SEC sued by seven states to kill Reg BI investment-advice rule

Plaintiffs claim that the SEC's rule would undermine consumer protections and that the agency exceeded its authority in promulgating the rule

Sep 10, 2019 @ 10:27 am

By Greg Iacurci

Seven states and the District of Columbia sued the Securities and Exchange Commission and agency Chairman Jay Clayton to overturn an investment-advice rule that is meant to overhaul how brokers work with their clients but that plaintiffs claim is too weak.

Attorneys general for the states — New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon — filed the lawsuit Monday in the U.S. District Court for the Southern District of New York. It is the first lawsuit that's been filed against the regulation.

The lawsuit — State of New York et al v. United States Securities and Exchange Commission and Walter "Jay" Clayton III — seeks to vacate the final rule, which was issued in June after a 3-1 vote by commissioners, and permanently prevent its implementation, which is scheduled for the end of June 2020.

Plaintiffs allege the SEC exceeded its statutory authority in violation of the Administrative Procedure Act by issuing the final rule.

"The day the release came out [about Reg BI], we figured the SEC would get sued, and here we are," said Lawrence Stadulis, co-chair of fiduciary governance at law firm Stradley Ronon Stevens & Young.

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Plaintiffs claim the SEC rule, known as Regulation Best Interest, "undermines critical consumer protections for retail investors" and increases investor confusion around the standards of conduct that apply when they get an investment recommendation from a broker versus a recommendation from a registered investment adviser.

They also claim that the rule makes it easier for brokers to market themselves as "trusted advisers" while still being able to give conflicted advice, and that the SEC contradicted "Congress's express direction" under the Dodd-Frank Wall Street Reform and Consumer Protection Act to harmonize the standard of conduct between brokers and RIAs.

Brokers must currently adhere to a suitability standard of care with clients, while RIAs adhere to a fiduciary standard of care. Reg BI sought to increase the standard of care for brokers, saying they must act in clients' best interests. Investor advocates, however, claim the rule falls short and constitutes a level of enhanced suitability.

A spokesperson for the SEC didn't respond to a request for comment on the lawsuit.

The lawsuit marks the latest turn in an ongoing fight among regulators, the financial services industry and investor advocates about how brokers should be allowed to interact with investor clients.

The Department of Labor issued a rule in 2016 that imposed a fiduciary duty on brokers making investment recommendations to savers in retirement accounts such as 401(k)s and IRAs. The rule was ultimately killed by the 5th Circuit Court of Appeals last year after surviving a lawsuit in Dallas federal court.

Three states that are party to the SEC lawsuit — California, New York and Oregon — had tried stepping in to defend the fiduciary rule when it appeared the Trump administration would abandon the rule in appellate court.

States such as Massachusetts, New Jersey and Nevada have proposed rules to require a fiduciary standard of care for brokers in the wake of the DOL fiduciary rule's death.

A rule that partially took effect in New York last month requires intermediaries selling annuities and life insurance to act in customers' best interests. The Certified Financial Planner Board of Standards Inc. is expanding its fiduciary standard for financial advisers and brokers who hold the group's CFP mark.

"Any time a regulator issues a standard-of-care rule, they're going to get sued," said Kevin Walsh, a principal at Groom Law Group. "We saw this with the DOL fiduciary rule, New York's [insurance regulation], and now with the SEC's Reg BI."

Plaintiffs in the lawsuit against the SEC have two primary legal hurdles to victory, Mr. Walsh said: A court must agree they have standing to bring the lawsuit, and it must agree with their interpretation of the Dodd-Frank Act.

The states argue the rule will cause them and their residents harm via lost revenue from taxable distributions from residents' savings accounts, which will be worth less due to brokers' conflicted advice. States will also "bear a greater financial burden to assist retirees and others" as a result of conflicted advice, which would cause a larger savings shortfall, according to the lawsuit.

The states, Mr. Walsh said, argue the SEC should have harmonized the broker and RIA standards of care because the Dodd-Frank law gave them the authority to do it. However, Dodd-Frank also said the SEC can't ban commissions and gave the agency the authority to adopt a different standard of care for broker-dealers than RIAs, he said, adding that all of these provisions are tough to reconcile.

"It's tough to anticipate how judges will look at this," he said.

Attorneys also question the logic of the plaintiffs' ultimate goal. Overturning Reg BI would seem to reinstate a more lax regulatory environment, they said.

"By vacating the rule, we're back to square one in terms of suitability," said Mr. Stadulis of Stradley Ronon Stevens & Young. "Isn't it better now than it was? I'm not sure what [the lawsuit] accomplishes."


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