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SEC Faces Second Lawsuit Over Reg BI, this Time from Fee Only Financial Planners
September 12, 2019
The XY Planning Network and a fee only financial planner based in New York City (who is a member of XYPN) filed a lawsuit seeking to have Reg BI vacated. This is the second lawsuit brought against the SEC regarding their promulgation of Reg BI earlier this year. Yesterday, I wrote a short list of my initial thoughts on the first lawsuit brought by eight state attorneys general. In that post, I suggested more lawsuits could be coming, not knowing a second lawsuit had already been filed by XYPN. Here are my initial thoughts on this lawsuit, again, in no particular order (but make sure to read all the way down to the end to fully understand how this lawsuit is similar but cleverly different than the one brought by the states): 1- For those who may not know, the XYPN, which is a network made up of fee only financial plannings specializing in serving Generation X and Generation Y customers, was co-founded by the omni-present Michael Kitces. 2- Unlike my suggestion yesterday that those seeking to have Reg BI vacated may engage in forum shopping, this second lawsuit was also brought in federal court in the Southern District of New York. 3- The “theory of the case” is similar to the first lawsuit, arguing that the SEC did not follow the alleged mandate required by Dodd Frank and the subsequent commission to create a uniform fiduciary standard for broker dealers and RIAs. 4- XYPN, however, has a different theory for standing, or why they are harmed by Reg BI: “The SEC’s “best interest” rule presents a significant threat to XYPN’s business and to the businesses of its members. It does so in two primary ways. First, XYPN’s business model depends in substantial part on financial planners having an incentive to register as RIAs. 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. Second, the SEC’s rule poses a competitive threat to XYPN’s members. In subjecting broker-dealers to a lower standard of conduct than RIAs, the rule allows broker-dealers to pursue their own financial interests even when providing the same financial-planning services as RIAs, while also reducing their legal exposure. And the rule does so while using the label “best interests” to refer to the lower standard of care applicable to broker-dealers, making it more difficult for RIAs to differentiate the fiduciary duty they owe—and their own “best interests” standard of conduct—from the duty owed by broker-dealers under the rule. This results in a competitive disadvantage to XYPN’s members, who sign a fiduciary oath to act in client’s best interests. And this competitive harm in turn injures XYPN by increasing members’ risk of failure and thus reducing membership fees.” 5- The fee only firm, Ford Financial Solutions, led by Julie Ford, says this about how Reg BI harms her and her firm: “Ford believes that the SEC’s “best interest” rule will allow broker-dealers to have an unfair competitive advantage in attracting new clients that she would otherwise serve. Specifically, Ford is concerned that, under the new rule, consumers will not be able to effectively differentiate the duty that she owes clients from the lower duty broker-dealers owe clients, which will harm her ability to attract new customers. Ford is also concerned that, under the new rule, broker-dealers will be able to provide the same advice that she does while having a lower level of responsibility to clients, fewer regulatory obligations, and thus less legal exposure.” 6- Broker dealers are able to provide financial planning services and avoid operating under a fiduciary standard thanks to an interpretation published at the same time as Reg BI which excludes from the definition of investment adviser a broker or dealer ‘‘whose performance of  advisory services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation’’ for those services (known as the ‘‘broker-dealer exclusion’’). 7- I see the logic in bringing this suit in the SDNY because the claims are similar enough as those brought by the states and it is likely the cases will be consolidated. I still think we can expect to see additional lawsuits brought (and maybe/probably in different court(s)). Missing from the mix thus far are consumer protection groups who will seek to represent the views of the customers who purchase advisory services. 8- These plaintiffs also seek to have Reg BI vacated, as in erased from the Federal Register, but the nature of the claim (and public comments made elsewhere) is that its possible a judge could down the road fashion a narrower remedy by redefining the “solely incidental” interpretation. In plain English, the plaintiffs in these cases could lose on the theory that the SEC was required to create a uniform fiduciary standard for both broker dealers and RIAs, but still get a win by dramatically expanding the definition of services that would require a broker dealer to act as a fiduciary. Broker dealers will be forced to act under the fiduciary standard or risk losing customers because of their inability to provide a wide array of services. Note that change to the interpretation is not what is asked for in the complaint (the complaint requests that Reg BI be vacated), but nothing stops the plaintiffs from amending their lawsuit in the future. What is the likelihood of such an outcome? No one can predict at this point what will happen. All we can do is follow the cases and do our best to prepare for all possible outcomes....
