Fiduciary Advisory Firms Sue to Block SEC’s Reg BI

Two advisory firms argue they are harmed by the “best interest” rule because it causes them a competitive disadvantage with respect to broker/dealers, and because the rule will increase rather than abate investor confusion.

The U.S. Securities and Exchange Commission faces a second lawsuit seeking to derail its implementation of the Regulation Best Interest rulemaking package.

The new lawsuit, filed in the U.S. District Court for the Southern District of New York, includes as plaintiffs two advisory firms, XY Planning Network and Ford Financial Solutions. Similar to another lawsuit filed just this week by eight state attorneys general, the second challenge suggests the SEC’s Regulation Best Interest package fails to meet the directions and demands set out by Congress in the Dodd-Frank Act.

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“One of the gaps that the Dodd-Frank Act sought to close concerned the standard of conduct applicable when individuals receive recommendations and advice on how to invest their money in markets,” the lawsuit states. “Investment advisers have traditionally been subject to a fiduciary standard, while brokers and dealers have not. Over time, the line between advisers and broker-dealers had blurred, with an increasing number of broker-dealers performing many of the same services as investment advisers, without having to satisfy the same regulatory requirements in doing so.”

According to the advisory firms filing suit, at first, the SEC heeded Congress’s mandate. Its staff studied the problem and prepared a report recommending the adoption of a universal standard of conduct, known as the “without regard to” standard.

“But last year, the SEC broke from Dodd-Frank’s requirements—and the recommendations of its own staff—by proposing a rule adopting neither a universal standard nor a ‘without regard to’ standard,” the complaint alleges. “Under the SEC’s so-called ‘best interest’ rule … a broker/dealer is permitted to take into account its own personal interests in providing recommendations and advice to investors on how to invest their life savings. This new rule means that broker/dealers may maintain harmful conflicts of interests while being able to market themselves as trusted advisers acting in their client’s best interests.”

The lawsuit suggests the rule thus circumvents a key goal of Dodd-Frank—leveling the playing field—and increases investor confusion.

In seeking to state an actionable claim, the lawsuit points out that one plaintiff is a network of registered investment advisers, while the other plaintiff is a member of that network and itself a registered investment adviser (RIA). They are said to be injured by the “best interest” rule because it causes them a competitive disadvantage with respect to broker/dealers, makes it more difficult to differentiate their fiduciary standard of conduct from the lower standard of conduct now applicable to broker/dealers, and reduces the incentive for broker/dealers to register as an investment adviser and thus join the network as a member.

The plaintiffs seek a declaration that the “best interest” rule exceeds the SEC’s statutory authority and is arbitrary, capricious, or otherwise not in accordance with law, in violation of the Administrative Procedure Act. They ask this Court to vacate and set aside the rule.

The text of the lawsuit offers background information about the differences between the advisory and brokerage professions. According to the plaintiffs, because the standard of conduct for broker/dealers has been lower than the standard for investment advisers—allowing broker-dealers to pursue their own financial gain when making recommendations to investors—brokers have a powerful incentive to avoid registering as investment advisers and being treated as such for regulatory purposes.

“This means that the traditional line between broker/dealers and investment advisers has broken down in practice, benefiting brokers to the detriment of investors and investment advisers,” the lawsuit suggests. “Among other things, the regulatory disparity between investment advisers and broker/dealers, and the increasingly blurry functional line between them, has undermined the ‘essential purpose’ of a key Depression-era statute, the Investment Advisers Act of 1940: ‘to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment adviser against the stigma of the activities of these individuals.’”

According to the complaint, the SEC’s staff conducted the study required by Dodd-Frank and published its report in January 2011 after receiving over 3,500 comment letters. Both the study and the comments demonstrated that there was substantial “confusion by retail investors regarding the roles, titles, and legal obligations of investment advisers and broker-dealers,” the lawsuit states.

