States File Lawsuit to Invalidate SEC Investment Advice Rule

On September, 9, 2019, seven states and the District of Columbia filed a lawsuit seeking to invalidate the recently announced Securities and Exchange Commission (SEC) investment advice rule. The Regulation Best Interest Rule, which is currently scheduled to be implemented by June 30, 2020, increases disclosures that must be provided to investors, but preserves many existing industry practices, such as the ability for brokers to use a commission-based sales model.

The plaintiffs contend that the rule undermines existing consumer protections because it will permit brokers to market themselves as trusted advisers while actually engaging in conflicts of interest that may harm their clients. The plaintiffs contend that practices such as sales contests, which they argue represent an obvious conflict of interest, are still permissible in many circumstances under the regulations.

Additionally, the plaintiffs argue that the rule causes confusion about which standards might apply when consumers are seeking investment advice. The regulations allow for different standards of advice to apply to investment advisers than those standards that apply to broker-dealers. The plaintiffs cite evidence from an SEC study that retail investors do not understand the difference between these two classifications, and the separate standards to which they are held.

The Dodd-Frank Act required the SEC to study where regulations are weak, and enact necessary changes to improve regulations to protect retail investors where necessary. The legislation also authorized the SEC to create regulations which would ensure uniform standards of investment advice applied to broker-dealers and investment advisers. The plaintiffs argue that the SEC ignored the conclusions of its own study, which demonstrated the need for a more robust regulation than what was actually proposed, and for rules which apply equally to both broker-dealers and investment advisers. For these reasons, the plaintiffs are asking the U.S. District Court for the Southern District of New York to hold the SEC regulation invalid.