Suit by States Challenges SEC Regulation Best Interest

Regulation Best Interest, the long studied and discussed Commission rule that addressed the standards governing broker-dealers when making an investment recommendation was challenged by in a suit filed by seven states and the District of Columbia. State of New York v. SEC, Civil Action No. 1: 19 -cv-0835 (S.D.N.Y. Filed Sept. 9, 2019). The suit claims the SEC’s regulation “increases confusion about the standards of conduct that apply when investors receive recommendations and advice from broker-dealers or investment advisers [and] makes it easier for brokers to market themselves as trusted advisors . . . and contradicts Congress’s express direction.”

Traditionally, broker-dealers have been obligated to render suitable advice. In contrast, advice given by investment advisers is governed by principles of fiduciary duty. The complaint argues that under Dodd-Frank the Commission was given the authority to harmonize the standards of conduct that apply to broker-dealers and investment advisers and draft a standard which would apply to all. Under that standard, when giving personalized investment advice about securities to retail customers, the professional must, according to Dodd-Frank as quoted in the complaint, “”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.’” By failing to apply its new rule to broker-dealers and investment advisers, and adopt this standard, the SEC acted contrary to Dodd-Frank. The result is to leave retail investors as confused regarding the applicable standards as ever, according to the complaint.

Regulation Best Interest adopted the first part of the standard quoted above regarding best interest, but excluded the language regarding the financial or other interest of the market professional. When adopting the Regulation the Commission also expressly limited the rule to broker-dealers when giving investment advice.

In adopting its Rule the Commission sought to raise the obligations of broker-dealers while crafting a provision suitable to their situation. Regulation Best Interest, the Commission stated, was designed “to draw on key principles underlying fiduciary obligations, including those that apply to investment advisers under the Advisers Act, while providing specific requirements to address certain aspects of the relationships between broker-dealers and their retail customers. The Rule was thus designed to enhance the obligations of the broker-dealer when making a recommendation rather than simply adopt the obligations of an investment adviser. The point was “to help customers better understand and compare the services offered by broker-dealers and investment advisers and make an informed choice of the relationship best suited to their needs and circumstances . . .” Stated differently, the Commission sought to create a situation that would enhance customer knowledge and understanding.

Whether the SEC acted in accord with the dictates of Dodd-Frank and promulgated an aid to retail investors is now a question that will be considered by the court in New York.

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