AG Frey Joins Coalition Suing SEC for Putting Brokers Ahead of Investors

September 10, 2019

AUGUSTA - Attorney General Aaron M. Frey today joined a coalition of eight attorneys general from around the nation in filing a federal lawsuit, in the Southern District of New York, challenging the Securities & Exchange Commission's (SEC) "Regulation Best Interest" for failing to meet basic investor protections that were laid out in the historic 2010 Dodd-Frank Act.

"Important fiduciary regulations were adopted as a result of the Dodd-Frank Act, which passed in partial response to the abuses which created the financial crisis," said Frey. "Those regulations provided necessary protections for investors by creating uniform standards which ensured that all financial professionals had a fiduciary duty to their clients. Regulation Best Interest would weaken those important protections."

In June, over an earlier objection made by a coalition of attorneys general, led by New York Attorney General Letitia James, the SEC adopted Regulation Best Interest, which purports to address long-standing investor confusion concerning the standards of care applicable to broker-dealers providing investment advice. While many retail investors mistakenly believe that broker-dealers must place investors' interests first, that has historically not been the case. In fact, federal law has generally only required that broker-dealers' recommendations be "suitable" with respect to the investor's objectives, meaning that a broker-dealer could sell an investor a lower-quality, higher-cost investment as long as that investment otherwise met the investor's investment objectives. Alternatively, investment advisors owe their clients a fiduciary duty.

This investor confusion motivated Congress to take action in 2010. With the passing of the 2010 Dodd-Frank Act, Congress authorized the SEC to draft regulations that would align the standard of conduct for broker-dealers and investment advisors. Under the Act, the SEC was authorized to impose a uniform fiduciary duty on broker-dealers and investment advisors, and require that their recommendations be made "without regard" to their own interests. This uniform fiduciary duty would ensure that investors were protected and treated fairly, regardless of the type of financial professional with which they worked.

While the SEC is claiming that Regulation Best Interest ends the confusion in the industry, the coalition of attorneys general are arguing that the regulation fails to heed Congress' call to action in a number of different ways.

First, the regulation fails to meaningfully elevate broker-dealer standards beyond their existing suitability requirements. In fact, the SEC's own professional staff recommended that the SEC adopt the uniform fiduciary standard articulated in the Dodd-Frank Act, but the regulation expressly rejects imposing a fiduciary standard on broker-dealers and, instead, allows them to consider their own interests when making recommendations.

Second, Regulation Best Interest is likely to produce continued investor and industry confusion because it relies on a vague "best interest" standard and leaves key terms undefined. Moreover, the SEC's adoption of a supposed "best interest" standard - while failing to actually implement requirements to realize that promise - will exacerbate investors' existing confusion over the duties of broker-dealers.

By enacting this flawed regulation, the SEC ignored Congress' express direction in the Dodd-Frank Act, making the regulation unauthorized, arbitrary, and unlawful.

Because the SEC claimed authority to issue Regulation Best Interest under such a broad set of statutory authority, it was necessary to file for relief in both the Southern District of New York and U.S. Court of Appeals for the Second Circuit, which has original jurisdiction over rules promulgated pursuant to the Securities Exchange Act of 1934.

Attorney General Frey joins the attorneys general of New York, California, Connecticut, Delaware, New Mexico, Oregon, and the District of Columbia in filing the lawsuit.

Supporting documents