Two lawsuits filed last week against the Securities and Exchange Commission's investment advice reform package point to an extended legal battle that is unlikely to be resolved before the new regulations must be implemented next year.
Although the outcome is impossible to predict, it will hinge on whether a court decides the SEC ignored a congressional mandate to set a uniform fiduciary standard for all financial advisers or acted within its authority to create a new broker requirement separate from the investment adviser standard.
One of the suits was brought by seven state attorneys general. They argue the SEC violated the Administrative Procedure Act by promulgating a broker requirement — Regulation Best Interest — that doesn't follow lawmakers' direction in the Dodd-Frank financial reform law to formulate a uniform standard of conduct that is no less stringent than the fiduciary duty that currently applies to advisers.
The attorneys general say Reg BI won't adequately protect investors from conflicted advice. They also assert that states will lose tax revenue as a result of the lower value of retirement distributions and will have to take on the costs of caring for retirees who don't have enough savings.
"This is not just about the Administrative Procedure Act; it's also about federalism," said Marlon Paz, a partner at Mayer Brown. "It's about the states' ability to protect their citizens and the federal government's ability to dictate a national [advice] standard. There's a long road ahead."
A separate suit filed by XY Planning Network and Ford Financial Solutions also argues that the SEC sidestepped Dodd-Frank. In addition, it claims Reg BI puts investment advisers at a competitive disadvantage because "it makes it more difficult to differentiate their fiduciary standard of conduct from the lower standard of conduct now applicable to broker-dealers."
In a blog post earlier this week, XY Planning Network co-founder Michael Kitces wrote that Reg BI allows brokers to provide comprehensive financial planning advice without adhering to fiduciary duty, "which creates, literally, a double-standard."
Barbara Roper, director of investor protection at the Consumer Federation of America, said Congress laid out a path for raising advice standards in Dodd-Frank, which bolsters the suits.
"They have a good argument," Ms. Roper said. "The SEC has chosen to ignore that clear statement of congressional interest."
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But another observer questioned whether Dodd-Frank gave the SEC an obvious road map for raising advice standards and whether the agency can successfully be charged with violating the APA.
"If I was a betting man, I would bet against them," James Lundy, a partner at Drinker Biddle & Reath, said of the lawsuits. "It's unclear to me whether the allegations have that direct level of support in the statute."
Bao Nguyen, a partner at Kaufman Rossin & Co., said Reg BI is based on "fiduciary principles" and establishes a higher standard of care for brokers. That makes it more difficult for states to argue that the measure leaves investors vulnerable.
"That's a tough one," Mr. Nguyen said. "This is what [the SEC] thought was the best approach, which is a better standard than the suitability standard."
Within the next two weeks, the SEC is expected to file a response to the suits, which target the highest priority on SEC Chairman Jay Clayton's agenda.
"I believe they are going to aggressively and vigorously fight these lawsuits as best they can," Mr. Lundy said.
The battle likely will extend well beyond the June 30 deadline for Reg BI implementation.
Brokerage firms should continue to adjust their compliance systems in preparation rather than sit back and watch the court proceedings, said Robert Lavigne, managing director at Bates Group.
"Firms need to push forward with their implementation plans and early in the first quarter need to be executing on those plans for the June deadline," he said.