By Stephen Hall and Micah Hauptman (this blog article originally appeared in The FinReg Blog — Commentary by faculty and affiliates of the Duke Law Global Financial Markets Center)
In June 2019, the Securities and Exchange Commission (“SEC”) finalized Regulation Best Interest (“Reg. BI”) on a 3-1 vote, with strong support from the broker-dealer industry and equally strong opposition from investor advocates. The SEC heralded the rule as a pragmatic and effective solution to the longstanding problem of conflicted investment advice from broker-dealers. Others, including Better Markets and the Consumer Federation of America, have excoriated Reg. BI as a weak and ineffectual rule that betrays Congressional intent and the SEC’s primary obligation to protect investors.
For decades, broker-dealers have been allowed to give investment advice to their clients without adhering to a fiduciary duty appropriate to their advisory role. Simply put, they have been allowed to serve their own self-interest when making investment recommendations rather than their customers’ best interest. As a result, brokers routinely recommend overpriced, underperforming, and often high-risk investments that generate huge fees and commissions for brokers and their firms but siphon away their customers’ hard-earned savings. The toll has been enormous, costing investors tens of billions of dollars a year.
The SEC now claims that Reg. BI solves the problem by requiring brokers to adhere to a “best interest” standard. But how does Reg. BI measure up? Does it really require brokers to act in the best interests of their clients when they provide advice about securities? Or is it just the familiar and demonstrably ineffective “suitability” standard dressed up in fancy garb and capped off with a deceptive title—in short, a rule that misleads investors into thinking they have regulatory protections it doesn’t actually provide? Sadly, it’s the latter, and soon, the fate of the rule will play out in federal court.
In September 2019, two groups of plaintiffs filed lawsuits in federal court challenging Reg BI. One was brought by a network of investment adviser firms and the other was brought by seven states and the District of Columbia. The lawsuits contend that the rule falls well short of what Congress said and intended in the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank gave the SEC explicit authority to finally impose a strong and uniform fiduciary standard on broker-dealers and investment advisers who provide personalized investment advice to retail investors. With their claims now pending before the United States Court of Appeals for the Second Circuit, they are asking the court to declare the rule invalid and to vacate it entirely.
Better Markets and the Consumer Federation of America filed an amicus (or “friend of the court”) brief in the Second Circuit supporting the petitioners’ claims and offering additional legal and policy reasons for vacating the rule. In our brief, we reviewed the advisory role and marketing tactics of brokerage firms; the SEC’s long-standing failure to regulate them as advisers; the resulting victimization of investors through conflicted advice; and the virtual consensus that in Dodd-Frank, Congress intended the SEC to solve these problems by imposing a genuine and uniform fiduciary standard on all brokers and advisers. Finally, we highlighted the SEC’s deliberate decision to shun this Congressional solution and to instead cater to the broker-dealer industry at the expense of investors, all contrary to some of the most basic canons of administrative law. In the following sections, we recap these arguments, which squarely support the challengers’ claim that the Second Circuit should vacate the rule.
1. The SEC has long allowed broker-dealers to act as advisers without adhering to a fiduciary or best interest standard, inflicting huge financial losses on everyday investors.
Every year, millions of vulnerable retail investors who lack financial expertise turn to financial professionals for advice about their investments. They place their trust and confidence in financial professionals to help them plan for a secure and dignified retirement, a child’s college education, or other long-term goals. Investors reasonably expect that, regardless of what type of financial professional they turn to—either a broker-dealer or a registered investment adviser—the advice they receive will be in their best interest, untainted by harmful conflicts of interest.
Unfortunately, the SEC has perpetuated a regulatory framework that applies different standards to the same advisory services and fails to ensure that all investors receive advice in their best interest. The agency’s approach has fostered widespread confusion among investors regarding the standards of conduct applicable to their trusted financial professionals. Worse, it has allowed broker-dealers to market themselves as advisers and to function as such, while also allowing them to act on powerful conflicts of interest by recommending over-priced and under-performing investments that line the broker-dealers’ pockets but cost investors tens of billions of dollars a year in lost savings.
