How Regulation Best Interest Impacts Broker-Dealers' Practice

Abstract

In June 2019, the Securities and Exchange Commission (“SEC”) adopted Regulation Best Interest (“Reg BI” or “Final Rule”) with a compliance date of June 30, 2020, aiming at improving protection for retail customers and enhancing the standard of conduct under the Securities Exchange Act of 1934 (“Exchange Act”) for broker-dealers and natural persons who are associated persons of a broker-dealer (“Broker-Dealers”) in the course of recommending any securities transaction or investment strategy to retail customers. The SEC also mandates a disclose form for investment advisers and broker-dealers (“Form CRS”). Additionally, the SEC excludes application to broker-dealer from the Investment Adviser Act of 1940 (“IAA”) if the “solely incidental” prong is satisfied. Reg BI imposes a general “best interest” standard which requires broker-dealers to act in the best interest of retail customers at the time the recommendation is made, without placing the interests of the firm ahead of the retail customer’ interest. The Reg BI Package will be carried out with following four prongs: 1). Disclosure Obligation, 2) Care Obligation, 3) Conflict of Interest Obligation, 4) Compliance Obligation. As the foregoing discusses, broker-dealers are bound by Reg BI that places their clients’ interests ahead of their own. Though the SEC intentionally attempts to augment the protection for retail customers by imposing obligations beyond existing suitability obligations , it declines to address the definition of “best interest” in the rule text, nor did the SEC label the new regulation as “Broker-Dealer Standard of Conduct” proposed by NASAA. In the Final Rule, the SEC adopted a “principles-based” approach to align with an investment adviser’s fiduciary duty and broker-dealers’ practice will be evaluated objectively on the ground of facts and circumstances of how the four component obligations of Regulation Best Interest are satisfied at the time the recommendation is made. This article will provide an analysis of the new Best Interest Standard and the potential impact of Conflict of Interest obligation on a broker-dealers practice. For example, how Reg BI differentiates among other regulation regimes, what limitations will be imposed on broker-dealers when rendering financial recommendation and advice, how broker-dealers mitigate or eliminate conflicts of interest arising from financial incentives in conjunction with their recommendations.