How Michael Kitces' and Alan Moore's plan to sue the SEC on XY Planning's dime -- on behalf of all RIAs -- is a good business risk and a sign of possible FPA impotency

Michael Kitces and Alan Moore are jumping into a breach left by the Financial Planning Association (FPA) on behalf of all RIAs in a lawsuit to overturn the federal Securities and Exchange Commission's (SEC) proposed Regulation Best Interest Advice. 

The move comes on the heels of a lawsuit filed Monday (Sept. 9)  by seven states and the District of Columbia that also seeks to overturn the measure, known informally as "Reg BI."

The states of New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon charge Reg BI confuses the difference between brokers and advisors and makes it easier for brokers to market themselves as “advisers” despite potential conflicts of interest. See: Posse of top cops from 17 states dresses down SEC, demand same fiduciary standards for broker-dealers and RIAs and cite other 'egregious' deficiencies in proposed son of DOL rule

Kitces and Moore sued on their own corporate dime Tuesday (Sept. 10) in US District Court for the Southern District of New York. The issue goes to the heart of the RIA proposition--a fiduciary duty to clients as defined by the Investment Advisers Act of 1940 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. 

"Alan and Michael are stand-up guys who really want to do right by the end consumer," says Steve Lockshin, founder and principal of AdvicePeriod, an SEC-registered investment advisor.  "Seeing them push back against rules that make no sense for the end-client is invigorating."

He adds: "I think this is as simple as right and wrong and looking out for the people who actually pay the taxes that pay the salaries of the people who are creating these blurred lines."

They hope to send the SEC back to the drawing board. 

But Kitces admitted in an RIABiz interview that the calculated business decision could cost $50,000 to $100,000 in legal fees before it's all over. The good news, he adds, is that XY Planning negotiated a flat fee with Gupta Wessler PLLC.

The Washington, D.C. law firm specializes in taking on the government all the way to the U.S. Supreme Court if necessary.

"They know exactly what it takes," says Kitces, whose office is based in Columbia, Md.  

"The lawsuit is being funded directly out of the pockets of Alan and myself, because we’re the owners of the business, and it’s our free cash flow that’s being spent." 

Stepping up

Moore says they decided to join the legal fray because no one in the RIA industry was willing to go up against the SEC. He zeroed in on the Washington D.C.-based FPA. 

The FPA would be most likely to challenge the rule because it's the largest organization representing Certified Financial Planners. As such, "it supports high standards of professional competence, ethical conduct and clear, complete disclosure when serving clients," according to its Web site. 

"I suspect their 'One FPA' initiative has been eating up most of their leadership time and focus, and this issue has fallen by the wayside," Moore says.

"It is surprising given that they have a full time team member dedicated to advocacy and public policy, and is certain a disappointment on our end. I hope they learn from this and are more proactive in the future. "

The Washington D.C.-based FPA has more than 24,000 dues-paying members. A basic professional firm membership starts at about $250 annually. 

The FPA is watching from the sidelines, said FPA spokesman Ben Lewis. The organization still deeply cares about the Merrill Lynch rule victory it won for RIAs in 2005 and isn't being side-tracked, he added.  

"A lawsuit is not the only course of action available as we continue to work on behalf of our members and the profession on this and other important advocacy issues that arise," the FPA said in a statement.

Lewis didn't rule out future regulatory advocacy with regard to Reg BI.

"We have submitted comment letters through the Coalition and have provided our members various educational opportunities on the SEC's new rules during every iteration and since finalization.

"We will continue to evaluate all options depending on the circumstances in line with our policies and values," he said. 

Rings hollow

The FPA assurance rings hollow, Kitces says, considering that the deadline for filing suit just passed.

He adds that FPA seems to be a shell of the organization it was in the early 2000s. Not only did the FPA fight for RIAs, "it spun off its broker-dealer division [which became the FSI] to clear the decks." 

 Kitces, has publicly sparred with the FPA for years but remains a member. See: Michael Kitces and FPA enter uneasy truce after Kitces apologizes and FPA publishes its audited financials 

"It's incredibly unfortunate to see the FPA over the span of 14 years go from being the leader of the charge against the SEC’s attempts to re-define the fiduciary purview of RIAs to no longer even having a material voice in the process," he said.

