FINRA Highlights Available Guidance and Resources Related to Regulation Best Interest

1 The SEC Adopted Reg BI under the Securities Exchange Act of 1934 (Exchange Act) on June 5, 2019. See Exchange Act Rule 15l-1; Regulation Best Interest: The Broker-Dealer Standard of Conduct, Exchange Act Release No. 86031 (June 5, 2019), 84 FR 33318, 33375 (July 12, 2019) (Reg BI Adopting Release). Concurrent with the adoption of Reg BI, the SEC also adopted Form CRS and related rules, which require SEC-registered BDs and IAs to deliver to retail investors a brief customer or client relationship summary that provides information about the firm. See Form CRS Relationship Summary; Amendments to Form ADV, Exchange Act Release No. 86032 (June 5, 2019), 84 FR 33492 (July 12, 2019).

2 For purposes of Reg BI, whether a “recommendation” is made is interpreted consistent with precedent under the federal securities laws and with how the term has been applied under FINRA rules. See Reg BI Adopting Release, supra note 1, at 33337. As the SEC explained, “the determination of whether a broker-dealer has made a recommendation that triggers application of Regulation Best Interest should turn on the facts and circumstances of the particular situation and therefore, whether a recommendation has taken place is not susceptible to a bright line definition. Factors considered in determining whether a recommendation has taken place include whether the communication ‘reasonably could be viewed as a call to action’ and ‘reasonably would influence an investor to trade a particular security or group of securities.’ The more individually tailored the communication to a specific customer or a targeted group of customers about a security or group of securities, the greater the likelihood that the communication may be viewed as a recommendation.” Id. at 33335 (citation omitted). See also Notice to Members 01-23 (March 2001); Regulatory Notice 11-02 (January 2011); Regulatory Notice 12-25 (May 2012). Also, where a BD agrees to provide a retail customer with specified account monitoring services, under Reg BI, such an agreement will result in buy, sell or hold recommendations even when the recommendation to hold is implicit. See Reg BI Adopting Release at 33325.

3 “Retail customer” is defined in Exchange Act Rule 15l-1(b)(1) as “a natural person, or the legal representative of such natural person, who: (i) [r]eceives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (ii) [u]ses the recommendation primarily for personal, family, or household purposes.”

4 Exchange Act Rule 15l-1(a)(1).

5 The Care Obligation requires the member or associated person, in making the recommendation, to exercise reasonable diligence, care and skill to:

• understand the nature of the recommended security or investment strategy involving a security—as well as the potential risks, rewards and costs of the recommended security or investment strategy—and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers based on that understanding;
• have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards and costs associated with the recommendation and does not place the financial or other interest of the member or associated person ahead of the interest of the retail customer;
• have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the member or associated person ahead of the interest of the retail customer. Exchange Act Rule 15l-1(a)(2)(ii).

6 The Disclosure Obligation requires the member or associated person, prior to or at the time of the recommendation, to provide the retail customer, in writing, full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer and all material facts relating to conflicts of interest that are associated with the recommendation. Material facts relating to the scope and terms of the relationship with the retail customer that must be disclosed include, but are not limited to:

• that the member or associated person is acting in the capacity of a BD or associated person with respect to the recommendation;
• the material fees and costs that apply to the retail customer’s transactions, holdings and accounts; and
• the type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer. Exchange Act Rule 15l-1(a)(2)(i).

7 The Conflict of Interest Obligation requires a member to identify and address conflicts of interest that may incline the member or its associated persons—consciously or unconsciously—to make a recommendation that is not disinterested. Specifically, members must establish, maintain and enforce written policies and procedures reasonably designed to:

• identify and at a minimum disclose, pursuant to the Disclosure Obligation, or eliminate, all conflicts of interest associated with recommendations;
• identify and mitigate any conflicts of interest associated with recommendations that create an incentive for the member’s associated persons to place their interest or the interest of the member ahead of the retail customer’s interest;
• identify and disclose any material limitations (e.g., a limited product menu) placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations and prevent such limitations and associated conflicts of interest from causing the member or the associated person to make recommendations that place the interest of the member or the associated person ahead of the retail customer’s interest; and
• identify and eliminate 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. Exchange Act Rule 15l-1(a)(2)(iii).

