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Federal appeals court upholds Regulation Best Interest

A federal appeals court upheld Regulation Best Interest in an opinion released Friday night, clearing the way for the new broker advice standard to be implemented Tuesday.

A group of state attorneys general, XY Planning Network and Ford Financial Solutions, an XYPN member, filed lawsuits last September to vacate Reg BI. They argued that the SEC ignored congressional intent, outlined in a provision in the Dodd-Frank Act, to establish a uniform standard of conduct for brokers and investment advisers. They said that standard should be the fiduciary duty to which advisers adhere under the Investment Advisers Act.

Instead, the SEC promulgated Reg BI for brokers, which the agency maintains is stronger than the current suitability rule, while continuing to regulate investment advisers separately under the fiduciary standard. The SEC said it wanted to preserve the broker business model while raising the advice standard.

In a unanimous decision, a three-judge panel of the 2nd U.S. Circuit Court of Appeals held the SEC acted properly in crafting Reg BI and that the measure was not arbitrary and capricious.

“Section 913(f) of the Dodd-Frank Act grants the SEC broad rulemaking authority, and Regulation Best Interest clearly falls within the discretion granted to the SEC by Congress,” Judge Michael H. Park wrote for the majority. “Although Regulation Best Interest may not be the policy that petitioners would have preferred, it is what the SEC chose after a reasoned and lawful rulemaking process.”

The three judges split on whether the plaintiffs were on solid ground to bring the suit. Park and Judge William J. Nardini held the state attorneys general did not have standing but Ford Financial Solutions did. Ford Financial argued Reg BI would put it at a competitive disadvantage to brokers.

Judge Richard J. Sullivan concurred with his colleagues in upholding Reg BI but also argued that Ford Financial lacked standing and that the case should have been dismissed before deciding on the merits of the challenge.

For the last three years, investment advice reform has been at the top of SEC Chairman Jay Clayton’s agenda. He always expressed confidence Reg BI would withstand a court challenge.

“We welcome today’s decision by the Second Circuit upholding Regulation Best Interest,” Clayton said in a statement Friday night. “As of next Tuesday, whether they choose to work with a broker-dealer or an investment adviser, Main Street investors will be entitled to recommendations and advice in their best interest – the financial professional cannot put its interests ahead of the investor.  My deep personal thanks to the hundreds of SEC professionals who contributed to this effort.”    

Plaintiffs maintained Friday night that Dodd-Frank required the SEC to promulgate a broker standard in accordance with the Investment Advisers Act and subject brokers to fiduciary duty when they provide advice that is more than solely incidental to an investment product sales recommendation.  

“We strongly disagree with the court’s permissive interpretation allowing the SEC to alter the substantive consumer protections Congress mandated in both the Investment Advisers Act and Dodd-Frank, will be exploring our options about whether to challenge this ruling further, and will continue to work proactively with the growing number of states and their own securities regulators who understand the business of advice has always only ever been fiduciary… and should remain that way for the protection of consumers,” XY Planning Network co-founder Michael Kites said in a statement.

Reg BI became the primary vehicle for investment advice reform after a Department of Labor regulation to raise the broker advice standard for retirement accounts promulgated during the Obama administration was vacated in 2018 by a federal appeals court. Its demise was hastened when the Trump administration stopped defending it.

Micah Hauptman, financial services counsel at the Consumer Federation of America, is hoping Reg BI will be revisited next year if President Donald Trump is defeated this fall. He noted all three 2nd Circuit judges hearing the Reg BI suit were appointed by Trump.

“The case was wrongly decided, but it’s not entirely unexpected given the makeup of the panel,” Hauptman said in a statement “Since Reg BI won’t meaningfully change the deeply flawed broker-dealer business model and will preserve perverse incentives that encourage and reward harmful advice, we fully expect to be back at this issue and fix Reg BI’s serious deficiencies in a new administration.”

But American Securities Association Chief Executive Chris Iacovella said the 2nd Circuit decision should put to rest opposition to Reg BI, including efforts by some states — New Jersey, Massachusetts and Nevada — to write their own investment advice regulations.

“Broker-dealers have been working around the clock for months to comply with this new national standard, which enhances protection, trust, and confidence for every American investor,” Iacovella said in a statement. “It’s time for the states to listen to the court, to refrain from pursing politically-motivated activist agendas, and to embrace the SEC’s national Best Interest standard.”



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