2. Section 913 of the Dodd-Frank Act was written and widely understood to provide for a uniform fiduciary standard for broker-dealers and investment advisers.
Congress recognized these profound shortcomings in the SEC’s regulation of investment advice and responded by granting the agency ample authority to cure those deficiencies through a rulemaking pursuant to Section 913 of Dodd-Frank. Section 913 was written and widely understood as a framework for the SEC to adopt a uniform fiduciary standard for broker-dealers and investment advisers who give personalized investment advice to retail investors, one that would effectively protect investors from conflicts of interest.
The plain language of Section 913(g) of Dodd-Frank makes clear that Congress intended the SEC to impose a strong and uniform fiduciary standard on broker-dealers and investment advisers. Following the enactment of Dodd-Frank, it was widely agreed that these were the chief purposes of Section 913. The benefits of doing so were also widely acknowledged: it would provide the same strong protections to investors, regardless of whether they receive advice from a broker-dealer or an investment adviser, and it would significantly reduce—if not eliminate—any confusion about the different duties that are owed by different financial professionals.
The industry itself initially held this view. Following a 2011 SEC staff study recommending that the SEC establish a uniform fiduciary standard for broker-dealers and investment advisers, industry participants confirmed that these were the underlying purposes of Section 913. For example, according to the leading broker-dealer industry trade association, SIFMA:
“The fundamental purpose of Section 913 of the Dodd-Frank Act is to provide for the establishment of a uniform fiduciary standard that applies equally to BDs and RIAs for the benefit of retail clients when personalized investment advice is provided. Section 913 requires that the uniform fiduciary standard be no less stringent than the general fiduciary duty implied under Section 206 of the Investment Advisers Act of 1940 (“Advisers Act”).”
3. The SEC refused to follow the text and purposes of Section 913. Instead, it merely enshrined existing policy and practice for broker-dealers, all while claiming it was providing new, “enhanced” protections.
Despite the fact that the text and purposes of Section 913 were clear and widely viewed as the framework for a uniform fiduciary rulemaking, the SEC expressly refused to promulgate such a standard. Reg. BI provides neither a uniform nor a fiduciary standard. Moreover, it disregards Congress’s clear directive in Section 913(g), which dictated the specific formulation of that uniform fiduciary standard, requiring advice to be provided “without regard to” the financial or other interest of the firm or financial professional.
Rather than establish a uniform fiduciary standard for broker-dealers and investment advisers alike, Reg. BI preserves different standards, imposes weak requirements on broker-dealers that mirror existing FINRA suitability requirements, exacerbates investor confusion, and relies almost entirely on disclosure as the principal investor protection mechanism, despite extensive evidence that disclosure does not protect investors. It imposes vague “best interest” requirements that may have an appealing ring but do little to solve the daunting problems confronting investors who need sound financial advice. This is not what Congress said or intended. Moreover, it belies the SEC’s own claim that the Rule will enhance investor protection.
1. The rule does not impose a uniform standard.
Reg. BI does not create a uniform standard for broker-dealers and investment advisers. As a result, investors will still bear the burden of understanding the confusing differences in the standards that apply to different types of financial professionals and how those differences might affect the services they receive.
2. Nor does the rule impose a fiduciary standard.
Reg. BI is decidedly not a fiduciary standard. The SEC explicitly refused to impose a fiduciary duty on broker-dealers’ personalized investment advice, either the one Congress set out in Section 913(g) of Dodd-Frank or any other.
The SEC’s decision not to adopt the specific formulation that Congress dictated in 913(g) was especially irrational. According to the proposing release, broker-dealer industry participants had raised the concern that the “without regard to” language could be read as prohibiting all conflicts of interest, including those arising from commissions. The SEC appeared to reject these concerns, explaining that this formulation would not actually prohibit business models or compensation methods, including those arising from commissions. And yet, the SEC still refused to embrace the “without regard to” standard. Instead, it shaped its policy to accommodate the broker-dealer industry’s view, which it knew to be unfounded. It stated, “In lieu of adopting wording that embodies apparent tensions, we are proposing to resolve those tensions through another formulation that appropriately reflects what we believe is the underlying intent of Section 913.” But replacing the “without regard to” formulation with a standard that allows broker-dealers to consider their own interests when making recommendations was an accommodation to industry without any rational justification—as well as a violation of Congress’s language and intent.
