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.