While the SEC pushes forward with implementing Reg BI, the plaintiffs in a pending suit counter that the agency has failed to address their arguments that the rule gives broker-dealers an unfair competitive advantage.
The April 14 reply brief filed in the 2nd U.S. Circuit Court of Appeals by attorneys for XY Planning Network (cofounded by Michael Kitces) argues, among other things, that the SEC’s Regulation Best Interest (Reg BI) “is just the latest in a series of attempts by the SEC to exceed or misapply its regulatory authority in ways that have required judicial scrutiny.”
A consolidated suit (XY Planning Network, LLC v. SEC) against Reg BI—which includes XYPN and eight Attorneys General representing seven states and the District of Columbia—is pending before the 2nd Circuit. The two suits were 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 the Attorneys General, challenged the regulation for “failing to meet basic investor protections” under the 2010 Dodd-Frank Act,” while XYPN’s suit contends that the rule did not adequately address the “blurred roles” between broker-dealers and investment advisers and ignored the will of Congress under Dodd-Frank.
“Since at least 1999, the SEC has fought the application of the Investment Advisers Act’s standards to broker-dealers, attempting to write them out of the statute by regulation,” XYPN’s response brief argues, adding that, “But in this latest round, the SEC has written a rule that cannot be squared with the plain text of the Dodd-Frank Act, has ignored evidence from its own empirical studies, and has even contradicted its own past interpretations of the Investment Advisers Act.”
The 38-page brief further contends that the SEC’s response fails to rebut these problems, “invoking rationales” that were not relied on in Reg BI, contradicting the Commission’s own past stances, relying on novel misinterpretations of the Dodd-Frank Act and misapplying the law of Article III standing.
Solely Incidental?
It notes, for example, that under the approach established by Reg BI and defended by the SEC in its reply brief, the SEC contends that the Investment Advisers Act’s “solely incidental” exception is satisfied so long as the provision of investment advice is “reasonably related” to a distinct “primary business,” namely (for broker-dealers) the “business of effecting securities transactions.”
In further citing the solely incidental interpretation, XYPN’s brief suggests that conclusion “rests on the bizarre premise that the regulatory framework should not turn on ‘the quantum or importance of the advice’ given by a business.” Moreover, it adds that the SEC never addresses the reality of how the BD industry is structured.
For its part, the SEC contends that the plaintiffs lack standing and desire an outcome beyond that dictated by the law. The SEC noted that, while the plaintiffs offer different theories to justify their suit, they each make the “same mistake” in that their purported injuries arise from the existing suitability regime, which Reg BI replaced.
The SEC further argues that, even if plaintiffs had standing, 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.”
XYPN refutes that argument, however, noting that Reg BI “is neither required nor permitted by the Investment Advisers Act or the Dodd-Frank Act. “When a broker-dealer advertises its services as providing personalized recommendations for how money should be invested, a consumer pays for those recommendations, and the execution of the recommendation occurs with the nearly costless click of a button, it is no longer plausible to say that the advice is ‘solely incidental’ to the ‘primary business’ of executing the transaction,” the brief states. It further contends that the Investment Advisers Act, therefore, requires that such transactions be regulated under the standards governing RIAs, not broker-dealers.
“The Dodd-Frank Act, meanwhile, provides the SEC with the authority to require broker-dealers and registered investment advisers to meet the same heightened fiduciary standard, but does not empower the SEC to make a distinct standard for broker-dealers,” XYPN further states.
It was not immediately clear when oral arguments for this case will be heard, but the 2nd Circuit has announced that until the COVID-19 crisis is over, it will hear all oral arguments using a teleconference platform.
The SEC announced April 2 that it intends to move forward with the regulatory package’s June 30, 2020 compliance date, despite disruptions caused by the COVID-19 pandemic.
