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Follow-up on SEC Guidance Regarding Broker-Dealers and Investment Advisors

On Behalf of | Jul 16, 2019 |

On June 5th, the SEC issued a four-part package of guidance with respect to the activities of broker-dealers and investment advisors. We prepared an Investment Management Law Alert focusing on one of those components, Regulation Best Interest (“Reg BI”). On July 12th, the SEC guidance was published in the Federal Register. Printing the June 5th release in the Federal Register does not change anything substantively, but it is worth commenting on some of the interim activities with respect to Reg BI.

First, although several commenters recommended that the SEC take the position in the final regulation that state regulation of the activity of broker-dealers would be preempted by Reg BI, the SEC declined to do so. Rather, in the preamble to Reg BI, it concluded instead that the preemption issue should be determined by the courts. While the permissibility of state regulation of the conduct of broker-dealers will be decided in the courts, and states are fully aware of these likely challenges, it is anticipated that the regulators in several states, who were awaiting the issuance of final regulations and are of the view that such regulations insufficiently protect investors, will issue guidance more protective of investors than the SEC regulations. Massachusetts has proposed such action. It will be interesting to see if such approaches will follow the example of New Jersey, and provide a carve-out for broker-dealers who are ERISA fiduciaries, or the example of Nevada, which provided no exclusion from coverage for broker-dealers who were ERISA fiduciaries.

Second, as seems to be the case with most controversial regulations, the likelihood is that there will be a legal challenge or challenges. The most likely challenges will come from those groups who believe that Reg BI does not sufficiently protect retail customers. Challenges could be based on the alleged insufficiency of the economic analysis of the SEC, or its failure to comply with the requirements of Dodd-Frank. A possible challenge could also come from investment advisors who believe that they should not be required to include in Form CRS a statement that both they and the broker-dealers are subject to the same “best interest” standard of conduct, a possible infringement of their First Amendment rights.

Third, FINRA has indicated that it will need to review and likely modify its guidance to broker-dealers. For example, Reg BI built upon FINRA’s suitability requirements, in some instances expanding on it, as with respect to Reg BI’s position on implicit holds, and FINRA has indicated that it will modify its rules to the extent that they have been mooted. However, even with respect to issues such as suitability, the FINRA rules will be retained for institutional customers, who were excluded from Reg BI.

Fourth, with the SEC guidance finalized, the focus switches again to the DOL, which has indicated that it intends to reissue regulations by year end, supplementing the SEC guidance, with regard to fiduciary investment advice. For example, because they are not retail customers, Reg BI does not apply to broker-dealer communications to plan sponsors and administrators of pension plans (other than a sole proprietor or self-employed individual receiving recommendations from a broker-dealer primarily for personal, family, or household purposes). An unanticipated element to the issuance of forthcoming DOL guidance was the resignation of Labor Secretary Acosta. On an interim basis, Assistant Secretary of Labor Patrick Pizzella will be the Secretary of Labor, and there is no indication that his views on the forthcoming fiduciary regulations differ from those of Acosta. Until a new Secretary of Labor is confirmed, progress on the regulation will presumably continue under the direction of Preston Rutledge, Assistant Secretary for the Employee Benefits Security Administration of the DOL. Further, the scope of the DOL proposed regulation may be limited to the extent that it wants to comply with the limitations set forth in the decision of the Fifth Circuit invalidating the DOL’s Fiduciary Regulation.