Consistent with Congress’s grant of authority in Dodd-Frank, the report recommended that the SEC “engage in rulemaking specifying a uniform fiduciary standard of conduct that is no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2) that would apply to broker/dealers and investment advisers when they provide personalized investment advice about securities to retail customers. … The report further recommended, as contemplated by subsection (g)(1), that ‘the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customer, 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.’ … Seven years later, in 2018, the SEC proposed a rule rejecting the approach recommended by the study in favor of preserving the regulatory gap that Congress intended to close.”

The full text of the complaint is available here.

Greystar Asks Court to Compel Arbitration in ERISA Suit

The move by Greystar comes after the 9th U.S. Circuit Court of Appeals issued a ruling that Schwab could enforce its retirement plan’s arbitration clause requiring participants to file individual claims and to waive class-action claims.

Greystar Management Services, L.P. has filed a Motion to Compel Arbitration and Dismiss the Complaint with the U.S. District Court for the Western District of Texas in a case alleging it breached its fiduciary duties under the Employee Retirement Income Security Act (ERISA) by allowing excessive administrative and investment fees to be charged.

Greystar argues that the plaintiff signed a Mutual Agreement to Arbitrate Claims that not only requires arbitration of her claims against Greystar but delegates to the arbitrator the power to decide questions regarding the applicability and enforceability of the agreement. In addition, it says the agreement contains a class action waiver foreclosing the plaintiff from bringing any class or collective action.

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According to the motion, in July 2016, Greystar implemented a new policy requiring all new and existing employees to enter into the Arbitration Agreement as a condition of employment with Greystar. All Greystar employees were given notice of the required Arbitration Agreement by email four times between July and September 2016. To facilitate employees’ review of the Arbitration Agreement, the Information Technologies (IT) department at Greystar created a module on Greystar’s employee training portal through which all employees could review the Agreement in full and either accept or decline the Agreement.

The motion further states that on August 1, 2016, as a condition of her continued employment, the plaintiff logged in to the employee portal using her Greystar credentials and assented to the Arbitration Agreement by clicking “I agree” on the appropriate screen in the portal. The plaintiff later confirmed by email to her supervisor that she and all other employees at her property had accepted the agreement. Greystar subsequently terminated any employees who had not accepted the Arbitration Agreement by October 1, 2016.

Specifically, the Agreement provides: “Except for the claims expressly excluded by this Agreement, both you and the Company agree to arbitrate any and all disputes, claims, or controversies (claim) that the Company may have against you, or that you may have against the Company and/or its parent corporation, affiliates, subsidiaries, divisions, officers, directors and agents thereof, which could be brought in a court of law, including, but not limited to, all claims arising out of or relating to your employment with the Company and/or the end of your employment with the Company.”

Greystar adds that the Arbitration Agreement also provides that “all claims must be pursued on an individual basis only,” and contains an explicit waiver by the plaintiff of any right to bring a class or collective action against Greystar.

The company contends that filing the class action lawsuit was in violation of the plain language of the Arbitration Agreement. On September 4, 2019, Greystar reminded her of her Arbitration Agreement and asked that she withdraw the complaint and proceed with arbitration, but she has not.

Greaystar says the Federal Arbitration Act (FAA) sets forth a “strong federal policy in favor of enforcing arbitration agreements.” As a result, “a court’s sole task is to determine whether a valid arbitration agreement has been presented and, to the extent the question is not delegated to the arbitrator, whether the claims alleged are arbitrable,” it adds. “Indeed, this Court’s task is particularly straightforward given that the Arbitration Agreement provides that the arbitrator, rather than a court, should decide questions of arbitrability.”

The move by Greystar comes after the 9th U.S. Circuit Court of Appeals in August issued a ruling in the Michael F. Dorman et al vs. The Charles Schwab Corp. et al case that Schwab could enforce its retirement plan’s arbitration clause requiring participants to file individual claims and to waive class-action claims.

Legal sources have said that the 9th Circuit’s ruling leaves unanswered questions, and arbitration is not the perfect option plan sponsors may think.

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