Federal appeals court judges appeared skeptical on Tuesday that the Securities and Exchange Commission exceeded its authority by reforming investment advice standards while continuing to regulate brokers and investment advisers separately.
The 2nd U.S. Circuit Court of Appeals heard an oral argument for lawsuits against Regulation Best Interest — the new broker advice requirement that’s the centerpiece of the SEC reform package. After the expedited hearing the court could issue a ruling just before Reg BI is due to be implemented on June 30.
Even as the SEC was defending Reg BI in court, Sen. Sherrod Brown, D-Ohio and the ranking member of the Senate Banking Committee, warned the agency on Monday to strictly enforce the measure and to report to Congress on violations that it finds.
Plaintiffs in the lawsuit — a group of state attorneys general and the XY Planning Network and a member firm — said the agency ignored congressional intent, outlined in a provision in the Dodd-Frank Act, to establish a uniform standard of conduct for brokers and investment advisers. They said that standard should be the fiduciary duty to which advisers adhere under the Investment Advisers Act.
But two of the three judges on the panel zeroed in on whether the Dodd-Frank law gave the SEC latitude to do what it did — impose a new standard for brokers that is different from the one governing advisers.
“The language of the statue is ‘may,’ right?” Judge Michael H. Park asked the attorney for the state attorneys general, Ester Murdukhayeva, implying that if Congress wanted the SEC to put advisers and brokers under the adviser standard, it would have been more prescriptive in the Dodd-Frank language.
Murdukhayeva said even though the word “may” is contained in Dodd-Frank, once the SEC started its rulemaking, it was bound by the Investment Advisers Act of 1940, which allows brokers only to give advice that is “solely incidental” to a sales recommendation without registering as investment advisers. She said Reg BI goes much further than that.
“The use of the word ‘may’ does not give the agency unfettered discretion,” Murdukhayeva said.
Dodd-Frank works in conjunction with the Advisers Act to limit how much latitude the SEC has in setting a separate broker standard, she argued.
Judge William J. Nardini asked Murdukhayeva: “If you’re saying that there’s only one permissible outcome, it’s got to be the fiduciary standard across the board, why did Congress say ‘may,’ why didn’t they say ‘must’?”
The SEC attorney, Jeff Berger, argued that Dodd-Frank gave the SEC authority to promulgate Reg BI as opposed to a uniform advice standard.
“’May’ is classic discretionary language,” Berger said.
Nardini pressed him on why a section of Dodd-Frank did outline certain parameters for a broker standard.
“Is that all it is, a big, heavy but optional hint?”
The SEC is regulating brokers and advisers separately to preserve the broker business mode while raising the broker advice standard, Berger said. If Congress wanted the SEC to treat brokers and advisers the same, it would have eliminated the broker-dealer exception for ‘solely incidental’ advice in the Investment Advisers Act, imposed a uniform standard through legislation or mandated a fiduciary rule.
“It did none of those things,” Berger said.
But the SEC undermined the Investment Advisers Act because Reg BI allows them to give advice that goes far beyond solely incidental, said Deepak Gupta, a lawyer for the XY Planning Network.
“The regulation is premised on the interpretation under which a broker can hold itself out to the public as an investment adviser, can provide frequent and significant investment advice to its clients and generate substantial revenue from that advice as part of it’s business model,” Gupta said. “No reasonable interpretation of the broker-dealer exception to the Investment Advisers Act supports that interpretation on which the regulation is premised.”
Reg BI enforcement
Separately, in a Monday letter to the SEC, Brown called on the agency to bear down on enforcing Reg BI and to keep Congress apprised of its efforts to put teeth in the measure.
Brown, a longtime critic of Reg BI who asserts it’s too weak, indicated he’s leery of SEC guidance to brokerages that it is looking for “good faith” efforts to implement the measure during the coronavirus pandemic. It suggests “investor protection is not a priority,” Brown wrote.
“Given these shortcomings, it is critical that the Commission fulfill its investor protection mandate through tough compliance examinations and enforcement of Reg. BI,” Brown wrote.
The SEC did not respond to a request for comment.