8 Under the Compliance Obligation, a member must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. Exchange Act Rule 15l-1(a)(2)(iv).

9 See Investment Advisers Act Release No. 5248 (June 5, 2019), 84 FR 33669 (July 12, 2019) (“Fiduciary Interpretation”). In addition, the SEC adopted an interpretation concerning the "solely incidental" prong of the BD exclusion from the Advisers Act. Investment Advisers Act Release No. 5249 (June 5, 2019), 84 FR 33681 (July 12, 2019) (“Solely Incidental Interpretation”).

10 The FAQs address the following topics: Retail Customer; Recommendation; Disclosure Obligation; Care Obligation; Conflict of Interest Obligation; Compliance Obligation.

11 See SEC Staff Bulletin on Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors (March 30, 2022) (SEC Staff Bulletin on Account Recommendations); SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Conflicts of Interest (Aug. 3, 2022) (SEC Staff Bulletin on Conflicts); and SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations (April 20, 2023) (SEC Staff Bulletin on Care). These resources and others (including resources concerning Form CRS, the Fiduciary Interpretation and the Solely Incidental Interpretation) are available on the SEC’s website.

12 For purposes of the Bulletins, the term “retail investor” is used to mean any person who qualifies as a “retail customer” under Reg BI or a natural person client of an investment adviser. See SEC Staff Bulletin on Account Recommendations, supra note 11 at note 2.

13 See supra note 11.

14 See SEC Staff Bulletin on Account Recommendations, supra note 11 at Question 1.a. (“The standard you must follow depends on the capacity in which you are acting (i.e., broker-dealer, investment adviser, or both). In addition, the antifraud provisions of the Advisers Act apply to investment advisers in connection with current and prospective clients. Accordingly, in many cases, both Reg BI and the Advisers Act apply as you assess an account type recommendation for current and prospective retail investors.”); Question 1.b. (“Where you have not yet established the capacity in which you will be acting, you should assume that both standards apply and disclose to the investor, prior to or at the time of the recommendation, that you are acting in both capacities. Firms should provide clear guidance, through policies and procedures and other instructions to their financial professionals, on how to disclose capacity to retail investors.”) (citation omitted).

15 Id. at Question 4.a. (“In addition to the factors discussed above, the staff believes that there are specific factors potentially relevant to rollovers that you should generally consider when making a rollover recommendation to a retail investor. These factors include, without limitation, costs; level of services available; features of the existing account, including costs; available investment options; ability to take penalty-free withdrawals; application of required minimum distributions; protection from creditors and legal judgments; and holdings of employer stock.”); Question 4.b. (“In the staff’s view, it would be difficult to form a reasonable basis to believe that a rollover recommendation is in the retail investor’s best interest and does not place your or your firm’s interests ahead of the retail investor’s interest, if you do not consider the alternative of leaving the retail investor’s investments in their employer’s plan, where that is an option.”).

16 Id. at note 26 (“In adopting Reg BI, the Commission determined not to require broker-dealers to document the basis for any recommendations, but encouraged them to take a risk-based approach when deciding whether to document certain recommendations.); Question 6 (“Broker-dealers and investment advisers are subject to recordkeeping rules that may affect their decisions or obligations to document the basis for account recommendations. Additionally, in the staff’s view, it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for certain recommendations.”) (citation omitted); Question 3.c. (“The existence of special features or other potential benefits would not alone support a reasonable belief that an account recommendation is in an investor’s best interest. Rather, such factors should be considered in light of the investor’s needs, investment objectives, and preferences, and your account recommendation must not place your interests or the interests of your firm ahead of the retail investor’s interest. It is the staff’s view that it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for such conclusions.”); Question 4.a. (“In the staff’s view, when making a rollover recommendation, it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for the recommendation.”); Question 5 (“In the staff’s view, however, if the retail investor ultimately directs you to open an account that is contrary to your recommendation, you would not be required to refuse to accept the investor’s direction. In such instances, the staff believes that it may be difficult for a firm to assess periodically the adequacy and effectiveness of its policies and procedures or to demonstrate compliance with its obligations to retail investors without documenting the basis for opening the account.”) (citation omitted); note 13 (“If you determine not to obtain or evaluate information that would normally be contained in an investor profile, the staff believes you should consider documenting the basis for your belief that such information is not relevant in light of the facts and circumstances of the particular account recommendation.”).

