reg-bi

What this skill does

# SEC Regulation Best Interest (Reg BI)

## Purpose
Analyze broker-dealer recommendations and compliance obligations under SEC Regulation Best Interest (17 CFR 240.15l-1). This skill covers the four component obligations (Disclosure, Care, Conflict of Interest, Compliance), the scope of what constitutes a "recommendation," how Reg BI compares to FINRA suitability and IA fiduciary duty, rollover guidance, dual-registrant considerations, and SEC examination priorities.

## Layer
9 — Compliance & Regulatory Guidance

## Direction
prospective

## When to Use
- Evaluating whether a broker-dealer recommendation satisfies Reg BI obligations
- Determining whether an interaction constitutes a "recommendation" triggering Reg BI
- Assessing compliance of share class or account type recommendations
- Analyzing rollover recommendations from employer-sponsored plans to IRAs
- Evaluating whether a dual-registrant has properly disclosed capacity (BD vs IA)
- Reviewing conflict of interest identification, disclosure, and mitigation procedures
- Building or auditing written supervisory procedures for Reg BI compliance
- Comparing the Reg BI standard to FINRA suitability or IA fiduciary duty
- Preparing for or responding to SEC Reg BI examinations
- Assessing whether "reasonably available alternatives" were adequately considered

## Core Concepts

### What Constitutes a "Recommendation" Under Reg BI
Reg BI applies whenever a broker-dealer or associated person makes a "recommendation" to a "retail customer" of any securities transaction or investment strategy involving securities, including account type recommendations. The SEC adopted the existing FINRA framework for what constitutes a recommendation but expanded its scope:

- **Explicit recommendations:** "You should buy X" or "I recommend allocating to Y."
- **Account type recommendations:** Recommending a brokerage account vs an advisory account, or a specific account type (margin, options-enabled, fee-based).
- **Implicit hold recommendations:** Agreeing with a customer's decision to continue holding a security when the associated person has a duty to monitor or review the account.
- **Rollover recommendations:** Advising a customer to roll assets from an employer plan (401(k), 403(b), pension) to an IRA. The SEC has specifically identified rollovers as triggering Reg BI (see SEC Staff Bulletin on Account Recommendations, 2022).
- **Investment strategy recommendations:** Recommending a strategy involving securities, such as a particular asset allocation, use of leverage, or concentration approach.

The "facts and circumstances" test considers whether the communication could reasonably be viewed as a suggestion to act. General education, broad asset allocation models without a specific recommendation, and responses to unsolicited orders generally do not trigger Reg BI.

### Disclosure Obligation (17 CFR 240.15l-1(a)(2)(i))
Before or at the time of a recommendation, the broker-dealer must provide the retail customer with full and fair disclosure of all material facts relating to the scope and terms of the relationship, including:

- **Form CRS (Relationship Summary):** A standardized, plain-language document (Form ADV Part 3 / Form CRS) that must be delivered at or before the earliest of: (1) a recommendation, (2) placing an order, or (3) opening an account. Form CRS describes the types of services, fees, conflicts, legal standard of conduct, and disciplinary history.
- **Material facts about the relationship:** The capacity in which the firm is acting (broker-dealer vs investment adviser), the material fees and costs the customer will incur, and the type and scope of services provided.
- **Material facts about conflicts of interest:** All material conflicts associated with the recommendation, including compensation-related conflicts (revenue sharing, 12b-1 fees, proprietary product incentives), conflicts arising from the firm's business model, and conflicts specific to the associated person.

Disclosure alone does not satisfy the obligation. The disclosure must be "full and fair" — it must be specific enough that a retail customer can understand the conflict and how it could affect the recommendation.

### Care Obligation (17 CFR 240.15l-1(a)(2)(ii))
The care obligation requires the broker-dealer and associated person to exercise reasonable diligence, care, and skill when making a recommendation. It operates at three levels:

- **Product-level:** The associated person must understand the potential risks, rewards, and costs of the security or strategy being recommended. This includes reading the prospectus or offering documents, understanding the product's structure and features, and knowing the fee layers.
- **Customer-level:** The recommendation must be in the best interest of the particular retail customer based on that customer's investment profile. The investment profile includes, but is not limited to: age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer discloses.
- **Reasonably available alternatives:** The associated person must have a reasonable basis to believe the recommendation is the best of the reasonably available alternatives. This does not require an evaluation of every possible alternative in the market, but the associated person must consider the alternatives the firm makes available and not recommend a more expensive or riskier product when a less expensive or less risky alternative available through the firm would equally serve the customer's needs.
- **No excessive costs or risks:** The associated person must not place their interest ahead of the customer's. Recommendations must not subject the customer to excessive costs, excessive trading (churning), or excessive risk relative to the customer's profile. A series of recommendations that are each individually suitable but collectively excessive (e.g., frequent switching between fund families) can violate the care obligation.

The SEC has emphasized that the care obligation is not a "best execution" or "lowest cost" standard, but cost is a factor that must be considered. When two products are substantially similar in features and risk, but one is significantly cheaper, recommending the more expensive product requires a documented, reasonable basis for why the costlier option better serves the customer.

### Conflict of Interest Obligation (17 CFR 240.15l-1(a)(2)(iii))
The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to:

- **Identify conflicts of interest:** Map all material conflicts associated with recommendations, including compensation structures, revenue sharing, proprietary products, principal trading, allocation of limited investment opportunities, and any other financial incentive that could influence recommendations.
- **Disclose conflicts or mitigate them:** At a minimum, disclose all material conflicts. For conflicts that create incentives for the associated person to place their interest ahead of the customer's interest, the firm must mitigate the conflict (disclosure alone is not sufficient for these conflicts).
- **Mitigation measures:** Common mitigation approaches include reducing variable compensation tied to specific products, implementing product-neutral compensation grids, leveling commission payouts across similar products, adjusting supervisory review for high-conflict recommendations, and limiting the scope of products an associated person can recommend where conflicts are severe.
- **Eliminate certain conflicts:** Reg BI requires outright elimination of sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time. This is the only area where Reg BI mandates elimination rather than mitigation