3. The rule even fails to establish a genuine “best interest” standard, instead simply dressing up the existing suitability standard in new garb.
Reg. BI does not even impose on brokers an unambiguous obligation to do what is best for their customers. The rule does not define “best interest,” which will inevitably allow brokers—the regulated industry—to develop their own self-serving interpretations. Moreover, the phrasing of the best interest standard in the Rule, including the prohibition against placing the adviser’s interest ahead of the client’s, essentially tracks the notoriously lenient FINRA suitability rule and its related guidance and case law. In FINRA’s words:
“In interpreting FINRA’s suitability rule, numerous cases explicitly state that ‘a broker’s recommendations must be consistent with his customers’ best interests.’ The suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests.”
The SEC thus adopted a close variant of an existing standard that is notoriously ineffective at curbing conflicts of interest, while falsely touting it as a significant new protection for investors.
Nothing in the ensuing discussion of Reg. BI’s “best interest” standard suggests that it will depart from the FINRA suitability regime. In fact, numerous organizations sought clarification on this point in comment letters specifically asking the SEC to provide a concrete analysis of how Reg. BI would differ from FINRA suitability as applied. The SEC never acknowledged or responded to those concerns and requests, in violation of its duty to address material issues raised in the comment process.
4. The rule does not require broker-dealers to recommend the best available investment options to investors.
In any event, Reg. BI does not in fact require broker-dealers to recommend the option that they reasonably believe represents the best match for the investor. The rule makes clear that broker-dealers are permitted to recommend investments that cost more for investors and pay more compensation to brokers, as long as they “consider” costs. Such a standard will invite broker-dealers to contrive justifications for recommending investments that are most beneficial to them, not their clients. This will also allow them to insist that they met the standard because they “considered” the cost but rejected lower-cost options that serve the same investment purpose. And just as with the phrasing of the “best interest” standard, the requirement in Reg. BI to “consider” costs mirrors FINRA guidance. As FINRA explains:
“Some of the cases in which FINRA and the SEC have found that brokers placed their interests ahead of their customers’ interests involved cost-related issues. The cost associated with a recommendation, however, ordinarily is only one of many important factors to consider when determining whether the subject security or investment strategy involving a security or securities is suitable.”
Here again, despite requests for clarification on whether Reg. BI would differ from FINRA suitability in this context, the SEC offered no analysis or even consideration of the issue.
5. The rule will continue to allow powerful conflicts of interest to persist.
In addition, Reg. BI continues to allow brokerage firms to artificially create harmful incentives that encourage and reward brokers for making specific recommendations that are very profitable to the firm but that are likely to taint their advice, to investors’ detriment. It requires only that they “mitigate” in some undefined way the harmful incentives they themselves create. And the accompanying guidance strongly suggests that the SEC will give firms broad discretion to determine what conflicts to mitigate and how:
“[W]e believe that broker-dealers are most capable of identifying and addressing the conflicts that may affect the obligations of their associated persons with respect to the recommendations they make, and therefore are in the best position, to affirmatively reduce the potential effect of these conflicts of interest such that they do not taint the recommendation.”
Many brokers dispensing investment advice have intentionally taken advantage of their clients by recommending high-cost, high-risk, and low-performing investments that enrich brokers at investors’ expense. The practice is deeply engrained and profitable. It is therefore fundamentally unrealistic to expect that the brokers subject to Reg. BI will use their discretion in a way that effectively neutralizes those conflicts of interest and maximizes investor protection.
6. The rule requires little in the way of conflicts mitigation.
The Release raises further doubt that the Rule will enhance investor protection by suggesting that the policies and procedures firms currently use under existing FINRA rules may constitute sufficient conflicts mitigation under the Rule. As a result, it’s not clear whether, how, and to what extent firms will be required to change their practices to comply. Here again, organizations raised concerns about the vagueness of the mitigation requirement and requested clarification on what types of conflicts Reg. BI would restrict and how. As with other important elements of the rule, the SEC failed to acknowledge those concerns or respond with clarification.
