Just hours ahead of its scheduled implementation, a federal court has sanctioned the legitimacy of Reg BI.
More specifically, the three-judge panel of the 2nd U.S. Circuit Court of Appeals (with one judge concurring in part and dissenting in part) ruled that Section 913(f) of the Dodd-Frank Act authorizes Regulation Best Interest, and Regulation Best Interest is not arbitrary and capricious.
The court heard arguments June 2 challenging the Securities and Exchange Commission’s Regulation Best Interest via a pandemic-necessitated teleconference. The two suits were originally filed in September 2019 in U.S. District Court for the Southern District of New York within 24 hours of each other—the first by a group of seven states[i] and the District of Columbia, followed shortly thereafter by XY Planning Network and Ford Financial Solutions, LLC. The plaintiffs had argued that the regulation did not adequately address the “blurred roles” between broker-dealers and investment advisers and not only failed to meet basic investor protections under the 2010 Dodd-Frank Act, but a ignored the will of Congress expressed under Dodd-Frank.
In a 28-page opinion, the court was unpersuaded, concluding that “Section 913(f) of the Dodd-Frank Act grants the SEC broad rulemaking authority, and Regulation Best Interest clearly falls within the discretion granted to the SEC by Congress.” The court went on to acknowledge that “although Regulation Best Interest may not be the policy that Petitioners would have preferred, it is what the SEC chose after a reasoned and lawful rulemaking process.”
Regulation Best Interest was not arbitrary and capricious because the SEC gave “adequate reasons for its decision[]” to prioritize consumer choice and affordability over the possibility of reducing consumer confusion, and it supported its findings with “substantial evidence,” the court wrote.
Beyond the issues presented, there was some question as to whether the plaintiffs even had standing to bring suit. Ultimately, with regard to that issue, the court concluded that “Ford has standing to bring its petition[ii] based on the impairment of its current ability to attract customers by touting the fiduciary duties it owes its clients. In other words, by enabling broker dealers to advertise their new best-interest obligation, Regulation Best Interest will put Ford and other investment advisers at a competitive disadvantage compared to the status quo.”
As for the states[iii] that had challenged Reg BI—the court ruled that they “lack Article III standing because their claim that Regulation Best Interest will cause a decline in state revenue is entirely speculative.”
[i]California, Connecticut, Delaware, Maine, New Mexico, New York, and Oregon.
[ii]XYPN had argued that Regulation Best Interest would injure investment advisers by making it more difficult for them to differentiate their standard of care from that of broker-dealers in advertising to attract customers. Julie Ford, owner of Ford Financial Solutions, LLC had testified that Ford “currently attract[s] and retain[s] clients by, in part, highlighting [the] firm’s fiduciary duty to clients,” in contrast to the less stringent suitability standard governing broker dealers. According to the ruling, Ford “claims that under Regulation Best Interest, broker dealers will be able to advertise that they must act in their clients’ 'best interests' just as Ford does," even though they will face “comparatively fewer regulatory obligations, lower compliance costs, and less legal exposure.”
[iii]The “State Petitioners” had claimed that Regulation Best Interest would diminish their tax revenues from investment income by allowing broker-dealers to provide conflicted investment advice to customers, which would be prohibited under a uniform fiduciary standard. The State Petitioners cite expert evidence claiming that “[t]he loss of retail investment returns due to conflicted financial advice causes harm to states by lowering their tax revenues.”
