updated 6:36 PM CET, Mar 18, 2023

Lawsuits fly in U.S., as saga over advice client 'best interests' rumbles on

An ongoing battle over the standards brokers, financial advisers and wealth managers in the U.S. should be held to – which dates back to the Obama years – took a new turn on Monday, when the states of New York, California, Connecticut, Delaware, Maine, New Mexico, Oregon, and the District of Columbia filed suit in the Southern District of New York asking that a controversial package of new rules approved in June by the Securities and Exchange Commission be vacated.

The SEC's Regulation Best Interest exceeded its statutory jurisdiction, and was arbitrary and capricious, the seven States and District of Columbia argued. 

Then, in a related development on Tuesday, XY Planning Network, a network of fee-only financial planners founded by well-known American advisers Michael Kitces and Alan Moore, filed its own suit against the SEC over the same regulations (XY Planning Network, LLC et al. v. United States Securities and Exchange Commission et al., (19-cv-8415).

As reported here in June, the SEC approved the Regulation Best Interest rules, which will govern the way "broker/dealers" will sell their investment products after June 30, 2020, even as debate about the merits of the new regime continued to rage across the country, and especially in Washington.

The vote was 3 to 1, with the dissenting vote cast against all four items on the day's ballot by Commissioner Robert Jackson Jr., the regulator's sole Democrat.

SEC chairman Jay Clayton, and commissioners Hester Peirce and Elad Roisman, voted in favor of the regulations.

In its suit, XY Planning Network (XYPN) argues that the SEC has created an unfair unfair competitive advantage for broker-dealers with the agency's Regulation Best Interest investment-advice rule.

Like the states, XYPN argues that in drafting its Reg BI doctrine, the SEC had ignored a key provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which holds that broker-dealers should be held to the same high standards of financial advice delivery as registered investment advisers (RIAs).

In addition, XYPN is also arguing that Reg BI fails to meet certain conditions set out in the Investment Advisers Act of 1940, which oblige anyone delivering financial advice for compensation to register as an investment adviser, and to be held to the so-called "fiduciary standard".

Under Reg BI, neither brokers nor dual registrants who market and deliver financial planning services are required to register as an investment adviser.

'undermines critical consumer
protections for retail investors'

In their "Complaint for Declaratory and Injunctive Relief", the seven states and District of Columbia argue that the final version of the SEC's Regulation Best Interest regulations  "undermines critical consumer protections for retail investors, increases confusion about the standards of conduct that apply when investors receive recommendations and advice from broker-dealers or investment advisers, makes it easier for brokers to market themselves as trusted advisers (while nonetheless permitting them to engage in harmful conflicts of interest that siphon investors’ hard-earned savings), and contradicts Congress’s express direction."

In addition to asking that the final Reg BI rule be "vacate[d] and set aside", they say they are also asking They say they are asking for a declaration that the final rule is "in excess of the SEC’s statutory jurisdiction, authority, or limitations; that the court declare the rule "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with [existing laws]"; and that the court enjoin the SEC from taking any action under the rule.

It also asks that the court refund the states the costs of bringing the legal case, and any other relief that it might "deem proper". 

Obama-era 'fiduciary rule'

As reported, the SEC stepped into the best interests issue after the Trump administration allowed an Obama-era "fiduciary rule," designed to raise the standards of advice provided by U.S. broker/dealers to bring them in line with RIAs, to be vacated, helped by pressure from major financial services companies that prefer the current regulatory regime. 

At issue is whether the current "suitability standard" for such investment products should be replaced by a "fiduciary rule" type of standard, which would require those advising on and selling investment products to ensure that the products' sale was in the "best interests" of the client and not, for example, them, or the product provider.

The process of the dismantling of the Obama fiduciary rule caught the eye of U.S. journalists and American consumers alike in 2017 and 2018, and soon, pressure on lawmakers and regulators like the SEC to do do something, or to appear to be doing something, became unavoidable. A number of U.S. states, including Nevada, Connecticut, New York, Maryland, New Jersey and Illinois began drafting and implementing their own best interest-types of regulations.

The battles over the US fiduciary rule and subsequent Regulation Best Interest have come as other countries around the world have also wrestled with how best to regulate the financial advice industry.  

It is also being watched with some interest by those advisers and product-purveyors who look after Americans resident overseas, many of which are SEC-regulated.

Technically speaking, U.S. expat-focused firms that are not advising on U.S.-based investments, or providing advice to U.S.-resident individuals, do not require – and for this reason often do not have – SEC-regulated status, and thus may not be directly affected by the SEC's Regulation Best Interest rule, whatever happens to it.

Some American expat-focused firms are SEC-regulated, though, and often already meet the “best interest” standard, sometimes referred to as the “fiduciary standard," and thus are not expected to change the way they do business as a result of what happens over the next few months, with respect to the Reg BI legislation, in Washington.

What is likely to continue, most experts say, is a growing emphasis on advisory businesses seeking to obtain some kind of accreditation, whether from the SEC, or the Certified Financial Planner Board of Standards, which has also been revamping its standards for those who hold the CFP certification.  

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