I want to make sure I understand this, if Conan is armed with a dagger (Reach 1) and confronts a Pict armed with a spear(Reach 3). Both have guard. If Conan attacks the Pict, his difficulty rating increases two steps to Challenging (D3). If the Pict attacks Conan, Conan’s Defense difficulty also increases to D3, right?
Only the attack against the pict would have the increased difficulty as long as the pict has guard (“If the defender has Guard, then the Difficulty of the attack increases by one step (…)”). You suffer no penalty to defense.
If the picts Guard is broken, Conan would instead gain 2d20 on his attack rolls.
No. The Pict attacks with Reach 3 vs. Reach 1, the Difficulty only increases, if the ATTACKER has the weapon with less Reach. The attacker does not have any advantage or disadvantage from having a longer Reach on his attack test Difficulty.