The Securities and Exchange Commission has responded to suits filed against Reg BI by a group of states and the XYPN Network, arguing that the plaintiffs lack standing, and desire an outcome beyond that dictated by the law.
The two suits were filed last September in the U.S. District Court for Southern District of New York within 24 hours of each other. One was filed by XY Planning Network (XYPN), a financial planning platform cofounded by Michael Kitces that claims to have more than 1,000 fee-for-service financial advisors focused on working with Gen X and Gen Y clients; the other was filed by eight state attorneys general (seven states and the District of Columbia[i]).
Adopted by the SEC on June 5, 2019, and controversial from the beginning, Reg BI establishes a “best interest” standard of conduct for broker-dealers and associated persons when making recommendations to a retail customer of any securities transaction or investment strategy involving securities. The SEC also adopted as part of that regulatory package a new rule to require broker-dealers and investment advisers to provide a brief relationship summary to retail investors, known as Form CRS. The compliance date for Reg BI is June 30, 2020.
The suits contend that the SEC’s rule did not adequately address what the organization saw as the increasingly “blurred roles” between broker-dealers and investment advisers and ignored the will of Congress under the 2010 Dodd-Frank Act. The XY Planning Network charged that “by failing to impose a standard of conduct for broker-dealers that is the same as the standard for investment advisers, as required by Dodd-Frank section 913(g), the SEC’s rule reduces the likelihood that broker-dealers will register as investment advisers, resulting in a loss of business for XYPN.”
Stand ‘Strand’
The SEC’s response to the appellate court started by claiming the parties had no standing to bring suit because neither was regulated by the rule. The SEC notes that the plaintiffs offer different theories to justify their bringing suit: “the States claim an injury to their public fiscs[ii] while XYPN claims competitor standing. But they each make the same mistake—their purported injuries arise from the existing suitability regime, which Regulation Best Interest replaces by increasing investor protections and increasing the burdens on broker-dealers.”
The SEC explains that since Reg BI reduces the risk of harm caused by conflicted advice (by requiring broker-dealers to do more to protect investors as compared to the status quo), vacating the rule (as the plaintiffs seek to do) “would exacerbate their injuries by reinstating a less protective suitability standard.” Moreover, the SEC says that the injuries claimed are “too speculative and hypothetical to support standing because they rest on attenuated chains of events involving independent actors not before this Court.”
Authority ‘Song’
But even if they had standing, the SEC claims that “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.” Moreover, the SEC argues that while the plaintiffs here claim that the SEC “…acted arbitrarily and capriciously, but they barely engage with the rule’s text, how the rule functions, or the Commission’s rationale”—all of which, the SEC claims “…demonstrate that the Commission assessed multiple viewpoints and promulgated a standard of conduct tailored to broker-dealers that will enhance protections for investors against potential harms caused by conflicts of interest while preserving investors’ ability to choose the type of relationship and fee arrangement that best suits them.”
In essence, the SEC says that the plaintiffs “…offer only policy arguments that never find a legal hook,” arguing that Congress should have subjected broker-dealers and investment advisers to the same standard by:
- applying to broker-dealers the fiduciary standard that has been tailored to investment advisers;
- creating a new uniform standard, despite the differences in services and compensation structures; or
- requiring that all financial professionals that provide advice register as investment advisers.
But that, the SEC, says, is not what Congress chose to do. “Congress directed the Commission to evaluate multiple alternatives and gave the Commission broad authority to balance investor protection with access to services, which it reasonably exercised in adopting Regulation Best Interest.”
‘Express’ Lines
Rather, the SEC argues that the Commission’s adoption of Regulation Best Interest is “consistent with the express authority granted by Congress in Section 913 of Dodd-Frank,” that “the text, structure, context, and history of Section 913 confirm that Section 913(f) is a broad grant of discretionary authority…” and that the essence of that is that Congress’ use of the word “may” rather than “shall” indicates the legislative intent that the SEC could choose to adopt either a uniform fiduciary standard or no standard at all.
The SEC goes on to accuse the plaintiffs of disregarding or downplaying “evidence suggesting that a fiduciary standard would reduce access to the transaction-specific recommendations and compensation arrangements provided by broker-dealers, harming investors who benefit from those services and fee structures,” and that they also “fail to substantiate their assumption that Regulation Best Interest is less protective than the investment adviser fiduciary standard,” and generally ignore “the rule’s enhancements over suitability and the extent to which it aligns with the fiduciary standard at the time a recommendation is made.”
The SEC also dismissed the contention raised by XYPN that Regulation Best Interest disadvantages investment advisers competing with broker-dealers, noting that “they fail to articulate a cognizable injury” because Regulation Best Interest does not “bestow” on broker-dealers a “lower regulatory burden” or reduce their “legal exposure.” Rather, they argue, “It does the opposite—it increases the regulatory burdens and legal exposure for broker-dealers,” going on to note that “complying with Regulation Best Interest will likely cost broker-dealers billions of dollars upfront and billions more annually.”
The SEC notes that, while XYPN asserts that, under suitability, retail consumers are “confused by the difference between broker-dealers and investment advisers,” they offer “no evidence—from customers—that the ‘best interest’ label will exacerbate this preexisting confusion, as opposed to ameliorating it”—before citing a case where the decision noted that courts do not accept “standing theories that rest on speculation about the decisions of independent actors.” Nor, the SEC argues, do they provide “evidence that customers will view a ‘best interest’ broker-dealer as more attractive than a ‘sworn fiduciary’ investment adviser.”
Ultimately, the response concludes that “the petitions for review should be dismissed for lack of jurisdiction. If the Court finds that the petitioners have standing, it should deny the petitions.”