The FPA famously battled the SEC over the so-called "Merrill Lynch rule" and ultimately won the lengthy legal war in 2007. The U.S. District Court of Appeals for the District of Columbia ruled in the FPA’s favor; the SEC chose not to appeal to the Supreme Court.

Securities attorney James Lundy, with Drinker Biddle & Reath LLP in Chicago also was surprised the FPA abdicated legal advocacy to a startup firm.

"Challenges to SEC rulemakings, historically, have been led by industry groups," Lundy says. 

Long path

Even though Kitces, Moore and the states are challenging the SEC’s rule, Lundy says it is an improvement.  

The Department of Labor's (DOL) Fiduciary Rule was supposed to be the vehicle to significantly expand the circumstances under which a person is considered to be a “fiduciary” under the Employee Retirement Income Security Act (ERISA). See: LPL Financial's DOL-rule memo to reps implies deeper message: Become an RIA or stand down on giving rollover advice

But it was vacated by The U.S. Fifth Circuit Court of Appeals in June a year ago, effectively killing it after the Trump administration refused to pursue an appeal. 

All that was left afterward was FINRA’s suitability rule. But it doesn’t delve into topics of conflicts and disclosures, Lundy says. 

The SEC stepped into the fray in April a year ago when it voted to propose Reg BI, a "package of rulemakings and interpretations designed to enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers."

“I think an objectively fair read is the SEC sought to make improvements on regulatory standards. It includes an obligation to disclose conflicts. But it stops short of a uniform fiduciary standard,” says Lundy. 

The states' legal challenge could lead down a long path, delving into states rights versus federal rights, Lundy says. In that sense, Kitces and Moore may have better legal standing. 

Advisor Act violated

Kitces and Moore say they did not want to piggyback on the states' lawsuit because it misses a fundamental point.

"What the states are saying is brokers are supposed to be regulated as the same standards as RIAs, and we disagree," Kitces says.

In contrast, Kitces and Moore argue in court papers the SEC's new rule violates the 1940 Investment Adviser Act.

“We think the SEC failed, and it can be vacated on that basis alone. The 1940-Investment Adviser Act says you still have to give advice wearing your RIA hat and not your broker-dealer hat,” Kitces says.

Moore adds: "We don't care how the SEC gets around to enforcing the Investors Act of 1940 so long as they do the job Congress has demanded of them. If they won't fix Reg BI to conform to the Investment Advisers Act of 1940, then we absolutely believe it needs to be vacated."

The Investment Advisers Act of 1940 unequivocally requires anyone delivering compensated financial advice to be an RIA and is required to follow the fiduciary standard.

Kitces adds: “We are reiterating what the states have said, but we’re raising a separate issue. We believe that Reg BI doesn’t fit the original Investment Adviser Act in the first place. This flies in the fact of rules that determine when you have to be an RIA in the first place."

Face saving

The proposed rule is actually a wolf in sheep's clothing, they contend.

“Because of the way the regulation is written consumers will now get a lower standard,” Kitces says.

Investors are now more at risk to get even more conflicted types of advice, Kitces says.

“You can now give worse advice with higher cost products, and you’re less accountable for your worst recommendations because you’re a sales person,” Kitces says.

“And, they can tell clients they’re using the best interest rule and how confusing is that to a person? Even the name of the rule will cause harm to consumers."

Moore is hopeful his firm can force the SEC to make changes -- and save face.

"If the SEC is willing to tweak the rule so that brokers are no longer able to give financial planning advice without RIA registration, then we will absolutely consider dropping our lawsuit."

Whether Kitces and Moore win in court remains to be seen. Whether they win in the court of public opinion seems more assured. 

XY Planning is acting because its self-interest aligns with what is truly good for all RIAs and investors, according to Bill Winterberg, of FPPad, a technology consulting firm for advisors. 

"In my opinion, this action by Kitces and Moore demonstrates that the pair are vehemently committed to protecting the interests of their network members, and also committed to protecting the interests of registered investment advisers who operate under a fiduciary standard of care when delivering financial advice to clients," he says.