In October 2019, the U.S. District Court for the Southern District of New York dismissed a consolidated lawsuit seeking to derail implementation of the U.S. Securities and Exchange Commission (SEC) Regulation Best Interest (Reg BI) rulemaking package.
Important to note, the case was dismissed due to the court’s self-declared lack of subject matter jurisdiction, and the ruling noted that motions had already been filed by the parties in the appropriate appellate court. In this case, because the Attorney General of New York is leading the litigation, this means the 2nd U.S. Circuit Court of Appeals will have to decide whether to hear the case and what to do about it. Now, with the case still pending, former Democratic legislators Christopher Dodd and Barney Frank have filed an amicus brief urging the 2nd Circuit to take up the case.
Legal experts have suggested that the 2nd Circuit is unlikely to halt Reg BI, and even if it does, a Supreme Court ruling could be required to derail the Trump Administration’s push to implement the new conflict of interest standards. Still, various parties continue to urge the 2nd Circuit to halt the rulemaking, including private advisory firms.
In their brief, Dodd and Frank’s basic argument is that Reg BI fails to meet the Congressional mandate established in the “Dodd-Frank Act,” which is named for the two former lawmakers. The amicus brief points back to the 2008 to 2010 period—the depths of the Great Recession—when the Dodd-Frank Act became law under a Democratically controlled Congress responding to the most severe economic crisis since the Great Depression.
“After extensively studying the root causes of the crisis, Congress responded in 2010 by enacting the Dodd-Frank Act in an effort to prevent a future economic collapse,” the brief states. “Dodd-Frank aimed to ‘promote the financial stability of the United States by improving accountability and transparency in the financial system.’”
According to Dodd and Frank, one of the shortcomings in financial regulation their Act addressed was the inconsistency between the standards of conduct applicable to broker/dealers and investment advisers when providing investment advice to consumers.
“At the time, broker-dealers—who provided only general financial advice and execution only services—were regulated by the Securities Exchange Act of 1934,” the brief says “Although that law had been interpreted to require broker/dealers to act in their clients’ best interests, it had also been interpreted to allow them to take their own financial interests into account without disclosing what those interests might be. Investment advisers, by contrast, provided more personalized advice and were thus held to a higher standard of care. Under the Investment Advisers Act of 1940 … they were treated as fiduciaries and required to take only their clients’ interests into account when offering investment advice.”
Echoing arguments made in the original lawsuit, Dodd and Frank suggest the financial industry has become far more complex and market demand for personalized services has increased. As a result, they argue, the boundaries between the services provided by broker/dealers and investment advisers eroded.
“Yet even though their services and marketing have become increasingly indistinguishable to retail investors, broker/dealers and investment advisers continued to owe investors different standards of care,” the brief states.
Dodd and Frank posit that, as it was crafting the Dodd-Frank Act, Congress recognized that it could not expect a full economic recovery if it did not restore the public’s trust in markets by eliminating the consumer confusion caused by these different standards of care.
“To address that problem, Congress directed the SEC to conduct a study on the effects of the different standards of conduct for broker/dealers and investment advisers, and to make relevant recommendations to address any inconsistency between the standards,” the brief continues. “Congress also provided that any rule responding to a regulatory gap in this area must provide for a uniform fiduciary duty to apply to all broker/dealers and investment advisers. The Act explicitly required that this uniform standard ‘shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.’”
The brief concludes that that Reg BI violates Congress’ mandate in Dodd-Frank Section 913, which required that any rule promulgated to address the inconsistent standards of care between investment advisers and broker/dealers must harmonize those standards of care.
“The rule therefore cannot stand,” Dodd and Frank argue.