The ink was still wet in the Federal Register when seven states and the District of Columbia filed a complaint on Sept. 9 against the Securities and Exchange Commission seeking to vacate the key component of its “generational” rule package that, most notably, imposes an enhanced “best interest” standard of conduct on broker-dealer interactions with retail clients.
Meanwhile, a network of investment adviser plaintiffs filed their own complaint the same day seeking the same relief.
The complaints, filed in the U.S. District Court for the Southern District of New York, are consolidated and pending before the Second Circuit Court of Appeals. Simultaneous with their filing in the Southern District, the states petitioned the Second Circuit to hear their complaint due to that court’s exclusive jurisdiction to decide rule challenges arising out of the Securities Exchange Act of 1934. The lower court consolidated the complaints and dismissed them for lack of subject matter jurisdiction “in favor of further litigation … before the Second Circuit.”
Notably, neither set of plaintiffs sought emergency relief in their complaints. With final briefs due in late March 2020, the Second Circuit will likely not issue a decision until shortly before Reg BI’s June 2020 implementation deadline.
Same Fate as the Fiduciary Rule?
Both complaints essentially allege the SEC acted contrary to its authority under Dodd-Frank when the agency failed to impose a fiduciary standard upon broker-dealers interactions with retail clients. As a result, the plaintiffs allege, the SEC violated the Administrative Procedure Act and Reg BI should be vacated.
At first blush, these complaints mirror the challenges that ultimately killed the Department of Labor’s fiduciary rule. However, important differences suggest that that Reg BI has a much better chance of survival.
In 2018, the Fifth Circuit vacated the fiduciary rule as an arbitrary and capricious exercise of administrative power. In reaching that conclusion, the Fifth Circuit noted that the DOL relied on a new interpretation of a 40-year-old statute (ERISA), and in doing so, effectively sought to transform the regulatory scheme of a trillion-dollar financial services industry, including many accounts not generally within the DOL’s purview (primarily, IRAs).
By contrast, the SEC issued Reg BI pursuant to a recent act of Congress (Dodd-Frank) that explicitly directed the SEC to promulgate rules addressing the standard of conduct for broker-dealer interactions with retail clients. Such interactions are clearly within the purview of the SEC.
Accordingly, it is difficult to see the Reg BI plaintiffs forging a path to success that mirrors the arguments that ultimately killed the fiduciary rule.
Success on the Merits?
The plaintiffs’ success will largely turn on:
- the level of deference to the SEC that the Second Circuit applies; and
- the court’s interpretation of two potentially competing sections of Dodd-Frank.
The plaintiff’s primary argument is that Dodd-Frank Section 913 directed the SEC to study the standard of care applicable to investment advisers and broker-dealers and “bridge any gap” between the two.
The plaintiffs point to the results of the SEC’s own study explicitly advocating for a uniform fiduciary standard and Section 913(g) of Dodd-Frank, which states that the SEC “may promulgate rules to provide that” the standard of conduct applicable to broker-dealers is “no less stringent” than the fiduciary standard under the Investment Advisers Act.
The SEC likely anticipated this challenge. In an accompanying release, the SEC recognized that while Section 913(g) does explicitly authorize the adoption of a fiduciary standard for broker-dealers, that rulemaking power does not negate a more general rulemaking authority under Section 913(f).
Under Section 913(f), the SEC has a general authority to “commence a rulemaking as necessary or appropriate … to address the … standards of care for brokers [and] dealers … providing personalized investment advice.” Indeed, the SEC explicitly stated that it was relying on this general rulemaking authority under Section 913(f) and not Section 913(g) in adopting Reg BI.
When faced with competing interpretations of a statute applicable to an administrative agency, the outcome will largely depend upon the degree of deference the court applies to the agency’s interpretation, often referred to as Chevron deference. If the Second Circuit finds that the SEC acted reasonably, it will likely give greater deference to the regulator’s interpretation of Sections 913(f) and (g).
Among other factors, the court will likely consider whether the SEC acted pursuant to a recent act of Congress (the SEC did), through formal proceedings (the SEC held an extensive comment period), and whether the agency’s interpretation is “not inconsistent” with clear statutory language.
Although the plaintiffs’ arguments focus largely on the consistency point, the issue will likely be decided in favor of the SEC given the “not inconsistent” standard and the permissive language in Section 913(g).
In view of the fact that the SEC’s promulgation of Reg BI appears to satisfy many of the factors that traditionally result in deference, it is likely that the SEC will receive this preferential treatment and prevail.
It is unlikely that Reg BI is going away. As the challenge plays out, firms should continue developing Reg BI-compliant systems, and expect FINRA and SEC examiners to ask about their plans for meeting the June 2020 deadline.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
David Buffa is a principal in the Retail Client Relationships practice group at Bressler, Amery & Ross. He focuses his practice on defending financial firms and executives in regulatory investigations, internal investigations and civil litigation before state and federal court.