Regulation Best Interest has arrived. Are you ready?

Jul 7, 2020

On Friday, June 26, 2020, the U.S. Court of Appeals for the Second Circuit upheld the Securities and Exchange Commission’s Regulation Best Interest in a unanimous opinion, following much controversy in the industry surrounding the rule.[1] The plaintiffs, which included multiple state attorneys general, XY Planning Network and Ford Financial Solutions, argued that the Commission, in promulgating the rule, ignored the congressional intent of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Plaintiffs argued that Section 913(g) of the Dodd-Frank Act requires the Commission to promulgate rules to hold broker-dealers to a standard of conduct not less stringent than the standard to which investment advisers are held under the Investment Advisers Act, i.e., a fiduciary standard.[2] As such, according to plaintiffs, the rule was arbitrary and capricious. The Commission, on the other hand, argued that Section 913(f) of the Dodd-Frank Act grants the Commission broad rulemaking authority and that promulgating Regulation Best Interest falls within the discretion granted to the Commission. Furthermore, the Commission argued that the new rule is consistent with congressional intent to protect consumers because it establishes a heightened standard of conduct for broker-dealers and associated persons when recommending securities transactions or investment strategies to retail investors.[3] In a unanimous decision, the three-judge panel held that the Commission acted properly in crafting Regulation Best Interest and that the rule was not arbitrary and capricious.[4]
The Commission also adopted Form CRS, which requires SEC-registered investment advisers and SEC-registered broker-dealers to provide a brief relationship summary that discloses client or customer relationships and any conflicts of interest. The compliance date for Regulation Best Interest and Form CRS filing is June 30, 2020. Form CRS must be delivered to (1) existing retail investors by July 30, 2020 and (2) new retail investors before or at the time of entering into an advisory agreement. The Commission expects to implement the rule immediately. 
This memorandum will take a closer look at Regulation Best Interest, discussing the historical background of the rule, the difference between standards of conduct for investment professionals, and the key points and requirements of the rule, and provide best-practice recommendations for compliance with the rule.
[2] XYPN argued that Regulation Best Interest will put investment advisers at a competitive disadvantage by making it more difficult for them to differentiate their standard of care from that of broker-dealers when advertising to customers, especially because XYPN highlights its adherence to the higher standard of care for investment advisers as a selling point to attract customers. The State Attorneys General Petitioners claimed that Regulation Best Interest will diminish their tax revenues from investment income by allowing broker-dealers to provide conflicted investment advice to customers, which would be prohibited under a uniform fiduciary standard.
[3] On June 5, 2019, as part of a rulemaking package, the U.S. Securities and Exchange Commission adopted Regulation Best Interest under the Securities Exchange Act of 1934.  See Securities and Exchange Commission, Regulation Best Interest: The Broker-Dealer Standard of Conduct, Release No. 34-86031 (June 5, 2019), https://www.sec.gov/rules/final/2019/34-86031.pdf available at (Last visited June 20, 2020).  Hereinafter “Regulation Best Interest Release”.
[4] In analyzing the language of Section 913, the court emphasized that Section 913(f) provided that the Commission “may commence a rulemaking, as necessary or appropriate in the public interest and for the protection of retail customers . . . to address the legal or regulatory standards of care for” broker-dealers.” As such, this broad grant of permissive rulemaking authority included promulgating Regulation Best Interest as adopted by the Commission.
Furthermore, the court addressed whether plaintiffs had Article III standing to petition the court. The court unanimously agreed that the state attorneys general lacked standing, but split on whether XY Planning Network and Ford Financial Solutions had standing to challenge the rule.

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