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October 30, 2019

States Sue SEC Over Best Interest Rule

states sue securities exchange commission

Last month, attorneys general from seven states filed suit against the Securities Exchange Commission challenging Regulation Best Interest, better known as “the Best Interest Rule” or “Reg BI”.  The complaint was filed in the Southern District of New York by attorneys general from California, Connecticut, Delaware, Maine, New Mexico, New York, Oregon and the District of Columbia. The lawsuit alleges that the Best Interest Rule increases confusion among retail investors about the standards that apply to broker-dealers versus investment advisers.

Background of Reg BI – Dodd-Frank  

The Dodd-Frank Act, passed in 2010, tasked the SEC with studying the existing standards of conduct for broker-dealers and investment advisers when advising retail customers, making recommendations bases on the outcome of the study, and establishing a fiduciary rule for broker-dealers in response. SEC completed the study in 2011 but took eight years to issue the accompanying regulations.  In the meantime, the U.S. Department of Labor issued its own fiduciary rule in 2016 under the Employee Retirement Income Security Act of 1974.  The Department of Labor’s fiduciary rule which was challenged by the financial industry and vacated by the U.S. Court of Appeals for the Fifth Circuit in June 2018.  The court’s decision was based in part on the fact that the Dodd-Frank Act had delegated the authority to make such rule to the SEC.

On June 5, 2019, the SEC passed a package of regulations aimed at reforming standards for brokers and financial advisors providing investment advice, which included Reg BI.  The regulations were published in the Federal Register on July 12, 2019.

Reg BI requires brokers to act in the best interest of a retail customer when making investment recommendation and prohibits brokers from putting their financial interests ahead of those of their customer.  Although the SEC claimed that Reg BI was “designed to enhance the quality and transparency of retail investors’ relationships with investment advisers and broker-dealers”, consumer advocates were critical of how effective it would be in protecting investors.

 The State Suit Against the SEC

The state attorneys general argue that Reg BI runs contrary to Congress’ express directive.  Reg BI did not incorporate any of the recommendations that came out of the SEC’s study.   For example, in the study, the SEC found that retail investors did not understand and were confused by the different standards of care applicable to investment advisers and broker-dealers.  As a result, it recommended that the SEC adopt a uniform fiduciary standard to both broker-dealers and investment advisers that mandates that investment advice be given “without regard to” the broker’s self-interest.

SEC declined to adopt a uniform fiduciary standard and instead created a “best interest obligation” for broker-dealers which the lawsuit claims are ambiguous and falls short of the standards contemplated by Dodd-Frank. The complaint states that Reg BI “produces a standard of care that is similar in large measure to, and fails to meaningfully elevate, the existing suitability obligation in FINRA Rule 2111”.

The attorneys general have asked the court to vacate and set aside Reg BI and enjoin the SEC from implementing, applying, or taking any action under it.  They are also seeking reimbursement of their attorneys’ fees and costs incurred in bringing the suit.

If you believe that you have been misled by a financial advisor or wish to engage the services of a securities lawyer, please call the Costello Law Group at 410-832-800 (or Toll-Free 877-418-0003) for a free consultation. Tom Costello of the Costello Law Group has 25 years of experience in stockbroker misconduct and investment fraud.

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