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New Year Brings Renewed Fiduciary Battle

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The start of 2020 has the industry grappling with an all too familiar conundrum — will a fiduciary-related rule ever come into play? As the Securities and Exchange Commission’s Regulation Best Interest faces its upcoming day in court, the industry is prognosticating whether Reg BI will suffer the same fate as the Labor Department’s now-defunct fiduciary rule.

Questions also linger as to whether Labor’s planned new fiduciary rule that “aligns” with Reg BI will proceed if Reg BI is vacated. Read on to see how one expert sees that playing out.

The lawsuits lobbed by XY Planning Network and seven state attorneys general against Reg BI “are still on track (and as we hope and anticipate, [Reg BI will be] vacated)” before the rule’s June 30 effective date, Michael Kitces, co-founder of XYPN, said in an early January email.

XYPN and the state attorneys general filed their briefs on Dec. 27 in the U.S. Court of Appeals for the 2nd Circuit. The SEC has until early March to reply to the XYPN and state AG briefs. “Our final response to the SEC will come in late March,” Kitces said.

Central to the suits’ argument is that the SEC violated the Dodd-Frank Act by creating a new standard for brokers when Congress instead directed the securities regulator to create a “harmonized” fiduciary standard for brokers and advisors.

Dodd-Frank Authors Say Reg BI ‘Cannot Stand’

Current and former Democratic lawmakers, including Dodd-Frank’s authors — former Congressman Barney Frank, D-Mass., and former Senator Chris Dodd, D-Conn. — agreed with Kitces in an early January amicus brief filed with the U.S. Court of Appeals for the 2nd Circuit that Reg BI violates Section 913 of Dodd-Frank.

Reg BI “fails to harmonize the standards for broker-dealers and investment advisers through a fiduciary rule, and is therefore at odds with the text and structure of Section 913, as well as Congress’ plan in passing it,” they told the appeals court.

Congress’ mandate in Section 913 “required that any rule promulgated to address the inconsistent standards of care between investment advisers and broker-dealers must harmonize those standards of care,” the current and former lawmakers said. “The rule therefore cannot stand.”

House Financial Services Committee Chairwoman Maxine Waters, D-Calif., and Senate Banking Committee ranking member Sherrod Brown, D-Ohio, further state in the amicus brief that Dodd-Frank did not give the agency permission to write a separate rule.

In its final rule, “the SEC suggests that it issued the rule pursuant to a ‘grant of rulemaking authority in Section 913(f),’ on the theory that that Section 913(f) provides an ‘overlapping, yet distinct, rulemaking power’ with Section 913(g).”

To be sure, the amicus brief continues, “Section 913(f) provides the SEC with the authority to ‘commence a rulemaking … to address the legal or regulatory standards of care for brokers, dealers, [and] investment advisers … for providing personalized investment advice about securities to such retail customers.’”

However, Section 913(f) “must be read in conjunction with the provision that immediately follows it — Section 913(g) — which provides specific limits on the SEC’s rulemaking authority,” the current and former lawmakers state.

“The SEC’s interpretation of Section 913 — that it allows the SEC to provide a different, lesser standard for broker-dealers that does not harmonize the standards across all financial professionals — would render superfluous Section 913(g), which specifically dictates that the SEC’s rule implement a uniform fiduciary standard of care,” according to the amicus brief.

The lawmakers — who stated that they either sponsored Dodd-Frank, participated in drafting it, or served on committees with jurisdiction over the federal financial regulatory agencies — said that “consumer confusion and the blurred distinctions between broker-dealers and investment advisers — and the consequences of that inconsistency for everyday Americans — spurred Congress to enact reforms” in the Dodd-Frank Act.

Duane Thompson, president of Potomac Strategies, said that “if XY Planning and the states can convince the 2nd Circuit that Congress spoke directly to the need to adopt a uniform fiduciary standard for both brokers and advisors … then we’re likely to see a decision vacating Reg BI on the basis that the SEC did in fact cherry-pick one provision in Dodd-Frank and therefore violated the Administrative Procedure Act by ignoring congressional intent.”

Adds Kitces: Section 913(f) of Dodd-Frank “only authorized the SEC to create new regulations ABOUT ‘personalized investment advice,’ and Section 913(g) defined the standard that must be created for ‘personalized investment advice.’ That makes 913(f) and 913(g) inextricably linked.”

Is Reg BI Doomed?

“It’s a tossup,” Thompson opines. “No one can say for certain — not petitioners’ counsel or even the panel of judges reviewing the case — assuming they’ve been appointed by now.”

(See related story: Don’t Sleep on Reg BI Compliance, Industry Officials Warn)

Keep in mind that President Donald Trump “flipped” the 2nd Circuit. “There are now five Trump-appointed judges on the 2nd Circuit, with Rs leading Ds overall 7-6 in active judges who could be appointed to the three-judge panel,” Thompson said.

“Typically it’s always an uphill battle for petitioners as the courts tend to give deference to the agency’s interpretation of the law it is tasked with overseeing,” Thompson said.

With Reg BI, “it’s the Dodd-Frank and Adviser Act statutes and whether the SEC action in adopting Reg BI was arbitrary and capricious by ignoring consumer studies and legislative intent that suggested both investors and Congress desired a fiduciary standard to apply.”

XYPN and the state AGs “also claim that the SEC exceeded its authority in adopting a less rigorous standard for brokers providing the same identical services as investment advisors governed by a higher standard of conduct,” Thompson added.

Kitces added that “if delays arise, or the Appeals Court takes a long time to decide the case, we may still pursue further action to delay the Reg BI implementation date. But frankly, it is our hope that, win or lose, the Appeals Court decides quickly, so the industry knows one way or the other if Reg BI is going to stay, or is being vacated.”

The court also could rule that the agency must revise Reg BI. “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, Kitces said.

Labor’s New Fiduciary Rule

What happens to Labor’s forthcoming fiduciary rule if the court strikes down Reg BI?

“It complicates matters for the DOL’s fiduciary proposal,” said Fred Reish, partner at Drinker Biddle & Reath, because a new DOL regulation “would likely be based, in large parts, on the SEC’s regulation.”

“Many of the substantive provisions of any DOL proposal will be, at the least, aligned with the Reg BI,” Reish explained. “When the SEC imposed a best-interest standard on broker-dealers, it was a material change in the regulatory landscape.”

One reason the U.S. Court of Appeals for the 5th Circuit vacated the prior DOL fiduciary regulation “was that two of the judges found that there hadn’t been any significant changes since the original DOL fiduciary definition was put in place in the 1970s. Obviously, Reg BI would overcome that argument,” Reish said.

That said, the authority for Labor to issue fiduciary regulations is found in the Employee Retirement Income Security Act (ERISA), Reish added, “and not in Dodd-Frank. As a result, any finding that Dodd-Frank limited the SEC [in issuing Reg BI] would not directly apply to the DOL.”

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


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