SEC Approves Regulation Best Interest —Investors Beware

Shareholder Advocate Fall 2019

October 16, 2019

By Laura H. Posner

Nearly a quarter of Americans say they never plan to retire, and it is not because they all love their jobs. Nearly half of Americans will reach retirement age with too little savings to fund it. Yet amidst this retirement crisis, when Americans turn to a financial professional for help, they may be putting their trust in someone whose interests are contrary to their own—a conflict that, when it leads to bad advice, imposes costs on investors that they simply cannot afford.

Given an opportunity to end this conflict and provide essential clarity to investors, the Securities and Exchange Commission (“SEC”) instead enshrined it. In June, the SEC finalized “Regulation Best Interest” (“Reg BI”), which essentially authorized brokers to put other interests before those of their investor clients as long as those conflicts are disclosed in some manner.1 Now investors’ best hope for protection from the dangers of such conflicted advice lies with state officials and others who are challenging Reg BI in court or imposing stricter standards for their own states.

The SEC’s approval of Reg BI flies in the face of regulators’ mission to protect investors of all sizes by issuing (and enforcing) rules and regulations designed to ensure that Wall Street puts investors first. As SEC Commissioner Robert J. Jackson explained in his public dissent of Reg BI: “[r]ather than requiring Wall Street to put investors first, [Reg. BI] retains a muddled standard that exposes millions of Americans to the costs of conflicted advice. Even worse, contrary to what Americans have heard for a generation, the [SEC] today concludes that investment advisers are not true fiduciaries. Today’s actions fail to arm Americans with the tools they need to survive the Nation’s retirement crisis.”2

Commissioner Jackson was not alone in his criticism: nearly every consumer and investor advocacy group, from the AARP to the Consumer Federation of America, sharply criticized Reg BI, along with op-ed writers in newspapers and financial magazines across America. Even investment adviser associations opposed it. The lone supporters of the SEC’s Rule were those who were set to personally gain from its weakness—broker-dealers.

As a result of the SEC’s failure to put investors first, Reg BI faces challenges on several fronts. In the wake of the SEC’s Final Rules on Reg BI, eight attorneys general—including those of California, Connecticut, Delaware, Maine, New Mexico, New York, Oregon and the District of Columbia—filed a federal lawsuit, State of New York et al v. United States Securities and Exchange Commission and Walter “Jay” Clayton III, in the Southern District of New York, arguing that Reg BI fails to meet basic investor protections that were laid out in the 2010 Dodd-Frank Act.3 “With this rule, the SEC is choosing Wall Street over Main Street,” New York Attorney General Letitia James said in a statement announcing the lawsuit. “Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first. The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place.” The lawsuit seeks to vacate the final Reg BI rule, which was issued in June after a 3-1 vote by the SEC, and permanently prevent its scheduled implementation on June 30, 2020.

The Attorneys General claim that Reg BI “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. Specifically, the Attorneys General argue in the lawsuit that the SEC exceeded its statutory authority in violation of the Administrative Procedure Act by issuing the final rule, and that Reg BI fails to meaningfully elevate broker-dealer standards beyond their existing suitability requirements and, instead, allows them to consider their own interests when making recommendations. They also argue that Reg BI is likely to produce continued investor and industry confusion because it relies on a vague “best interest” standard and leaves key terms undefined, exacerbating investors’ existing confusion over the duties of broker-dealers. The lawsuit states that the “Commission’s disregard for Congress’s directives in the Dodd-Frank Act

will harm Plaintiffs and their residents. Among the harms they will suffer, Plaintiffs will lose revenue from the taxable portions of distributions from their residents’ investment and retirement accounts that are worth less because of expensive conflicts of interest in investment advice; Plaintiffs will bear a greater financial burden to assist retirees and others whose savings are insufficient to meet their needs due to conflicted investment advice; and the regulation will harm Plaintiffs’ strong quasi-sovereign interest in protecting the economic well-being of their residents.”

Immediately following the filing of the Attorneys General lawsuit, an organization of over 1,000 registered investment advisers, XY Planning Network, and one of its members filed a second lawsuit that seeks to set aside or delay implementation of Reg BI. Like the Attorneys General, the investment adviser plaintiffs argue the SEC exceeded its authority under Dodd-Frank, in violation of the APA, by adopting a rule that neither establishes a universal conduct standard, nor a standard that requires broker-dealers to make recommendations without regard to their own financial interests.

Meanwhile, states including Nevada, New Jersey, New York and Massachusetts have either approved, proposed or are considering actual fiduciary rules for broker dealers operating within their state borders. For example, Nevada enacted a new law, effective July 1, that imposes a fiduciary duty on broker-dealers and investment advisers. Similarly, the New Jersey Bureau of Securities is in the final stages of implementing a regulation which requires advisors and brokers offering retail advice in the state to adhere to a uniform fiduciary standard. And William F. Galvin, Secretary of the Commonwealth of Massachusetts, released a proposed broker-dealer conduct rule that will “apply a fiduciary duty of care and loyalty to both investment advisers and broker-dealers who handle money belonging to anyone in Massachusetts.”

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

Meanwhile, the U.S. House of Representatives, led by the Chair of the House Financial Services Committee, Representative Maxine Waters (D-CA), approved legislation in June that would block Reg BI from taking effect. That provision was approved as part of the annual Financial Services and General Government Appropriations Act (H.R. 3351) to fund the SEC and a broad range of government agencies for the 2020 fiscal year. A companion provision is unlikely to be approved by the current Senate but may come up later this year as a bargaining chip during congressional budget negotiations.

While the fate of Reg BI is pending, we urge all investors to take matters into their own hands—seek out and demand true fiduciary advice from financial professionals willing to put your interests first—and continue to press for meaningful protections in both the states and with your government representatives, so that all investors can have the opportunity for a safe and secure retirement.

1. Reg BI followed in the wake of a rule issued in 2016 by the Obama Administration’s Department of Labor that would have 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 abandoned by the Trump Administration and then killed by the 5th Circuit Court of Appeals last year after surviving a lawsuit in Dallas federal court.

2. Currently, brokers are only required to have a reasonable basis to believe a recommended transaction or investment strategy is “suitable” for a customer in light of the customer’s investment profile, not that the recommended transaction or strategy be the best or even good for the investor.  Reg BI builds on the obligation to provide suitable recommendations by requiring that broker-dealers also consider potential risks and relative costs associated with recommendations, disclose certain information about the broker-client relationship, and disclose or eliminate certain conflicts of interest.   Importantly, while the standard of conduct established in Reg BI draws in certain respects from key fiduciary principles, it does not establish a fiduciary standard for broker-dealers or require that investor interests are put first.

3. Section 913 of the Dodd-Frank Act called for a commission to conduct a study regarding gaps or deficiencies in the regulation of broker-dealers and investment advisers and authorized the SEC to promulgate rules requiring that the standards of conduct for providing personalized investment advice “be the same and that the standard shall be to act in the best interest of the investor” but “without regard to” the personal interests of the financial professional providing the advice.

4. Following the release of Reg BI, several other states and state securities regulators, including those in Connecticut, Illinois, Maryland, and Mississippi, also signaled a willingness to implement their own broker-dealer conduct rules that will be more rigorous than the standard set out in Reg BI.