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Independent Broker Dealer Consortium

States Sue SEC in Latest Challenge to Reg BI

n the long-running debate over the standard of care for broker-dealers and investment advisers. It triggered compliance schedules and required registered broker-dealers and advisory firms to develop internal policies and procedures in order to satisfy the new standards. The passage of Reg BI, however, did not quell the ongoing controversies over the appropriateness and adequacy of standards and investor protections.

Like its Department of Labor Fiduciary Duty Rule predecessor, Reg BI is undergoing a variety of challenges from numerous quarters. In past posts, we have reviewed some of the more serious challenges that impact broker-dealers and investment advisers. Most notably, state securities regulators are asserting their shared authority over financial market products and services by promulgating new state rules that offer their in-state-resident investors greater protection than afforded under Reg BI. New Jersey, Maryland, Nevada and New York, among others, have taken the lead in issuing proposed rules that would impose a uniform fiduciary standard of care for broker-dealer recommendations to retail investors. As discussed, these proposals, echoing the DOL Fiduciary Rule, will likely face federal preemption challenges and will require a judicial determination as to their sustainability. 

This week, Reg BI suffered another state challenge, this time in the form of a lawsuit filed against the SEC by seven State Attorneys General (“State AGs”). Here’s a closer look.


On September 9th , the State AGs from New York, California, Connecticut, Delaware, Maine, New Mexico, Oregon and the District of Columbia brought a declaratory and injunctive action against the SEC and Walter “Jay” Clayton III (in his capacity as SEC Chair) in the United States District Court for the Southern District of New York.

State Policy Position

The State AGs argue that Reg BI (i) “undermines” consumer protections for retail investors, (ii) “increases the confusion about the standards of conduct that apply when investors receive recommendations and advice from broker-dealers or investment advisers,” and (iii) allows brokers to hold themselves out as trusted advisers despite inherent conflicts of interest. SEC Chair Clayton has publicly addressed several of these concerns.

State Legal Arguments

As a matter of law, the State AGs allege, first and foremost, that the SEC disregarded the 2010 Dodd-Frank Act mandate that requires broker-dealers to act under the same standard of conduct as investment advisers and without regard to their own financial interests. The critical Dodd-Frank section at issue, Section 913 (Study and Rulemaking regarding Obligations of Brokers, Dealers and Investment Advisers), is explicit, say the AGs, in requiring that the standards be “harmonized” and that the standard for brokers “…shall be the same as [empasis added] the standard of conduct applicable to an investment adviser under section 211 of the Investment Advisers Act of 1940.” The plaintiffs also argue that the SEC disregarded the findings of the agency’s own study required under Section 913 of the Dodd-Frank Act by “fail[ing] to apply a uniform fiduciary standard to both broker-dealers and investment advisers.”

Second, the State AGs emphasize that Section 913 amended both the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to authorize the Commission to promulgate rules regarding the standards of conduct. The State AGs contend that the Commission cannot base its authority to issue Reg BI on provisions of the Exchange Act that flow from those amended authorities and that do not authorize the Commission to disregard the standard of conduct mandated by that section.

Finally, the State AGs argue that, as a matter of law, Reg BI exceeds the SEC’s statutory authority and that it is arbitrary and capricious under the Administrative Procedures Act. The State AGs are asking the Court to vacate and set aside the rule, and to permanently prevent the SEC from “implementing, applying, or taking any action” under it.

States Claim Reg BI Harm

In terms of harm caused by Reg BI, the State AGs argue, in part, (i) economic harm due to lower tax revenues as a result of the diminished value of investment and retirement accounts beset by conflicts of interest; (ii) additional economic costs, including the need to provide public assistance, “in meeting the unmet needs of retirees and other residents in their states”; and (iii) a reduction in the “strong quasi-sovereign interest” that states have in maintaining the economic well-being of their residents.


If there is a feeling of déjà vu, that should come as no surprise. Only eighteen months ago, the Fifth Circuit vacated the Fiduciary Duty Rule after a finding that the Department of Labor exceeded its statutory authority by promulgating it.

That is not to say that the same outcome is expected on Reg BI. Though the SEC has not yet even filed an answer, the policy arguments are not new. (The states may likely reassert them again, along with their authority to issue higher standards on behalf of their in-state residents, in any future preemption case.)

In the meantime, “firms should not slow their efforts or their implementation preparation for Reg BI compliance,” says Robert Lavigne, Managing Director, Bates Compliance. Bates will continue to keep you apprised.

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