United States: Regulation Best Interest: The Next Big Thing For Broker-Dealer Cross-Border Private Wealth


The broker-dealer cross-border private wealth industry is no stranger to recent challenges, and on the horizon looms another—the U.S. Securities and Exchange Commission's ("SEC") proposed Regulation Best Interest ("Reg BI"). As a required offshoot of the Dodd-Frank Act and an anticipated follow-up to the Department of Labor's ("DOL") failed fiduciary rule, Reg BI has passed its August 2018 comment period and is back before the SEC for consideration.

Although its final form is yet to be known, many believe that some level of "best interest" regulation is a certainty. However, Reg BI may create more disruption to the cross-border private wealth management business than it resolves. Reg BI—which requires disclosure and mitigation, or elimination, of many potential conflicts—is premised heavily on an economicsdriven model that fails to take into account many of the issues underlying cross-border investment, such as geographic diversity, dollarization of assets, heightened need for privacy and security, use of complex structures for tax and succession planning, and similar highly personalized customer interests.

Additionally, it may disproportionately affect products traditionally used by international customers, such as structured products and offshore mutual funds, and disproportionately affect brokers specializing in cross-border who change employment more frequently than their U.S. domestic counterparts.

Further, because Reg BI creates a duty to act to a defined standard, the proposed rule fails to recognize the difficulty of completing those duties in foreign countries with customers whose frame of reference is predominantly local, not in English, and who have complicated product and holding structure needs.


Far from new, the concerns over customer transparency and customer protection regarding complicated broker-dealer compensation arrangements gained renewed prominence in the aftermath of the Great Recession. With greater industry emphasis on advisory models charging not per trade but on assets under management, it became more difficult to determine if financial professionals were operating in the best interest of their clients. As a result, Section 913 of the Dodd-Frank Act directed the SEC to study the implications of standards for broker-dealers and investment advisers and granted the SEC the authority to craft a uniform fiduciary standard for both. While the SEC tackled the many difficulties in establishing a brokerage fiduciary standard, the DOL charted its own standards for retirement accounts. Introduced in 2016, the DOL's fiduciary rule created implementation difficulties for advisers and brokers until its eventual stay of implementation by the Trump administration and vacatur by the Fifth Circuit Court of Appeals in March 2018. Because the DOL rule applied only to retirement accounts, non-U.S. customers were largely unaffected. However, the respite was short-lived: In April 2018, the SEC announced its proposed Reg BI in response to DoddFrank's mandate. The proposal draws no distinction between U.S. and nonresident clients and applies with equal vigor to SEC and Financial Industry Regulatory Authority ("FINRA") registered representatives and their associated persons wherever situated, including non-U.S. associates.


Reg BI is intended to establish a higher standard of affirmative conduct, including disclosure and care obligations for brokerdealers and their associated persons (for ease of reference sometimes collectively referred to herein as "broker-dealers") when making recommendations to retail customers (i.e., a person who uses the recommendation primarily for personal, family, or household purposes). While proponents cite to the lack of an imposed fiduciary duty, some commentators argue that there seems to be little functional distinction left. In summary, Reg BI requires broker-dealers to act in the best interest of retail customers when recommending securities transactions. Reg BI specifies that in order to satisfy the best interest obligation, broker-dealers must:

  1. Prior to, or at the time of making the recommendation, disclose to the customer, in writing, material facts relating to the scope and terms of the relationship, including all material conflicts of interest related to the recommended transaction.
  2. Exercise reasonable diligence, care, skill, and prudence to: (i) understand the potential risks and rewards of the transaction and have a reasonable basis to believe that the transaction could be in the best interests of at least some 2 Jones Day White Paper retail customers; and (ii) have a reasonable basis to believe that: (a) the recommended transaction is in the best interest of the particular customer, based on both the customer's investment profile (e.g., the customer's age, other investments, financial situation and needs, tax status, investment objectives, experience and time horizon, liquidity needs, and risk tolerance) and the relevant risks and rewards; and (b) any series of recommended transactions is not excessive and is in the customer's best interest (when viewed together) under the customer's investment profile.
  3. Establish, maintain, and enforce written policies and procedures that, with respect to recommendations to retail customers, are reasonably designed to: (i) identify and disclose or eliminate all associated material conflicts; and (ii) identify and disclose and mitigate, or eliminate, material conflicts of interest arising from associated financial incentives

