in their professional relationships with retail clients. To that end, the Securities and Exchange Commission (SEC) adopted new regulations, including Regulation Best Interest (Reg BI).
From suitability to best interest
Broker-dealers, who are licensed by the Financial Industry Regulatory Authority (FINRA), a government-approved regulatory organization, have historically been held to a “suitability” standard in their work with investors. With Reg BI, they must now adhere to a “best interest” standard when they make investment product recommendations to retail clients, without placing their own interests first.
Interestingly, while the best interest standard is more stringent than the suitability standard, the SEC chose not to impose the even higher standard of a fiduciary (required of investment advisors) on these broker-dealer recommendations.
Retail customers targeted
A retail customer for this purpose is “a natural person, or the legal representative of such natural person” in this circumstance:
- When a broker-dealer recommends a “securities transaction or investment strategy involving securities” and
- The customer “uses” the recommendation mainly for “personal, family, or household purposes.”
The SEC explains (at the first link above) that the legal representative of a natural person is a “non-professional (i.e., non-regulated) legal [representative].” Examples include trustees, executors, people with powers of attorney, and conservators, who can stand in for the retail clients for whom they have protective responsibilities in relationships with broker-dealers.
Four obligations
For the broker-dealer to meet the best interest standard to a retail customer, the regulation sets out four required obligations:
- Disclosure obligation regarding the scope and terms of the broker-dealer relationship with the retail customer, including fees, costs and conflicts of interest
- Care obligation to exercise “reasonable diligence, care, and skill” to understand “potential risks, rewards, and costs” of recommended investments considering the best interest of a retail client
- Conflict of interest obligation to identify, disclose, mitigate or eliminate broker-dealer conflicts of interest that could incentivize the broker-dealer to put their own interests before the client’s, including elimination of sales contests and quotas, bonuses and “non-cash compensation” based on selling specific securities “within a limited period of time”
- Compliance obligation to establish written policies and procedures for compliance with Reg BI
This may not be the last word
While the best interest standard is more stringent than the suitability standard, some critics argue Reg BI does not go far enough to protect investors, according to FinancialPlanning. Reg BI is not even a year old yet, but many speculate that the incoming Biden administration may attempt to put even more teeth into the new Reg BI standard.
