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Regulation and Compliance > Federal Regulation

SEC's Regulation Best Interest Comes Under Attack

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The Securities and Exchange Commission’s Regulation Best Interest came under legal assault in early September when two separate lawsuits were filed challenging the rule’s validity. More challenges are likely on the way, at least one attorney predicts.

Seven states along with the District of Columbia filed a suit in the Southern District of New York on Sept. 10 against Reg BI for failing to institute a uniform fiduciary standard and “meet basic investor protections” that were laid out in the Dodd-Frank Act.

The same day, XY Planning Network (XYPN), co-founded by well-known industry planner and blogger Michael Kitces, also filed a lawsuit challenging broker-dealers’ ability to deliver comprehensive financial planning services under the rule.

With Reg BI, “the SEC is choosing Wall Street over Main Street,” said New York Attorney General Letitia James, who’s leading the coalition of AGs, in a statement. “Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first.” The other attorneys general hail from California, Connecticut, Delaware, Maine, New Mexico, Oregon and the District of Columbia.

The states also maintain in their suit that Reg BI adds to investor confusion about the regulatory requirements broker-dealers are held to versus those of investment advisors.

In its suit, also filed in the Southern District of New York, XYPN argues that under the SEC’s so-called “best interest” rule, “a broker-dealer is permitted to take into account its own personal interests in providing recommendations and advice to investors on how to invest their life savings. This new rule means that broker-dealers may maintain harmful conflicts of interests while being able to market themselves as trusted advisers acting in their client’s best interests.”

The rule “thus circumvents a key goal of Dodd-Frank — leveling the playing field — and increases investor confusion,” XPYN’s lawsuit states.

Kitces, XYPN’s co-founder, told IA that “We think the court would have to vacate Regulation Best Interest or, alternatively, if the SEC is willing to modify the rule and state that financial planning advice is investment advice that is not solely incidental, that would put Reg BI back in compliance” with Dodd-Frank.

Said Kitces: “Fiduciary competitiveness is being damaged,” under Reg BI.

As it stands now, Kitces told IA, XYPN is “not seeking out co-plaintiffs. If we have standing we can move forward. We are hopeful there will be amicus briefs filed.”

XYPN also alleges that the SEC exceeded its authority by allowing dual registrants under Reg BI to use advisor-like titles and to hold out as being in the business of providing financial planning advice when selling brokerage services and products.

“In the end, there is a place for both the sale of brokerage products and services, and financial planning and other investment advice, but reducing consumer confusion requires a clear separation between the two, including a requirement that all financial planning advice be delivered under an RIA and subject to the RIA’s fiduciary duty,” Kitces said. “Brokers and dual-registrants should not be able to use titles that connotes they are in the business of providing fiduciary advice unless they do so at all times.”

Mixed Views on Lawsuits

Industry officials and attorneys were quick to weigh in with their thoughts about the lawsuits.

James Lundy, a partner at Drinker Biddle & Reath’s Chicago office and a former SEC attorney, said in a recent compliance alert that the states’ challenge is unusual. “Interestingly, challenges to SEC rulemakings historically have been led by industry groups. That said, based on their public complaints since the proposed releases, some expected certain investor advocacy groups to attempt to take the lead in challenging this rulemaking effort by the SEC.

Ultimately, the states have elected to the lead the charge.”

However, Lundy opined, the states “will not have the last say.” With Reg BI “being one of the main priorities of [SEC] Chairman Jay Clayton’s tenure, we should expect the SEC and Chairman Clayton to vigorously and zealously defend” the rule.

David Buffa, a principal at the law firm of Bressler, Amery & Ross and a member of Bressler’s Retail Client Group, which develops solutions for firms subject to Reg BI, added in a comment to IA that “compared to the challenges that ultimately struck down the DOL’s fiduciary rule, I believe the SEC has a greater likelihood of success due to the broad discretion authorized by Dodd-Frank.”

The AGs’ complaint “relies heavily on a provision of Dodd-Frank that authorized — but arguably did not require — the imposition of an investment advisor-level standard of care on broker-dealers, and due to the ambiguity in Dodd-Frank and SEC’s formal study and rulemaking process, it seems likely that the [court] will side with the regulator.”

Buffa said firms should not put their Reg BI implementation efforts on hold in light of the complaints, as they are the “first of many anticipated challenges to the SEC.”

Reg BI’s compliance date is June 30, 2020.

Barbara Roper, director of investor protection for the Consumer Federation of America, said that CFA agrees with the premise of the states’ lawsuit, “that, in adopting Reg BI, the SEC ignored clear congressional intent and that the result is a rule that is too weak to protect investors.”

Added Roper: “Whether in the short run, as a result of this lawsuit, or in a future administration, the rule will need to be scrapped and extensively revised to provide investors the protections they need and deserve.”

Susan Neely, president and CEO of the American Council of Life Insurers, argued in a statement, however, that the attorneys general challenge “misses the mark. Reg BI is consistent with the Dodd-Frank Act’s mandate requiring the SEC to review investment advice standards and develop better rules, if necessary, to protect consumers.”

Reg BI Harm

Attorneys for Bates Research noted in a recent notice that the states argue in their lawsuit that Reg BI causes economic harm “due to lower tax revenues as a result of the diminished value of investment and retirement accounts beset by conflicts of interest.”

Additional economic costs, the states’ claim, include the need to provide public assistance, “in meeting the unmet needs of retirees and other residents in their states”; and “a reduction in the ‘strong quasi-sovereign interest’ that states have in maintaining the economic well-being of their residents.”

XYPN, meanwhile, argues that Reg BI presents “a significant threat” to its business and to the businesses of its members in two ways.

First, XYPN’s business model depends “in substantial part” on financial planners having an incentive to register as RIAs. By failing to impose a standard of conduct for broker-dealers that is the same as the standard for advisors, “as required by Dodd-Frank section 913(g), the SEC’s rule reduces the likelihood that broker-dealers will register as investment advisers, resulting in a loss of business for XYPN,” the lawsuit states.

Second, the SEC’s rule “poses a competitive threat” to XYPN’s members.

“In subjecting broker-dealers to a lower standard of conduct than RIAs, the rule allows broker-dealers to pursue their own financial interests even when providing the same financial-planning services as RIAs, while also reducing their legal exposure,” the lawsuit states.

The rule does so “while using the label ‘best interests’ to refer to the lower standard of care applicable to broker-dealers, making it more difficult for RIAs to differentiate the fiduciary duty they owe—and their own ‘best interests’ standard of conduct—from the duty owed by broker-dealers under the rule,” XYPN argues.

“This results in a competitive disadvantage to XYPN’s members, who sign a fiduciary oath to act in client’s best interests.”

Washington Bureau Chief Melanie Waddell can be reached at [email protected].


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