Reg BI also requires that certain books and records be maintained, including: (i) a record of all information given to and received from retail customers and (ii) the identity of each natural person at the broker-dealer who is responsible for the retail account.

Under Reg BI, broker-dealers would be required to act in an undefined, but highly prescribed, "best interest" of their retail customers. The context of the mandatory best interest determination centers almost exclusively on prohibiting the brokerdealer from placing its financial interest ahead of the client's and disclosing any information which may lead a customer to believe that the broker is not consciously or unconsciously "disinterested."

Reg BI is triggered by (i) a recommendation; (ii) to a retail securities customer; (iii) on a securities transaction or strategy. While "recommendation" remains defined by FINRA, "retail customer" is defined in Reg BI without regard to corporate or individual form or wealth. Instead, a retail customer is defined by the purpose of the trade as one who "... uses the recommendation primarily for personal, family, or household purposes."1 The definition of "customer" does not require an account relationship, rather merely that one receives a recommendation.

At its core, Reg BI creates a standard of conduct at the time the recommendation is made that does not place the interest of the broker-dealer ahead of the interest of the retail customer.2 Reg BI prescribes satisfying this obligation by way of a three-dimensional, four-part obligation. The proposal designates specific duties to the broker-dealer institutionally and the recommending individual broker at the product level. Reg BI calls for the institutional broker-dealer to disclose, in plain-English writing, all material conflicts of interest associated with the recommendation. Under Reg BI, the standard for assessing materiality is based on whether the conflict carries the expectation that it "might incline a broker-dealer—consciously or unconsciously—to make a recommendation that is not disinterested."3 Accompanying SEC proposals command the provision of a Client Relationship Summary ("CRS") designed to address certain specific institutional conflicts of interest, such as the difference between advisory and brokerage accounts.

The second of the four-part steps imposes a duty of care upon the maker of the recommendation, usually the individual broker, and prescribes the exercise of reasonable diligence, care, skill, and "prudence." The recommendation must have a reasonable basis based on the customer's investment profile which is expansively redefined to include tax status and any other information the customer may disclose to the broker.4 The propriety of the recommendation also is to be considered in the context of frequency and number of trades and must not be excessive as a series of recommendations, even if appropriate when viewed in isolation.5

Reg BI would require the establishment, maintenance, and enforcement of policies and procedures designed to identify, disclose, or eliminate material conflicts of interest associated with the recommendation, and identify and disclose, and mitigate, or eliminate, material conflicts of interest related to the financial incentives of the broker-dealer. The isolation of financial incentives as a class of conflicts requiring mitigation or elimination is one of Reg BI's most pronounced departures from current requirements and is perhaps the most difficult conflictof-interest obligation to implement. It establishes a burden on brokers arguably greater than that of investment advisers.

Lastly, Reg BI's record-keeping provision described above is not to be minimized in its application to cross-border customers. Given the complex purposes for which foreign customers invest, the availability of personal information mandated to be held by brokerages may well increase the targeting of brokerages under Reg BI for nonfinancial discovery, such as divorces and commercial disputes.


The disclosure obligation requires the broker-dealer to disclose to the retail customer, in writing, all material conflicts of interest associated with the recommendation, along with material facts, such as the capacity in which the broker is acting, fees and charges, and the type and scope of services being provided by the broker and any other facts that the broker-dealer determines are material.


