Welcome to the Bloomberg Law Podcast. I'm June Grosso. Every day we bring you insight and analysis into the most important legal news of the day. You can find more episodes of the Bloomberg Law Podcast on Apple Podcasts, SoundCloud and on Bloomberg dot com slash podcasts. Seven states and d C accused the Securities and Exchange Commission of watering down a final regulation intended to protect the customers of broker dealers from conflicts of interest, and they're suing over it.
Joining me is John Coffee, professor at Columbia University Law School. So Jack, what does the new rule do and what do these states say it should do? Well? Essentially, the new rule doesn't do that much. The hope was, or at least the hope of these eleven states and many others, was it the rule would say that brokers have to put their client's interests first. They have a fiduciary duty to their clients and a fiducia areas to treat the
client's interests as paramount. The new rule and said instead says the brokers cannot subordinate the client's interests to their own. That's a lot weaker than saying put the client's interests first and says you cannot subordinate the client's interest to your interests in many settings. And these eleven states that are so think that's too little. I am sympathetic to what they're saying, but I don't think this litigation can win because courts just do not do the line drawing
necessary to write a new rule. They're not going to dictate to the administrative agency, with all the expertise the sec where that line should be drawn. There is, however, an even bigger issue lying here which is going to come up soon. Also. One impact of this new weak federal rule is it may cause courts to be required to supersede, reverse, and cancel the rules in all the states. Many states already say, maybe half the state's already say that the broker owes a fiduciary duty to the client.
This new week federal rule may pre empt all the state rules. By preempt, I mean if there's a conflict between federal law and state law, federal law supersedes and wins, and that may mean that states like California that have a strong fiduciary duty standard may find that that has to be reversed. New York has no such rule. They don't say that the broker is a fiduciary to you. But that's the other issue that's going to be underlying this leviation as well, whether state law is now going
to be canceled by this new federal rule. Let's talk first about the possible success of this lawsuit. Business groups and lobbyist sued over a similar fiduciary standard proposed by the Labor Department, and last year in appeals court overturned that regulation. Is that the federal yes, so explain why they did that. Well, they thought there were procedural errors in the way that the Commission had gone about it. Uh.
But this this is a different litigation. They want a strong rule mandated, and that's very unusual for a federal court to tell the agency, this is the rule you must adopt. It's easy to reverse the rule, much harder to write a rule and impose it on the federal agency. Now, looking at at the rule, SEC Chairman Jake Clayton said in a speech on Monday that it brings disclosures in
line with what the reasonable investor would expect. New York ag Letitia James says that it doesn't address the confusion of consumers. Does it do anything to help consumers who are confused about the conflicts that broker dealers does some good? I won't say that it's meaningless. It does improve the duty that the broker owes the clients somewhat, but not nearly as much as state law and many jurisdictions already does.
It says that you can't subordinate the client's interests to your own interest as broker, but doesn't mean you have to put the client's interests first. For example, you could have a proprietary product and you don't have to tell the client that that same product is available from your competitors at a much lower cost. Uh, that's not you didn't subordinate his interest. You just didn't put his interest first and tell them that your rivals had a better product.
So then will there also be more litigation about whether the state rules are superseded by the federal rules. Well, I think sooner or later, the state rules are going to be applied in some case and the broker and the industry is going to say that state rule is invalid. They're going to treat the state rule as being invalidated. But no court has yet ruled, and it's a question about when that issue is going to arise. But all the state rules are in jeopardy. That's all I can say.
It will be the industry that will say the state rule is invalid and they're not going to suit at the outset. They're going to wait till the case arises in which the state tries to say that their rule has to be followed. In this case under Dodd Frank, the intent was to bring the standard of conduct for stockbrokers on conflicts of interest in line with the stricter standard for financial advisors. I believe why did the SEC
decide not to do that? They didn't do that. The question was can we reconcile and even up the obligation z owed by an investment advisor who is a fiduciary with the obligations that are broker host who isn't the fiduciary, but under the standards of a private body called SINA, the financial industry regulatory authority has to observe certain suitability rules and make sure he doesn't recommend products that are
clearly unsuitable to the investor. So they were supposed to even the amount reach some kind of balance between the two. In fact, what they did was raised the standard for the broker a little bit and then lower the standard for the investment advisor a considerable amount. So we've leveled off, not at the intermediate point, but at a point that reduces the duties of investment advisors and moves the duties
of brokers up a little. So investors lost here. I think this was a giant lobbying battle at the SEC, and the industry won out over the over the clients investors. So what what is to be done at this point? If the lawsuit won't work well, I doubt that the lawsuit will win. I suspect this could be a political issue if we ever have a presidential election in which a Democrat gets elected. I suspect that a new SEC appointed by a new president will reconsider this issue, but
that would take several years. In the meantime, I don't think after this long a lobbying battle that the SEC is going to change as it is presently constituted. Can you explain to the average person why Dodd Frank was passed nearly a decade ago, why it took so long to even get this watered down version. It's certainly a very good question. Of course, these are intense lobbying battles. Brokers do not want to be subject to a do
they want to sell their own products. They don't want it to say that their competitor's product has a better price to it. They don't want to have a constant duty to warn the investor about risky faces. Uh. They are scared about the liabilities that would be involved here. I understand their fear of liability. But I thought that the ten of Congress was to get some fair intermediate compromise between the duty that investment advisors owed and the duty,
the lesser duty that brokers had to observe. And I'm afraid the compromise has not come out in the middle, but substantially below the midpoint of that difference. Less than a minute here. But can Congress do anything? Okards can do anything he wants to do. But if you've observed Congress recently, it's fairly paralyzed. Uh. Things might go through
the House, but they won't go through the center. And we're entering into an election year, and in an election year, I don't expect that there will be much of a compromise effort to pass legislation. Thank you so much. Jack. As always, that's John Coffee. He's a professor at Columbia University Law School. Thanks for listening to the Bloomberg Law Podcast. You can subscribe and listen to the show on Apple Podcasts, SoundCloud, and on bloomberg dot com slash podcast. I'm June Brosso.
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