Shadows cast over Reg BI just months before start

The Securities and Exchange Commission's best-interest standard is slated to take effect in a little more than four months, but there are still plenty of fights left with respect to regulating the industry.

A high-profile lawsuit continues to linger and the first state moved on Feb. 21 to implement a fiduciary standard of its own, but financial services professionals nevertheless are preparing for the implementation of the SEC standard on June 30.

The SEC's rule package is commonly known as Reg BI for its centerpiece best-interest standard that aims to compel brokers to put clients' financial interests ahead of their own and requires them to mitigate financial conflicts, The new rules do not affect retirement plans, except some small 401(k) plans served by brokers. But financial professionals who provide advice to retirement plan participants, including rollover recommendations, are subject to the new rules.

Many broker-dealers will likely scale back their rollover recommendation business and instead focus on rollover education with clients, said Fred Reish, a Los Angeles-based partner for law firm Faegre Drinker Biddle & Reath LLP.

"If you're a broker-dealer you don't have any choice but to get ready because if it turns out that they aren't delayed or overturned, what are you going to do if you wait until April to start getting ready?" Mr. Reish said. "You cannot do it that fast. Turn around three times and it's going to be June 30."

In September, three months after Reg BI was approved, eight attor- neys general filed a federal lawsuit challenging the rule, saying it doesn't sufficiently protect investors under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The same month, a lawsuit similar in scope was filed by XY Planning Network, a Bozeman, Mont., financial planning platform for fee-for-service financial advisers seeking to serve Generation X and millennial clients.

XY Planning Network, in essence, claims that the SEC's new rule fails to hold brokers to the same tough fiduciary standard governing RIAs. In creating Reg BI, it claims the SEC exceeded its regulatory authority by permitting comprehensive financial planning services to be delivered in connection with the sale of brokerage products without requiring a financial planner to register as an investment adviser and/or without fully subjecting such financial planning advice itself to a registered investment adviser's fiduciary duty.

The lawsuit's primary goal is to have Reg BI vacated "so we can start over and try to get a better rule in place," said Michael Kitces, XY Planning Network's co-founder, Washington. He would like a rule where all financial planning advice is subject to the RIA's fiduciary duty.

The two lawsuits have been bound together since they're challenging the rule in similar ways, Mr. Kitces explained.

In January, former Democratic legislators Sen. Chris Dodd of Connecticut and Rep. Barney Frank of Massachusetts filed an amicus brief in connection with the lawsuits along with 10 other federal lawmakers, telling the 2nd U.S. Circuit Court of Appeals in New York that Reg BI "cannot stand."

Under Dodd-Frank, Congress directed the SEC to study 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 amicus brief said. Moreover, Congress also said 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 brief said.

Reg BI "perpetuates the very inconsistency in standards of care that Congress passed the Dodd-Frank Act to fix and violates Dodd-Frank," the brief states.

Mr. Kitces said the SEC has interpreted Dodd-Frank incorrectly. "To the extent the courts think there's any ambiguity and look to legislative intent, it's kind of hard for the SEC to claim that they were following the legislators' intent when the actual legislators said the SEC is wrong," Mr. Kitces said.

Kevin Walsh, a principal at Groom Law Group LLP in Washington, said the section of Dodd-Frank in question is vague at points and reflects differing viewpoints from lawmakers at that time. "That lack of consensus led to language that makes it easy to cherry pick and say 'clearly Congress wanted to do what we're saying,'" Mr. Walsh said.

An SEC spokeswoman declined comment.

While legal timelines are difficult to forecast, because of Reg BI's June 30 effective date, Mr. Kitces expects the court to respond "relatively expeditiously" so a ruling made in April or May.

Reg BI also has plenty of backers who say it raises the bar for recommendations made by financial professionals to their clients and surpasses the responsibilities laid out in the existing Financial Industry Regulatory Authority's suitability rule. The latter rule has similar goals and requires, in part, that a broker-dealer or associated person has "a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer."

Jason Berkowitz, chief legal and regulatory affairs officer for the Insured Retirement Institute in Washington, said it seems "odd to argue that the regulator in raising the bar for recommendations didn't raise it far enough and as a result the courts should somehow return to the status quo of the suitability standard. That seems backward to me for consumer interested groups."

Reg BI is a step up from the suitability rule, Mr. Walsh said. "It's a really unusual posture where you've got plaintiffs arguing essentially for a return to the prior regulatory framework because better is not best in their view," he said.

On Feb. 21, Massachusetts Secretary of the Commonwealth William F. Galvin finalized a fiduciary standard that will require broker-dealers and their agents to provide investment advice and suggestions "without regard to the financial or any other interest of any party other than the customer."

Today, only investment advisers must adhere to that standard. The rule takes effect March 6.

"Since the SEC has failed to enact a meaningful conduct rule to protect working families from abusive practices in the brokerage industry, it has been left to my office to apply a real fiduciary standard on broker-dealers and agents in Massachusetts," Mr. Galvin said in a statement.

During a comment period that concluded in January, the financial services industry implored Mr. Galvin to at least wait for Reg BI to be implemented before enacting a separate rule.

"If (state) concerns prove to be accurate and there are gaps or Reg BI is not sufficient, then (the financial services industry) would be very happy to come to the table and work with those individual states to identify and explore solutions to those gaps," Mr. Berkowitz said. "To try to do that prior to Reg BI having a chance to work in the real world is premature and not constructive." To determine whether Reg BI is effective will depend on how the SEC enforces its new rule, Mr. Reish said, adding there are provisions that are "tough but vague." Notably, the term "best interest" is not clearly defined, critics say.

"I can't agree with Massachusetts saying it's not robust, but on the other hand I can't say that it is robust until we see how it's actually enforced," Mr. Reish said. "In any event, it is a step up. There's no doubt that Reg BI is more demanding than the suitability rule."

Having different fiduciary standards in 50 states would be an administrative nightmare for financial service providers, Mr. Reish said. Nevada and New Jersey are also eying fiduciary standards of their own. Prior to Massachusetts finalizing its rule, experts said they expect there to be legal challenges to these initiatives.

The Department of Labor is also working on a revamped fiduciary rule that administration officials have said will "harmonize" with Reg BI. A Labor Department spokesman did not respond to a request for comment.