States Sue the SEC to Stop Reg BI…My Initial Thoughts
September 11, 2019
As I fly home this morning* from the great State of New York, I have read the 38 page complaint filed by eight states against the SEC regarding Reg BI. People have been asking me for my initial impressions…so here they are in no particular order. 1- The Attorneys General bringing the lawsuit are from New York, California, Connecticut, Delaware, District of Columbia, Maine, New Mexico, and Oregon. 2- The case has been filed in federal court in the Southern District of New York. 3- Could we see more cases filed in different courts? Maybe. Probably. Those fighting Reg BI could follow the game plan instituted by those who fought the DOL Fiduciary Rule and engage in what’s called “forum shopping” which means not putting all your hope in one court so multiple cases are filed in different courts the litigant believes may be friendly. The courts are almost always in different appellate circuits, again with an eye to the idea that the circuit may be friendly as well. It’s like buying multiple tickets to a raffle. Except there are rules against a single litigant filing the same claim in more than one court, so like minded parties get together and plan their strategy with some testing certain theories in one court and other theories in another court. 4- Why do states even get a say in fighting a federal regulation published by a federal agency? The legal term for this is called “standing.” The simplest explanation is that the states have to show they may be harmed if Reg BI stays on the books. The following justification for standing is given in the lawsuit: “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.” 5- The primary allegation by the states is that the Dodd-Frank statute authorized, and a subsequent study recommended, that broker-dealers and RIAs be subject to a uniform standard and that the standard be a fiduciary standard. It is undisputed the SEC declined to take this approach with Reg BI. 6- The states also take issue with Reg BI’s rejection of an overly prescriptive approach of a fiduciary standard and its alternative adoption of a best interest standard that largely pushes the work of creating a compliance and enforcement framework down to the individual firms: “In addition, although the Final Rule requires firm-level efforts to develop, maintain and enforce compliance policies to address potential conflicts of interests, these requirements provide no assurance that harmful conflicts will not taint broker-dealer advice. Instead, the Final Rule defers to firms to develop these policies, which will be judged against the vague and undefined “best interest” standard, amid a broader regime that permits almost all conflict of interest obligations to be satisfied through disclosure. 84 Fed. Reg. at 33,385, 33,491 (to be codified at 17 C.F.R. § 240.15l-1(a)(2)(iii)).” 7- An underlying aspect of the case is a complicated legal argument that Section 913 of Dodd-Frank required the SEC to act in a certain way (creating a uniform fiduciary standard) as opposed to whether they had discretion to act in the way that they did (not creating a uniform fiduciary standard). Fighting over the rules of rule making was also at the center of the strategy against the DOL Fiduciary Rule. It’s esoteric and complicated but will end up being the key to the final outcome. I don’t believe from what I’m reading the court will have to decide whether a fiduciary standard or best interest standard is better, although there will be a lot of ink spilled on that point. Instead the court will have to decide whether the SEC properly followed the rules of rule making in declining to adopt a uniform fiduciary standard. It’s nuanced but it’s an important nuance. 8- Finally, what do the states want? They want Reg BI “vacated” which essentially means stricken from the Federal Register as if never published, just like what the 5th Circuit did to the DOL Fiduciary Rule. They also want the SEC stopped from applying or enforcing Reg BI in anyway. So to all those in the industry who in good faith try and adhere to the rules, whatever they may be…this storyline is starting to feel familiar again. We’re going to have to walk and chew gum and therefore (1) do the hard work of getting ready for the effective date of Reg BI next year, (2) carefully monitor the outcome of this lawsuit and maybe more to come, (3) we are also supposed to see DOL Fiduciary Rule 3.0 proposed before the end of the year too, so the industry will also need to carefully analyze that proposed rule and submit detailed comment letters probably by late spring, and (4) don’t forget, actually provide the best service you can to your clients. Buckle up, the next 9 to 12 months are going to be interesting. *It is hard to believe 18 years have passed since 9/11/2001. In the desire that we never forget that day or the days that followed, I hope today can be one filled with acts of kindness and empathy for both others and yourselves....
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