17 See SEC Staff Bulletin on Conflicts, supra note 11.

18 Id. at Question 10 (“For example, firms should evaluate whether a limited product menu or otherwise limiting the range of products offered, such as share classes offered, (either by the firm or an affiliate) creates a conflict that could incline the firm or its financial professionals to offer advice or make recommendations that place the interests of the firm or its financial professionals ahead of the retail investor’s interest. In the staff’s view, firms should consider establishing product review processes for the products they offer (or that are offered by an affiliate). Such a product review process could include, for example:

• identifying and mitigating the conflicts of interest associated with the product, such as payments for inclusion on a firm’s menu of products offered (sometimes referred to as shelf space);
• declining to recommend or provide advice with regard to a product where the firm cannot effectively mitigate the conflict;
• evaluating the use of “preferred lists”;
• restricting the retail investors to whom certain products may be recommended;
• prescribing minimum knowledge and/or training requirements for financial professionals who may provide recommendations or advice with regard to certain products; and
• conducting periodic product reviews to identify potential conflicts of interest, whether the measures addressing conflicts are working as intended, and to modify the measures or product selection accordingly.”) (citations omitted).

19 Id. at Question 5 (asking: “My firm has identified all of its conflicts of interest. Once the firm discloses the conflicts to retail investors, have we satisfied our obligations under Reg BI and the IA fiduciary standard?” and responding: “No. Disclosure of conflicts alone does not satisfy the obligation to act in a retail investor’s best interest. Further, as discussed below, certain conflicts should (and in some cases, must) be addressed through mitigation. Where such conflicts cannot be effectively addressed through mitigation, firms may need to determine whether to eliminate the conflict or refrain from providing advice or recommendations that are influenced by that conflict to avoid violating the obligation to act in a retail investor’s best interest in light of the investor’s objectives. Moreover, even if conflicts are sufficiently addressed, under both Reg BI and the IA fiduciary standard, firms and their financial professionals can provide recommendations or advice only when they have a reasonable basis to believe that the recommendation or advice is in the retail investor’s best interest.”) (citations omitted); Question 12.c. (“While firms should disclose the existence and potential effects of such conflicts, the staff reminds firms that disclosure of conflicts alone does not satisfy a firm’s obligation to act in the retail investor’s best interest.”).

20 Id. at Question 13 (“The staff believes that identifying and addressing conflicts is not a “set it and forget it” exercise. Firms should monitor conflicts over time and assess periodically the adequacy and effectiveness of their policies and procedures to help ensure continued compliance with Reg BI and the IA fiduciary standard. Reasonably designed policies and procedures that address conflicts may later cease to be reasonably designed based on subsequent events or information obtained, such as through supervision (e.g., exception testing of recommendations), and the actual experience of the firm.”).

21 See SEC Staff Bulletin on Care, supra note 11 at Question 17 (“In the view of the staff, firms and financial professionals should consider whether less complex, less risky or lower cost alternatives can achieve the same objectives for their retail customers as part of their overall reasonable basis analysis. Moreover, firms and their financial professionals generally should apply “heightened scrutiny” to whether a risky or complex product is in the retail investor’s best interest.”); Question 18 (“Examples of products where heightened scrutiny may be necessary include, but are not limited to, inverse or leveraged exchange-traded products, investments traded on margin, derivatives, crypto asset securities, penny stocks, private placements, asset-backed securities, volatility-linked exchange-traded products, and reverse-convertible notes.”).

22 Id at Question 19 (“In the staff’s view, firms that make recommendations of, or provide advice about, complex or risky products to retail investors should also consider documenting the process and reasoning behind the particular recommendation or advice, including consideration of less complex alternatives, and how it fits within the retail investor’s broader goals or strategy.”).

23 In Regulatory Notice 23-08, FINRA updated and supplemented prior guidance concerning private placements to highlight a member’s obligation under Reg BI, when recommending a security, to conduct a reasonable investigation of the security.

24 On August 1, 2019, FINRA published a Reg BI and Form CRS Checklist to help members assess their obligations under Reg BI and Form CRS, and understand key differences between FINRA Rules and Reg BI and Form CRS. An updated version of the checklist was published on October 18, 2023.