Is Reg BI headed for the courts?

Investment advisers might assert unfair competition if 'best interest' and 'fiduciary' terminology merge while standards differ.

Opponents of the Labor Department’s fiduciary rule killed it last year in the courtroom. Those set to fight the Securities and Exchange Commission’s coming advice reform regulation might also brandish the legal sword to see if it cuts both ways.

The DOL rule, which would have required brokers to act in the best interests of their clients in retirement accounts, was vacated by the U.S. Court of Appeals for the Fifth Circuit. The decision held up when the Trump administration failed to defend the measure.

The brokerage industry plaintiffs asserted harm to their sector caused by what they called the DOL’s regulatory overreach. Could investment advisers make a similar claim that the SEC proposal — the centerpiece of which is Regulation Best Interest — harms them, and file a suit?

Yes, it is early for such speculation. The SEC probably won’t release a final rule until this summer. But, then again, football fans start debating who will play in next year’s Super Bowl minutes after this year’s contest concludes. The pending SEC regulation essentially is the Super Bowl of the financial advice sector.

Buzz about a suit increased substantially when 11 former SEC chief economists filed a Feb. 6 comment letter calling the economic analysis included in the SEC proposal “weak and incomplete.” The regulatory impact of a regulation is usually front and center when it is challenged in court.

Tyler Gellasch, a former counsel to former SEC commissioner Kara Stein, last week called a suit against the rule likely.

The key to pursuing a legal challenge is finding plaintiffs who have standing to bring the lawsuit. That’s where investment advisers come into the picture.

Under Regulation Best Interest, brokers cannot put their own interests ahead of their clients’ interests. SEC chairman Jay Clayton argues it raises the broker advice requirement above the current suitability standard.

But brokers and advisers would continue to be regulated separately under the SEC proposal, with advisers still adhering to a fiduciary standard. Regulation Best Interest would ostensibly close the gap between broker and adviser oversight.

Indeed, brokerage firms welcome such convergence. Industry officials argue that brokers already act in the best interests of their customers and that they have been unfairly tainted in comparison to advisers.

“Moving to a fiduciary standard — or Regulation Best Interest — across the whole gamut of our business is going to help,” Valerie Brown, executive chairwoman of the independent broker-dealer Advisor Group, said at a Financial Services Institute conference last month. “Because then this 'two-standard-of-care’ thing starts to go away, which I think has damaged the reputation of our industry.”

That’s precisely what grates the nerves of some advisers. Earlier this week, the National Association of Personal Financial Advisors launched a campaign to educate consumers about what they call the chasm between 'best interest’ and 'fiduciary duty.’

“Best interest doesn’t mean anything. Fiduciary means something,” said Dave O’Brien, principal at Evolution Advisers and NAPFA chairman-elect. “It introduces more confusion. I hope the SEC will listen to the adviser community and define 'best interest.’”

If Regulation Best Interest is implemented, it could create a market in which brokers call themselves advisers but aren’t regulated as advisers. This situation was at the heart of a lawsuit more than a decade ago against the so-called “Merrill rule.”

“Many advisers think [the SEC proposal] exposes them to unfair competition,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “They would have a strong argument.”

Mr. O’Brien isn’t aware of any advisers preparing a court challenge yet — and wants to avoid such an outcome.

“I hope we can achieve a cleaner, more consumer-friendly approach” to advice reform.