7. The rule relies too much on ineffective disclosures, to be largely written by broker-dealers.
The SEC not only adopted an extraordinarily weak rule, essentially preserving the status quo, it also failed to provide investors with the tools they would need to distinguish between broker-dealers and investment advisers, to understand key differences in the services they provide, and to make appropriate choices between the two types of financial professionals. The SEC’s chosen regulatory approach relies heavily on a pre-engagement Customer Relationship Summary (“Form CRS”), supposedly designed to enable investors to make an informed choice regarding which type of relationship or account would be the best option for them.
The SEC adopted this approach despite the fact that all available evidence had shown disclosure was unlikely to serve its intended regulatory function. Here again, it flouted the most basic requirements of notice and comment rulemaking by failing to adequately consider important factors and by drawing irrational conclusions in the face of widespread evidence that contradicted its policy preferences.
The SEC made matters worse by ceding to firms the responsibility for figuring out how to describe their services, investment offerings, fees, and conflicts of interest, using their own choice of wording. Just as it is unrealistic to expect firms to mitigate the conflicts that they themselves create, it is equally unrealistic to expect firms to create honest, clear, and effective disclosures, when they are the primary causes and beneficiaries of that investor confusion through their deceptive marketing practices. Under these circumstances, the SEC’s decision to delegate such enormous discretion to the regulated industry was irrational.
8. In light of all these weaknesses, the rule will mislead investors, not protect them.
Far from enhancing investor protection, Reg. BI threatens to do more harm than good. Under Reg. BI, broker-dealers will be in a position to claim that they are legally required to serve investors’ best interests, lulling them into a false sense of security. In reality, Reg. BI establishes a much weaker standard, one that is almost indistinguishable from the familiar and ineffective suitability requirement that has governed brokers for years. The SEC has failed even by its own modest measure to produce a satisfactory rule.
Perhaps the overarching defect in Reg. BI, and what makes it so weak and ultimately irrational, is the SEC’s blind acceptance of the broker-dealer industry’s arguments against applying a uniform fiduciary standard to their advisory activities, without undertaking any effort to subject those claims to independent scrutiny.
Specifically, the SEC accepted the industry’s false premise that applying a fiduciary duty to broker-dealers would threaten their very business model, thus depriving investors of “access” and “choice”—a proposition that finds no credible support in the Release or anywhere else. The SEC never even attempted to determine whether these conclusory and speculative claims from industry were actually valid. Nor did it meaningfully consider what “access” and “choice” investors would be sacrificing if brokerage firms were subject to a fiduciary duty. Investors do not “choose” to be misled about the services they receive; nor do they “choose” to receive highly conflicted advisory services; and they certainly do not “choose” to suffer the extraordinary financial costs that flow from harmful conflicts of interest. The loss of such phantom “choices” benefits rather than burdens investors.
In short, the SEC blindly accepted the brokerage industry’s self-serving claims and consistently favored their business interests over the needs of investors. It promulgated a rule that caters to brokers’ existing business model rather than one that requires brokers to adapt to a meaningful fiduciary standard, and it strained to justify its approach by invoking the interests of investors without adequate support. This is irrational rulemaking of the first order.
Reg. BI was divorced from any reasonable assessment of the facts and the law. It was first and foremost a regulatory action designed to preserve and protect the broker-dealer industry, not vulnerable investors. It appears by all accounts that Reg. BI’s “best interest” standard is designed to operate as a slogan, not a meaningful and enforceable standard designed to ensure investors are protected from the harms that result from brokerage conflicts of interest.
 See, e.g.,Jason Furman & Betsey Stevenson, The Effects of Conflicted Investment Advice on Retirement Savings, Obama White House(Feb. 23, 2015), https://obamawhitehouse.archives.gov/sites/default/files/docs/cea_coi_report_final.pdf (noting that “[c]onflicted advice leads to lower investment returns” and estimating that brokerage conflicts cost Americans $17 billion in retirement savings every year).
