Suitability vs. Fiduciary Duty vs. Reg BI: What Applies

Regulation Best Interest

Under the SEC's adopting release, when a broker-dealer or its associated person makes a recommendation of a securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, it must act in the retail customer's best interest at the time and may not place its own financial or other interest ahead of the customer's. The release says this is satisfied only by meeting four component obligations: disclosure, care, conflict of interest and compliance.

A retail customer is a natural person, or that person's legal representative, who receives the recommendation and uses it primarily for personal, family or household purposes. Under the Care Obligation, the broker-dealer must understand the potential risks, rewards and costs of the recommendation and consider them in light of the customer's investment profile.

The adviser fiduciary duty

In its interpretation, the SEC says the Advisers Act establishes a federal fiduciary duty for investment advisers, made up of a duty of care and a duty of loyalty. It is principles-based and applies to the entire adviser-client relationship, and the SEC says it cannot be waived, though it applies in a manner that reflects the agreed scope of the relationship.

FINRA suitability, Rule 2111

FINRA Rule 2111 requires a reasonable basis to believe a recommended transaction or strategy is suitable for the customer, based on the customer's investment profile. Its supplementary material describes reasonable-basis, customer-specific and quantitative suitability. Supplementary material .08 says the rule does not apply to recommendations subject to Reg BI, so Reg BI governs a retail-customer recommendation that falls in its scope. Because Reg BI is limited to retail customers, this leaves rule 2111 relevant to other recommendations; that is an inference from the two texts rather than a statement either one makes.

Form CRS

FINRA says that as part of the same rulemaking the SEC required broker-dealers and investment advisers to provide a brief relationship summary, Form CRS, to retail investors.

Worked example: why costs matter to a recommendation

A broker-dealer representative recommends $20,000 of a fund to a retail customer. A similar alternative the firm also offers has a different annual cost. The Care Obligation requires understanding the potential risks, rewards and costs of a recommendation, and the release says the firm should consider reasonable alternatives it offers, if any. The cost ratios below are illustrative.

• Fund B costs $160 more each year on the same $20,000, so cost is a real input when comparing otherwise similar options.
• Cost alone does not decide the recommendation. It is weighed with risks, rewards and the customer's investment profile.
• The same duty-of-care idea appears in the adviser fiduciary duty and in FINRA suitability, but the governing standard depends on who is recommending and to whom.

Common exam traps

• Reg BI is a broker-dealer standard for retail customers. It does not make a broker-dealer an adviser, and it is not the Advisers Act fiduciary duty.
• Reg BI is triggered by a recommendation. The Advisers Act duty applies across the whole adviser-client relationship.
• Suitability under 2111 is not the standard for a recommendation that is subject to Reg BI.
• "Retail customer" is a natural person using the recommendation for personal, family or household purposes. A business or institution is not covered by that definition.
• Disclosure alone does not satisfy Reg BI. The release lists four obligations, and all four must be met.

Practice and related pages

• Series 7 practice: accounts and suitability
• Series 65 practice: fiduciary duty
• Series 63 practice: fiduciary duty
• Series 63 vs. Series 65
• Broker-dealer vs. investment adviser
• Series 65 practice questions
• Series 7 practice questions