Regulation BI: What You Need to Know

Regulation Best Interest (BI) is a Securities and Exchange Commission (SEC) rule that safeguards investors and sets conduct standards for financial advisors. It requires advisors to prioritize their clients' interests in investment recommendations, unlike the previous suitability standard.

Basics

Broker-dealers are required by the SEC rule of Regulation BI to recommend financial products that prioritize their customers' best interests. They must also disclose any conflicts of interest or financial incentives related to these products. This rule sets a standard of conduct for broker-dealers when making securities transactions or suggesting investment strategies under the Securities and Exchange Act of 1934.

A Brief History of Regulation BI

The SEC approved Regulation BI with a 3-to-1 vote on June 5, 2019. Its main goal is to raise the standard of conduct for broker-dealers beyond just suitability. This means broker-dealers must prioritize their customers' interests when making investment recommendations, putting the customers first.

Broker-dealers must follow the suitability standard set by the Financial Industry Regulatory Authority (FINRA) when suggesting an investment, ensuring that the investment is appropriate for the specific client. However, suitability is different from the fiduciary requirement, which demands that recommendations not only be suitable but also in the client's best interest. Over the past two decades, broker-dealers have evolved to provide more comprehensive investment advice, going beyond mere trade execution. Unlike financial advisors, broker-dealers were not always required to disclose potential conflicts of interest when recommending investment products or strategies.

Department of Labor’s Fiduciary Rule

The Department of Labor (DOL) proposed the fiduciary rule in 2017 with the aim of legally binding financial professionals offering retirement planning advice to prioritize their clients' interests. The rule required full transparency, including disclosing fees and commissions and presenting beneficial investment options. However, it faced opposition and was eventually vacated in 2018.

After the fiduciary rule's demise, Regulation BI emerged in 2020 as a new hope for investors. It shares a similar focus on putting investors' best interests first and eliminating conflicts of interest, providing a transparent landscape for investment advice. Regulation BI aims to enhance the standard of conduct for financial professionals, ensuring that customers' interests are prioritized.

Regulation BI and Its Surrounding Controversies

Critics considered Regulation BI a weak replacement for Regulation FD. Co-founders of the XY Planning Network, Michael Kitces, and Alan Moore, filed a lawsuit against the SEC in the U.S. District Court for the Southern District of New York to block Regulation BI's implementation. This was followed by seven states and the District of Columbia filing a similar lawsuit, arguing that Regulation BI did not meet the guidelines set by the Dodd-Frank Act for broker conduct.

On the other side, the Securities Industry Financial Markets Association (SIFMA), representing the brokerage industry, defended Regulation BI. SIFMA's President and CEO, Kenneth E. Bentsen, Jr., stated that the rule offered stronger provisions compared to Regulation FD and that it would enhance investor protection and promote increased professionalism among financial service providers.

Regulation BI and Retail Investors

Regulation BI aims to improve the relationship between retail investors and financial professionals. It focuses on product and service disclosures, broker-dealer conduct, and information provision to help investors make better decisions. Broker-dealers must disclose essential facts about their products and services and their relationship with customers. They are also required to exercise due diligence and care when providing recommendations to retail customers, understanding the associated risks, rewards, and costs.

Conflict of Interest Elimination Policies and Procedures

Broker-dealers are required to establish, maintain, and enforce written policies and procedures to identify and disclose or eliminate conflicts of interest. These policies must:

• Prevent any limitations on offerings, like a limited product menu or proprietary products, from causing the firm or its financial professionals to prioritize their interests or the firm's interests over the retail customer's interests.
• Mitigate conflicts that might lead the firm's financial professionals to prioritize their interests or the firm's interests over the retail customer's interests.
• Eliminate sales contests, sales quotas, bonuses, and non-cash compensation based on the sale of specific securities or types of securities within a limited timeframe.

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.

Conclusion

Regulation Best Interest ensures that advisors recommend investments prioritizing investors' best interests. Firms are encouraged to remove incentives for specific investment vehicles, focusing solely on their clients' profitability. This transparency empowers investors to plan their retirement and wealth-building strategies with all the necessary information.