Many have called Reg BI a "suitability plus" standard. While closely related to the FINRA suitability requirements, it neither mimics nor replaces suitability. Instead, Reg BI would require an analysis and cascading compliance program to consider a customer's perceived best interest, not just threshold suitability. While the FINRA requirements of reasonable basis suitability and customer-specific suitability remain intact, the undertaking of those would, under Reg BI, be subject to a specific standard of reasonable diligence, due care, skill, and prudence. This objective standard would require a more diligent approach to a customer's investment objectives than before and relevant extraneous considerations that cannot be waived contractually or disclosed away. It also would effectively require a broader array of investment alternatives to be considered, where available.

Suggested diligence and disclosure includes the cost to the customer, as well as the level of remuneration to the broker. However, a lower cost product does not immunize a broker from the methodology. Liquidity, volatility, and extraneous risk all must factor into the mix. In the end, an articulated and demonstrable reason for a recommendation should be constructed.


In perhaps its most innovative and complicated assertion of affirmative duty, the SEC has tackled the multiple conflicts inherent in a multifaceted industry and separated them into silos defined by the existence of financial incentives. Importantly, the conflicts inherent in broker-dealer compensation, such as acting as principal, selling proprietary products, or receiving trailers post-sale, are not prohibited, per se. However, the disclosure must be the result of policies and systems that reliably identify, eliminate, or mitigate those material conflicts. Additionally, if material conflicts of interest arise from financial incentives tied to the recommendation, disclosure alone is insufficient. Those conflicts must be subject to disclosure and mitigation or elimination.

Under Reg BI, a material conflict of interest would exist if "a reasonable person would expect [it] might incline a broker-dealer—consciously or unconsciously—to make a recommendation that is not disinterested" and if it brings the compensation of the broker-dealer and the individual broker to the forefront of the analysis.6

In proposing Reg BI, the SEC identified a wide range of practices that it believes "preliminarily" would constitute material conflicts arising from financial incentives, such as sales contests and sales-based recognition awards. The SEC requested comment on the scope of the conflicts to be impacted. Depending on the result of its deliberations, many products, including mutual funds of multiple classes, structured products, and non-U.S. mirror funds, may be subjected to much deeper diligence, disclosure, and potentially mitigation or elimination as to varying modes of compensation. Similarly, the presence of revenue and asset benchmarks in employment contracts may require much greater disclosure, if not mitigation and elimination.


While the broker-dealer cross-border private wealth industry is subject to the same standards and regulations attached to all SEC and FINRA registered broker-dealers and their associated persons, its uniqueness in the application of Reg BI lies in certain key differences from the U.S. domestic practice, among them:

  • Foreign investment into U.S. accounts is often driven by many non-economic factors, including dollarization for currency risk, family security risk, geographic diversification, and international tax considerations.
  • Due to international tax considerations, among other things, many international clients invest through offshore 4 Jones Day White Paper holding vehicles, such as PICs, trusts, foundations, or other vehicles, adding complicated tax analysis to any "best interest" standard.
  • Non-U.S. investors necessarily operate often within a frame of reference more attuned to their home country experiences and in languages other than English.
  • Brokers who service cross-border clients must often travel to service their clients in countries that may restrict, either legally or prudentially, the provision of financial documents and system access while traveling.
  • Non-U.S. investors gravitate toward more complex products and structures that often implicate more complex compensation and remuneration components.
  • Because of time, technology, and geography, many nonU.S. investors grant their representatives brokerage discretion, creating further overlap between the boundaries of brokerage and advisory.
  • International financial representatives exhibit more mobility than domestic representatives and their financial compensation may be more exposed to benchmark-laden transition packages which may now require fulsome disclosure.


1 Reg BI, subsection (b)(1)(B).

2 Reg BI, subsection (a).

3 Regulation Best Interest, SEC Release No. 34-83062 ("SEC") p. 169.

4 Reg BI, subsection (b)(2).

5 SEC, at p. 150.

6 Id., at p. 169.

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