Inside the last-ditch effort to overturn Reg BI

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A coalition of states and a prominent network of fee-only advisors has fired back at the SEC in its bid to overturn Regulation Best Interest, arguing that that the rule falls short of a congressional mandate that any new advice regulations would hold brokers and advisors to equally stringent standards.

The plaintiffs are asking a federal appeals court to strike down Reg BI, which they say gives cover to brokers who provide personalized investment advice but who don't have to meet the fiduciary obligations that govern advisors.

"This regulatory scheme is neither required nor permitted by the Investment Advisers Act or the Dodd-Frank Act," attorneys for the XY Planning Network, one of the parties that sued the SEC, wrote in a brief.

"When a broker-dealer advertises its services as providing personalized recommendations for how money should be invested, a consumer pays for those recommendations, and the execution of the recommendation occurs with the nearly costless click of a button, it is no longer plausible to say that the advice is 'solely incidental' to the 'primary business' of executing the transaction," they wrote. "The Investment Advisers Act therefore requires that such transactions be regulated under the standards governing registered investment advisors, not broker-dealers."

XYPN's lawsuit against the SEC has been combined with another suit brought by Ford Financial Solutions, a New York-based planning firm, and the states' lawsuit, which counts California, Connecticut, Delaware, Maine, New Mexico, New York, Oregon and the District of Columbia as plaintiffs.

An SEC spokeswoman declined to comment, but attorneys for the commission have blasted the lawsuits as meritless, claiming both that the plaintiffs lack standing in the case and that their argument rests on a misreading of Congress' intent in the Dodd-Frank Act.

The disputed portion of that law, section 913, granted the SEC the authority to enact a uniform fiduciary standard, but did not mandate it. It also gave the commission authority to make a rule stipulating that brokers must act in their clients' best interest — provided that any best interest standard be "no less stringent" than the rules for advisors.

"[E]ven if they had standing, their argument that the commission exceeded its statutory authority disregards the text of Dodd-Frank, which gave the commission express, but discretionary, power to adopt a rule imposing a standard of care for broker-dealers," the SEC's attorneys wrote in a brief filed in March.

No ‘legal hook’

The plaintiffs claim the SEC is relying on a selective interpretation of Dodd-Frank, while ignoring the provision in section 913(g) of the law, which calls for any best interest standard to be equally rigorous for brokers and advisors.

"If the SEC had actually meant to enact a rule that met the 'no-less-stringent requirement,' it would have relied on section 913(g), and then we wouldn't be suing them in the first place," XYPN co-founder Michael Kitces writes in an email. Kitces is a Financial Planning contributor.

The firm detailed its strategy for complying with the SEC’s regulation ahead of its June 30 enforcement date.
April 16

The SEC's attorneys counter that the plaintiffs "barely engage" with the text of the rule in their lawsuit, and "offer only policy arguments that never find a legal hook."

They also offer a familiar defense of the approach the SEC took in tailoring rules that bring the spirit — but not the letter — of the fiduciary standard to the brokerage sector.

"Regulation Best Interest aligns with key principles underlying the fiduciary duty owed by investment advisors, which evolved to fit the services and fee arrangements they offer," the SEC's attorneys wrote. The agency did not broadlyimpose a fiduciary duty in recognition of "the differences between transaction-specific advice and an ongoing advisory relationship and between their typical compensation arrangements."

Double standard

The plaintiffs argue that this approach fails to account for the significant degree to which the brokerage and advisor industries have converged, with two types of professionals often providing fundamentally similar services yet operating under different standards of conduct.

To illustrate, attorneys for the plaintiffs asked the court to imagine a lawyer who advertises "wealth management and financial planning services" and engages with clients about their financial goals, helps them select investments, collects fees and commissions and signs contracts.

The fictional lawyer, "Charles," then claims that the execution of contracts — a legal service — is in fact his primary business, and that the provision of investment advice is "merely incidental," and that, therefore, he is not an investment advisor and has no fiduciary responsibility.

"Under the approach established by the SEC in Regulation Best Interest and defended in its brief, Charles would be in the clear: He should not be considered an investment advisor subject to the consumer protections established in the Investment Advisers Act of 1940," the plaintiffs’ lawyers write.

The result is absurd, the lawyers say. “Brokers can continue to emphasize to their customers that they provide long-term relationships based on trusted advice and argue that their advice does not 'differ either in kind or quality' from that of registered investment advisors."

One for all

For brokers to claim that providing investment advice is "solely incidental" to their primary role as an executor of transactions runs counter to the ways that many are promoting their practices and working with clients. It’s "a blurring of the lines between broker-dealers and investment advisors," Kitces wrote in a blog post last September in which he explained the rationale for the lawsuit.

Kitces says the lawsuit aims to codify what he sees as congressional intent to impose a fiduciary responsibility on all financial advice, regardless of whether it comes from a broker or an advisor. That could either entail brokers operating under a fiduciary standard or getting out of the business of providing advice altogether in favor of simply executing transactions.

"[T]he point is not to challenge the broker-dealer model, but simply to separate brokerage sales from investment advice," Kitces wrote.

The lawsuit has drawn considerable attention from the industry and politicians. Former Rep. Barney Frank (D-Mass.) and former Sen. Chris Dodd (D-Conn.), the architects of the 2010 Wall Street reform bill, have filed a brief supporting the lawsuit. Outspoken critics of uniform fiduciary proposals in Congress such as Reps. Ann Wagner (R-Mo.) and French Hill (R-Ark.) have filed briefs supporting the SEC's position.

Other groups familiar to the ongoing fiduciary debate have similarly filed "friend-of-the-court" briefs, including the FPA and Consumer Federation of America in support of the plaintiffs, while industry organizations like FSI and SIFMA have submitted briefs calling on the court to uphold Reg BI.

"Contrary to the petitioners' arguments, Regulation Best Interest is well within the broad, discretionary authority given to the SEC through Dodd-Frank," David Bellaire, FSI's general counsel, writes in an email describing his group's theory of the case. "Congress did not mandate rulemaking, let alone prescribe a specific standard be applied to all financial advice."

Square one?

The path forward for the lawsuit is unclear, particularly amid the coronavirus pandemic. Oral arguments have yet to be scheduled, while the SEC is expecting brokers to comply with its rule by the end of June.

"We're waiting for guidance from the court about whether they will still hold oral arguments, whether they will be in-person or telephonic, or whether the court will decide to issue a ruling without," Kitces says.

The plaintiffs’ first challenge is the question of standing. Duane Thompson, senior policy analyst at Fi360, expects that XYPN, at least, will prevail on that issue, meaning that the court would end up ruling on the merits of the case.

"It all boils down to what did Congress intend, and did the agency act in an arbitrary or capricious way and ignore or flout the will of Congress," Thompson says.

He also cautions that there is no guarantee that the judges in the case will fast-track the matter in light of Reg BI’s looming compliance date.

"The courts don't necessarily look to the deadline," Thompson says. "If I was going to hazard a guess, I'd say that it's not going to have a decision by June 30. That's obviously going to leave a lot of firms in limbo if the court vacates the rule. Then we're back to square one."

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Regulation Best Interest SEC regulations SEC XY Planning Network Lawsuits Litigation RIAs