 Form CRS actually obscures differences by requiring broker-dealers and investment advisers to describe their respective legal obligations in identical terms. See Form CRS Relationship Summary; Amendments to Form ADV, 84 Fed. Reg. 33,532-33,533 n.507-08 (July 12, 2019).
 See, e.g., Letter from Heather Slavkin Corzo, AFL-CIO, et al., to Jay Clayton, Chairman, Sec. & Exch. Comm’n, at 3 (Apr. 26, 2019), https://www.sec.gov/comments/s7-07-18/s70718-5417927-184568.pdf (“the Commission must support its best interest definition with concrete examples of practices that are required under Reg BI that are not required under FINRA suitability as well as practices that are prohibited under Reg BI that are not prohibited under FINRA suitability”).
 See, e.g., Release at 33,390; see also id. at 33,391 (“we are providing broker-dealers with flexibility to develop and tailor reasonably designed policies and procedures that include conflict mitigation measures, based on each firm’s circumstances”).
 Release at 33,391 (“While many broker-dealers have programs currently in place to manage conflicts of interest, each broker-dealer will need to carefully consider whether its existing framework complies with this provision.”); see also id. at 33,392 (“In certain instances, we believe that compliance with existing supervisory requirements and disclosure may be sufficient…”).
 See, e.g., Letter from Heather Slavkin Corzo, AFL-CIO, et al., to Jay Clayton, Chairman, Sec. & Exch. Comm’n, at 6 (Apr. 26, 2019), https://www.sec.gov/comments/s7-07-18/s70718-5417927-184568.pdf (“the Commission must provide greater clarity regarding how the obligation to eliminate or mitigate conflicts would apply to different types of conflicts”).
 Perhaps the best example of the gap between the SEC’s claims about the Rule and the disappointing reality lies in the provisions governing sales contests. The SEC proudly explains that the Rule prohibits sales contests and related incentives that are based on the sale of specific securities or specific types of securities within a limited period of time. However, as the SEC concedes in a footnote, this narrow prohibition parallels restrictions that already exist under FINRA rules. Release at 33,395 n.785. (“FINRA rules also establish restrictions on the use of non-cash compensation in connection with the sale and distribution of certain types of products. See FINRA Rules 2310, 2320, 3221, and 5110.”).
 See, e.g., Angela A. Hung, et al., Investor and Industry Perspectives on Investment Advisers and Broker-Dealers 111 (2008), https://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf (investors’ inability to distinguish between different types of financial professional persisted even after they were presented with fact sheets designed to clarify key differences between broker-dealers and investment advisers); see alsoBrian Scholl, Office of the Investor Advocate & Angela A. Hung, RAND Corporation, The Retail Market for Investment Advice25-26 (Oct. 2018), https://www.sec.gov/files/retail-market-for-investment-advice.pdf (same); Angela A. Hung et. al., Investor Testing of Form CRS Relationship Summary(Nov. 2018), https://www.sec.gov/about/offices/investorad/investor-testing-form-crs-r…(qualitative interviews showed a widespread lack of comprehension and confusion surrounding proposed Form CRS).
 Form CRS Relationship Summary; Amendments to Form ADV, 84 Fed. Reg. 33,493, 33,502 (July 12, 2019).
 See, e.g., Release at 33,322 (“We have declined to subject broker-dealers to a wholesale and complete application of the Advisers Act because it is not tailored to the structure and characteristics of the broker-dealer business model.”); Release at 33,466 (explaining that applying the uniform standard under Section 913(g) “would impose a new regulatory paradigm on broker-dealers relative to the baseline,” supposedly leading to increased costs for retail customers and “a different menu of choices”); Release at 33,390 (“we want to enhance investor protection while preserving, to the extent possible, access and choice for investors”). Congress itself anticipated this form of resistance to the application of a fiduciary standard to brokers, and it nullified the threat to the broker business model by providing, for example, that the receipt of commission compensation would not in and of itself violate the fiduciary standard. Section 913(g)(1).
 See Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43(1983) (prohibiting an agency from relying on factors “which Congress has not intended it to consider” and requiring it to “articulate a satisfactory explanation for its action,” one that is consistent with the evidence before the agency).