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The Second Circuit Upholds Reg BI

On June 26, 2020, the U.S. Court of Appeals for the Second Circuit issued its ruling on the challenge to the legality of the Regulation Best Interest final rule (Reg BI), promulgated by the U.S. Securities and Exchange Commission (SEC) under the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. As reported on June 2, 2020, the Second Circuit entertained oral argument. It issued its ruling late in the day on June 26, just prior to Reg BI’s June 30, 2020, implementation date two business days later.

The Second Circuit’s ruling had three holdings: (1) the individual investment adviser petitioner had standing to bring the petition to review, but the state petitioners did not; (2) section 913(f) of the Dodd-Frank Act authorized the SEC to promulgate Reg BI; and (3) Reg BI is not arbitrary and capricious under the Administrative Procedure Act (APA). We focus the analysis herein on the latter two holdings.

Ironically, the Second Circuit ruling involves an interpretation of the word “may.” The SEC Division of Enforcement has regularly taken the position that this general term lacks specificity for appropriate investment adviser disclosure language. Yet, instead of attacking this term, the SEC successfully argued that the use of the term “may” by Congress in the Dodd-Frank Act allowed the SEC the flexibility to promulgate Reg BI without being restricted to a uniform fiduciary standard.

Specifically, this holding explains that:

The Dodd-Frank Act authorizes the SEC to promulgate Regulation Best Interest. Congress stated that the SEC “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. Dodd-Frank Act § 913(f) (emphasis added).

This broad grant of permissive rulemaking authority encompasses the best-interest rule adopted by the SEC. Contrary to Petitioners’ argument, Section 913(g) does not narrow the scope of Section 913(f) but rather provides a separate grant of rulemaking authority.

The key language in each of the provisions at issue is “may,” which is permissive and reflects Congress’s grant of discretionary rulemaking authority to the SEC. See id. § 913(f) (“The Commission may commence a rulemaking …”); id. § 913(g)(1) (“the Commission may promulgate rules …”); id. § 913(g)(2) (“The Commission may promulgate rules …”). Congress gave the SEC the authority to promulgate rules under any of these sections — or to make no rule at all. With Regulation Best Interest, the SEC chose to proceed under section 913(f), not sections 913(g)(1) or (g)(2). (See XP Planning Network, LLC. et. al. v. United States Securities and Exchange Commission et. al.p. 19.)

Regarding the Petitioners’ argument that Reg BI violated the ABA as arbitrary and capricious in this holding, the Second Circuit challenged this position by describing this claim as a preference for a uniform standard policy argument “dressed up as an APA claim.” Continuing, this holding described that the SEC “carefully considered and rejected a fiduciary rule.” Further, this holding disagreed with the Petitioners’ claim that Reg BI is arbitrary and capricious because it is based on an incorrect interpretation of the “solely incidental” and “special compensation” prongs of the broker-dealer exemption form the Investment Advisers Act of 1940.

The appellate court credited the SEC with issuing an interpretive release on “solely incidental” as it relates to this exemption. Interestingly, this interpretive release was included as part of the final package of rules and releases, but not the proposals. The Second Circuit, however, points out that Petitioners did not challenge the “solely incidental” interpretive release. Petitioners’ second argument in support of its arbitrary and capricious position points to consumer confusion, but this also is denied. The Second Circuit noted that the SEC considered the evidence of consumer confusion, but found the benefits of decreased costs and consumer choice, as evaluated by the SEC, to favor the adoption of Reg BI.

With the SEC’s success before the Second Circuit and the June 30, 2020, Reg BI implementation date for the brokerage industry, it appears that Reg BI is here to stay.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume X, Number 183


About this Author

James G. Lundy, Drinker Biddle, regulatory investigations lawyer, financial services compliance attorney

James G. Lundy represents clients in Securities and Exchange Commission (SEC), Commodities Futures Trading Commission (CFTC), self-regulatory organization, and other financial regulatory agency investigations and examinations, and compliance and governance counseling, white collar criminal investigations, and complex business litigation.

With 12 years of senior SEC experience and more than two years of in-house experience at a futures and securities brokerage firm, Jim has developed an in-depth working knowledge of the various...

Bruce Ashton, Drinker Biddle Law Firm, Los Angeles, Employment Benefits Attorney

Bruce L. Ashton has more than 35 years of experience handling employee benefits matters. His practice concentrates on representing plan service providers (including RIAs, independent record-keepers, third-party administrators, broker-dealers and insurance companies) in fulfilling their obligations under ERISA. His experience includes representing public and private sector plans and their sponsors, negotiating the resolution of plan qualification issues under IRS remedial correction programs, advising and defending fiduciaries on their obligations and liabilities, and structuring qualified plans, non-qualified deferred compensation arrangements.

Combining his employee benefits and transactional experience, Bruce is also active in the installation and funding of employee stock ownership plans (ESOPs).

Sandra Dawn Grannum, Finance, Securities Lawyer, Drinker Biddle Law Firm

Sandra Dawn Grannum concentrates her practice on securities, broker/dealer arbitration, litigation, mediation and regulatory defense.

Sandy has tried complex multimillion-dollar arbitrations before FINRA, AAA and JAMS across the country. She has tried more than 50 arbitrations before the NASD and FINRA through award represented brokerage firms, banks, clearing firms, and associated persons. In addition, she has successfully pursued cases in state and federal courts and in adversarial proceedings before bankruptcy courts.

Joshua Waldbeser, Employment lawyer, Drinker Biddle

Joshua J. Waldbeser counsels plan sponsors and committees with respect to their fiduciary responsibilities under ERISA, as well as design and operational considerations for 401(k) plans, ESOPs and other defined contribution plans, cash balance and traditional defined benefit plans, and deferred compensation arrangements of all types. Josh also works extensively with insurance companies, investment advisors and funds, banks and trust companies, broker-dealers, record keepers, TPAs and other service providers with respect to ERISA, tax, securities and...

Fred Reish, Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

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