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Compliance October 3, 2019
Co-Founder of XY Planning on Why His Firm Has Sued the SEC Over Reg BI
The rule blurs the line between advice and sales, potentially hurting both advisers and investors, he says.
Reported by Lee Barney
XY Planning Network co-founder Michael Kitces says he filed a lawsuit against the U.S. Securities and Exchange Commission (SEC) seeking to derail its Regulation Best Interest (Reg BI) on behalf of the best interests of registered investment advisors (RIAs) and the protection of consumers.
Kitces, whose firm is the lead plaintiff in the case, says Reg BI permits broker/dealers (B/Ds) to put their interests ahead of clients in several ways. “First and most directly, it literally has no provision that requires B/Ds to mitigate their conflicts of interest,” Kitces says. “Under Reg BI, brokers themselves have an obligation to mitigate conflicts of interest and act in the best interests of customers when making a recommendation, but brokerage firms themselves only have to disclose but not mitigate them.
“The second challenge to this, which is a bit more pernicious, is that the SEC blessed dual registrants, that is, allowing people who are an RIA and a B/D—the latter legally being a product salesperson—to switch hats anytime they want without clearly disclosing this to clients,” Kitces continues. “So, a dual registrant may be giving advice to a client and then, without making it clear to the client because they continue to use the ‘financial adviser’ title, switch hats to being a B/D and then sell them products. The problem is the client doesn’t know when the adviser stopped being an adviser because [he] can say [he’s] an adviser throughout the whole process.”
The bottom line, Kitces says, is that “while the SEC thinks it improved the standard—and in many ways this is true—the real problem is that it redrew the dividing line between an RIA and a B/D, which is why we have sued the SEC and are challenging the rule.”
Kitces maintains that broker/dealers who are providing advice and then subsequently selling products to clients will not, actually, be held up to a higher standard. Instead, he says, the SEC “essentially reduced the standard for broker/dealers who provide advice but have conflicted interests and are selling products.”
Congress has set forth two ways that the SEC can fix this problem, Kitces says. The first is the Dodd–Frank Act of 2010, which says that brokers should be held to the same fiduciary standards as financial advisers when providing advice. The second is the Investment Act of 1940, which states that a B/D cannot give advice in the first place and must register as a registered investment adviser (RIA) instead.
Besides blurring the lines between RIAs and B/Ds, Kitces says, Reg BI puts organizations that support RIAs at a disadvantage to organizations that support B/Ds.
In sum, he says, he doesn’t “think B/Ds should give advice and be held to a fiduciary standard. Let them continue to run the mechanics of how markets work, conducting trades and initial public offerings. Let brokers be brokers and advisers be advisers. The SEC put out a rule in 2005 that unequivocally said that if a broker were to give financial planning advice, [he] would have to register as a RIA and be a fiduciary. The rule got vacated in a lawsuit in 2007 for unrelated reasons. We say, bring back the 2005 rule on financial planning advice.”
Ford Financial, the second plaintiff in the case, says it is deferring all questions to XY Planning Network, but released this statement: “We are proud to stand up for our fellow fiduciary advisers and the people we serve. Money implicates our deepest values, hopes and fears. When receiving comprehensive financial planning advice, consumers deserve the utmost clarity on the nature of the advisory relationship.”