On September 9, 2019, the states of New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon, and the District of Columbia (collectively, the States) filed a complaint for declaratory and injunctive relief against the SEC challenging Reg BI. By way of background, the SEC finalized Regulation Best Interest: The Broker-Dealer Standard of Conduct (Reg BI or the Final Rule) on June 5, 2019. The SEC also issued a final rule regarding Form CRS and two final Commission Interpretations. The implementation date for Reg BI and Form CRS is June 30, 2020.

Interestingly, challenges to SEC rulemakings historically have been led by industry groups. That said, based on their public complaints since the proposed releases, some expected certain investor advocacy groups to attempt to take the lead in challenging this rulemaking effort by the SEC. Ultimately, the States have elected to the lead the charge.

In its release announcing the lawsuit, New York Attorney General James provided:

“With this rule, the SEC is choosing Wall Street over Main Street. Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first. The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place. Despite the SEC’s refusal to do its job, New York will continue to lead the charge to protect the millions of individuals investing in their futures, including the millions of Americans saving for retirement.”

The States allege that “this lawsuit challenges a final regulation issued by the [SEC] that 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.”

The States seek to “vacate and set aside” the Final Rule for three reasons:

  • First, the States allege that the Final Rule exceeds statutory authority because the SEC “disclaimed reliance on the delegation of rulemaking authority under the Dodd-Frank Act” to Congress.
  • Second, the States allege that the Final Rule is not in accordance with applicable law because “the Dodd-Frank Act requires that any [SEC] regulation establishing a broker-dealer standard of conduct must provide that the standard ‘shall be the same as’ the standard that applies to investment advisers under Section 211 of the Advisers Act” and the Final Rule has not done so.
  • Third, the States allege that “the Final Rule is arbitrary and capricious because the [SEC’s] justification for its decision runs counter to the evidence before the [SEC], relies on factors Congress did not intend the [SEC] to consider, and disregards material facts and evidence.”

The States, however, will not have the last say. With this rulemaking effort being one of the main priorities of Chairman Jay Clayton’s tenure, we should expect the SEC and Chairman Clayton to vigorously and zealously defend Reg BI. Thus, as we know from prior industry rule challenges, there will be much more to come.