In a recent blog post, I referred to Regulation Best Interest, also known as Reg BI. In this post, I’ll explain how it benefits you, the investor.

Why was it needed, and how does it affect you?

Until recently, investors were often victimized by unscrupulous advisors and slick sales pitches. Reg BI was put in place by the Securities and Exchange Commission (SEC) to stop those practices. Advisors must justify, in writing, why making the recommended investment is in the client’s best interest. The days of a client discovering a hidden restriction, which the advisor conveniently never mentioned, are over.

How does it work?

It requires advisors to do several things:

• Only make recommendations that are in the client’s best interest. This includes any securities transaction or investment strategy involving securities. If it does not fit into a client’s objectives, financial circumstances, or tolerance for risk, the advisor may NOT recommend it. Liquidity restrictions, limitations on payments to beneficiaries could pose problems for the client and must be disclosed. The advisor must provide a written explanation showing why the product is in the client’s best interest.

• Clearly identify any conflicts of interest the advisor may have in recommending a product. A conflict of interest arises when the advisor places his or her interest ahead of the client’s interest. Products with high commissions for the advisor, and high sales charges paid by the client, have an inherent conflict of interest. Sales contests, quotas, bonuses, and “non-cash” awards create an incentive for the advisor and must be disclosed to the client.

• The advisor must consider “reasonably available alternatives” to the product he or she is recommending. Let’s say an advisor recommends a product with high costs and high commissions. He or she must explain in writing why it is better for the client than a comparable, low cost product.

One last, important point: Does the recommended transaction involve penalties and/or additional limitations? Certain types of transactions are particularly prone to abuse. For example,

• Replacement or exchanges of variable life insurance or variable annuity products, especially when the client must pay surrender charges to make the transaction. Even worse, the new investment may very well have its own, brand new set of surrender charges.

• Rollovers, transfers, or exchanges from low-cost liquid investments, such as mutual funds, to high-cost illiquid ones, such as non-tradable REITs. Why should you trade low cost flexibility for high cost rigidity? Good question, one the advisor would have to answer in writing.