A coalition of state attorneys general filed a federal lawsuit against the Securities and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI) rules on Monday. States included in the filing are New York, California, Connecticut, Delaware, Maine, New Mexico, and Oregon. Washington, D.C., was also included.
The suit, filed in the United States District Court for the Southern District of New York, was led by New York Attorney General Letitia James. In a press release, Attorney General James argued that the rules failed to meet basic investor protections legislated in the 2010 Dodd-Frank Act.
A separate suit against the SEC followed on Tuesday by XY Planning Network (XYPN), a group of fee-only financial planners. According to Investment News, XYPN is also citing a provision in the Dodd-Frank Act as the basis of their suit. However, XYPN co-founder Michael Kitces said the Reg BI rules also fail to meet the standards of the Investment Advisers Act of 1940.
Refresher: Regulation Best Interest
The Reg BI rules, passed in a 3 to 1 vote by the SEC in June, was written to establish a standard of conduct for broker-dealers when recommending financial products or investment strategy to their clients. It requires that broker-dealers only make recommendations that are in the ‘best interest’ of their customers and to clearly outline any potential conflicts of interest and incentives they themselves may have regarding their recommendations. Prior to these rules, federal law generally only required broker-dealers to make ‘suitable’ recommendations to their clients.
SEC Commissioner Robert Jackson voted against the measure, claiming the rules fall short of ensuring brokers will work in the best interest of their clients because it fails to sufficiently define the higher standard of conduct.
Investment Advisors have a different standard of conduct. Registered Investment Advisers (RIAs) are entities registered with the SEC to practice in the investment advisory business according to the Investment Advisers Act of 1940. Because the representatives of RIAs’ service is solely based on providing advice, they are required to act as fiduciaries. This means they have an explicitly defined duty to put their client’s interests before their own.
The States’ Case
Like Commissioner Jackson, the suit filed by the state attorneys general argues the rules don’t explicitly do enough to protect investors.
“With this rule, the SEC is choosing Wall Street over Main Street,” New York Attorney General James said in the release. “Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first. The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place.”
In 2010, Congress authorized the SEC to align the standards of conduct between broker-dealers and investment advisors with the passing of the 2010 Dodd-Frank Act. According to Attorney General James’s office, while the SEC claims that the Reg BI rules align the standard of care between these two sides of the business, they in fact do not. This is because they fail to explicitly impose a fiduciary duty of care on broker-dealers by instead calling for a “vague” best interest standard. Ultimately, the filing argues, the Reg BI rules fail to meet the congressional mandate in Dodd-Frank.
XYPN’s Case
The XYPN filing makes the same Dodd-Frank arguments as the States’ case. However, it goes further by also claiming the rules fail to meet the standards of the Investment Advisors Act of 1940. The Investment Advisors Act requires any person providing financial advice for compensation to register as an investment advisor and subjects them to the fiduciary standard.
Kitces, the XYPN co-founder, told Investment News that under Reg BI, brokers and dual registrants who make financial recommendations should be required to register as an investment adviser.
“The SEC has now allowed the giving of financial advice without a fiduciary standard, which was never allowed or intended by the Investors Act of 1940,” said Alan Moore, XYPN co-founder, to Investment News. “It has created and will continue to create immense amounts of consumer confusion and is ultimately anti-competitive to financial planners … who are holding themselves out as fiduciaries.”
Essentially, the XYPN suit is motivated by the prospect RIAs will be unfairly held to a higher standard than brokers who provide similar services.
How these suits play out remains to be seen, and it’s entirely possible more suits will be filed.
What can you expect from Reg BI as a broker?
It’s important to remember that Reg BI was written to raise the standard of conduct for broker-dealers from recommending ‘suitable’ investments to investments that are in their clients’ ‘best interest.’ Sure, the above lawsuits have valid arguments regarding the extent and implication of the rules, but you should expect Reg BI will probably require brokers to do more documentation to prove they are working in their client’s best interest and communicating all possible conflicts of interests.
We won’t know for sure how the Reg BI rules will affect the industry until the SEC starts enforcing them in 2020. If you’re a broker, it’s a good idea to start making efforts to increase your documentation on client interaction now..
For more financial information, follow NEXT Financial Group, Inc. (NEXT) on Facebook and LinkedIn.
https://ag.ny.gov/press-release/ag-james-leads-coalition-suing-sec-putting-brokers-ahead-investors
https://www.investopedia.com/what-is-the-sec-s-regulation-bi-best-interest-rule-4689542
https://www.nextfinancial.com/next-blog/regulation-best-interest-passes-sec/
