Broker-Dealers Archives - Columbia Law Review

Introduction “Our Nation is facing a savings crisis.”[footnote]Robert J. Jackson Jr., Comm’r, SEC, Statement on Final Rules Governing Investment Advice (June 5, 2019), https://www.sec.gov/news/public-statement/statement-jackson-060519-iabd [https://perma.cc/8Z2H-YYVX] (“Many young workers are unable to save at all; half of America’s retirees have saved less than $65,000 and face the terrifying prospect of running out of money in retirement.” (citing Vanguard, How America Saves 2018, at 34, 51 (2018), https://pressroom.vanguard.com/nonindexed/HAS18_062018.pdf [https://perma.cc/92ZP-NT5D])).[/footnote] And in the midst of this savings crisis, commentators have speculated whether federal securities regulators are taking a step back from their usual level of oversight.[footnote]While SEC Chairman Jay Clayton has reaffirmed his commitment to SEC enforcement, his tenure as Chairman has prioritized promoting initial public offerings and reducing regulatory burdens on capital formation. See Kurt Wolfe, Where Have the SEC Enforcement Actions Gone?, Law360 (Sept. 19, 2018), https://www.law360.com/articles/1084059 (on file with the Columbia Law Review ). But see Oversight of the U.S. Securities and Exchange Commission: Hearing Before the H. Comm. on Fin. Servs., 115th Cong. 65 (2018) (statement of Jay Clayton, Chairman, SEC) (“I can assure you that our Enforcement Division will continue its vigorous enforcement of the federal securities laws and hold bad actors accountable.”).[/footnote] States, on the other hand, have been willing to fill the apparent enforcement vacuum.[footnote]In the consumer finance context, the trend is clear. See, e.g., Matthew Levine, DFS Enforcement to Increase Focus on Consumer Protection: ‘Where CFPB Steps Down, DFS Has to Step Up’, N.Y.L.J. (Sept. 3, 2019), https://www.law.com/newyorklawjournal/2019/09/03/dfs-enforcement-to-increase-focus-on-consumer-protection-where-cfpb-steps-down-dfs-has-to-step-up (on file with the Columbia Law Review ). In the securities context, the trend is less clear. But see infra section III.B (arguing that states took on a corrective, agency-policing role following the SEC’s promulgation of Regulation Best Interest).[/footnote] In certain areas of securities law, the division between federal and state jurisdiction is clear; but in others, the blurred lines of federalism give rise to concurrent jurisdiction, allowing one enforcer to pick up the slack when the other’s enthusiasm recedes.[footnote]See infra sections I.A.1–.2.[/footnote] In recent years, no division between federal agencies, state regulators, and other organizations within securities law has been more debated—and more politically heated—than the law surrounding broker-dealers.[footnote]For an overview of broker-dealer duties in different jurisdictions, see infra Part I.[/footnote] Broker-dealers execute trades for clients and occasionally offer advice, serving a crucial role in American financial markets for main street investors.[footnote]See infra notes 16–18 and accompanying text.[/footnote] In 2017 alone, the Financial Industry Regulatory Authority (FINRA), an important regulator of broker-dealers nationwide, oversaw an average of $168 billion in value of trade executions each day,[footnote]See FINRA, 2018 FINRA Industry Snapshot 1, 5, 28 (2018), https://www.finra.org/sites/default/files/2018_finra_industry_snapshot.pdf [https://perma.cc/XC6E-JNAS].[/footnote] conducted more than 7,800 regulatory exams, and returned “$66.8 million in restitution to harmed investors.”[footnote]FINRA, 2017 FINRA Annual Financial Report 3 (2017), https://www.finra.org/sites/default/files/2017_AFR.pdf [https://perma.cc/N44N-3VGB] [hereinafter FINRA, 2017 Annual Report].[/footnote] Specifically, the current controversy surrounds the nature of a broker-dealer’s duty to clients: whether it is a fiduciary relationship, similar to investment advisers under the Investment Advisers Act of 1940; a nonheightened duty typical of arm’s-length transactions, as some state courts have found; a standard mandating that the suggested investment merely be “suitable,” as required by FINRA; or somewhere in between.[footnote]See infra section I.A.[/footnote] In June 2019, the SEC used the authority that Congress had delegated in Section 913 of the Dodd–Frank Wall Street Reform and Protection Act to issue Regulation Best Interest (Reg BI).[footnote]Regulation Best Interest: The Broker-Dealer Standard of Conduct, 84 Fed. Reg. 33,318 (July 12, 2019) (codified at 17 C.F.R. § 240.15 l -1 (2020)).[/footnote] Broadly, Reg BI defined the duty of broker-dealers to retail customers as one of “best interest” but provided little guidance regarding what that duty entails.[footnote]Reg BI institutes a “General Obligation,” which is satisfied by four component obligations: disclosure, care, conflict of interest, and compliance. See infra notes 71–74 and accompanying text.[/footnote] What is clear is that the SEC implemented an obligation less demanding than fiduciary duty,[footnote]The SEC expressly stated that Reg BI is not a fiduciary standard but confusingly incorporated other elements of traditional fiduciary duty into the best interest obligation. For a longer discussion of how Reg BI derogates from the fiduciary standard, see infra section I.B.1.[/footnote] in turn confusing the broker-dealer industry[footnote]See, e.g., Bradley Kellum, Tammi Ling, Allen Meyer, Michael Moloney & Farooq Sheikh, Oliver Wyman, Time to Start Again: Preliminary Views on Regulation Best Interest 5 (2019), https://www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2019/jun/Oliver_Wyman_Regulation_Best_Interest.pdf [https://perma.cc/JH85-VHVC] (“Despite industry requests, the SEC did not provide prescriptive guidance around many aspects of the final Rule . . . . [B]roker-dealers will need to . . . develop their own firm-specific interpretations.”).[/footnote] and threatening the validity of state laws or proposed regulations that require fiduciary duty.[footnote]See, e.g., id. at 9 (noting that Reg BI made “it difficult to determine what will happen in states that have already, or are planning to propose their own fiduciary standards” and that Reg BI “will add an incremental layer of complexity”).[/footnote] The SEC also failed to clarify Reg BI’s intended preemptive effect and left the question to the courts.[footnote]See Regulation Best Interest, 84 Fed. Reg. at 33,435 n.1163.[/footnote] This Note addresses the preemption question that the SEC left open, arguing that Reg BI likely preempts only those state laws that implement a duty lower than that of “best interest.” But even state laws that clear the preemption floor—those that require fiduciary duty—must cohere with the objectives and methods of execution that undergirded Congress’s enactment of Section 913 of the Dodd–Frank Act. Accordingly, Part I introduces the broker-dealer regulatory framework and the origins of Reg BI. Part II then provides an overview of preemption doctrine, argues that Reg BI sets a regulatory floor, and identifies an area of potential conflict between congressional intent and state fiduciary rules. Part III suggests two arguments—one based in empirical evidence, another in federalism—to reconcile the conflict, strengthening the states’ defense against a federal regulation that seeks to diminish investor protection.