The Securities Industry and Financial Markets Association filed a lawsuit last week challenging two regulations enacted by the state of Missouri that require additional recordkeeping for advisers and brokers recommending or selecting investments with a “non-financial objective.” The rules took effect on July 30.

The Missouri regulations require advisers to obtain client signatures on “state-scripted documents” before giving advice “that incorporates a social objective or non-financial objective.” The client must re-sign this document at least once every three years and every time such advice is given. The same signature requirement also applies to brokers recommending or selecting such investments for a client.

The lawsuit is SIFMA v. JOHN R. ASHCROFT, Secretary of State of Missouri; and DOUGLAS M. JACOBY Missouri Securities Commissioner. It was filed in the U.S. District Court for the Western District of Missouri, Central Division.

SIFMA argues that federal law already requires advisers to act in their client’s best interest. The lawsuit says that this regulation would restrict an adviser’s ability to act in their client’s best interest because it does not precisely define what “non-financial objective” means. Under federal law, advisers must consider criteria such as a client’s time horizon, liquidity needs, risk tolerance, and investment objectives. Some of these interests go beyond “maximizing financial returns.”

“Investment advice routinely requires the consideration of multifaceted objectives that are customer-specific and may not be solely focused on maximizing financial returns,” the complaint reads. “Some customers also wish to incorporate faith or values-based objectives, or local community investment objectives, into their investment selections.”

Lacking Specificity

The complaint also alleges that the regulations are unconstitutionally vague and violate due process rights under the 14^th Amendment, reading: “what about mutual funds focused on emerging sources of energy, local community improvement bonds, or church bonds? Or strategies that consider corporate management’s ties to their communities as a factor in evaluating companies’ long-term prospects? And what about managers who focus on volatility management rather than purely on expected return? The Rules are drafted such that financial firms and professionals are left guessing as to when a written consent must be secured. This is a clear violation of the due process principles of the Constitution.”

The definition of “incorporates a social objective” is “to consider socially responsible criteria in the investment or commitment of client funds for the purpose of seeking to obtain an effect other than the maximization of financial return to the client,” the complaint continues.

According to the complaint, “socially responsible criteria” is criteria that furthers “A. International, domestic, or industry agreements relating to environmental or social goals; B. Corporate governance structures based on social characteristics; or C. Social or environmental goals.”

Federal Pre-emption

The National Securities Market Improvement Act (NSMIA), federal law passed in 1996 which limits state government’s ability to regulate advisers, pre-empts this regulation, the complaint argues. Only the SEC can regulate advisers with $100 million or more in assets, though the complaint argues Missouri’s rules would apply to them as well. States may take anti-fraud enforcement action against federally registered advisers, but little else. This was intended to create a uniform national securities market that would not be bogged down by state differences, SIFMA says.

Further, the NSMIA prohibits states’ regulating securities that are offered on national exchanges. NSMIA prohibits states from imposing restrictions on the offering of these “covered securities.”

On pre-emption grounds, once again, SIFMA’s complaint argues that to the extent Missouri’s regulations implicate retirement plans subject to the Employee Retirement Income Security Act, then they are invalid as well. Advisers who advise or provide other fiduciary services to any ERISA-covered plan are regulated by ERISA. The lawsuit says that the federal pre-emption language in ERISA is intentionally broad so as to create a uniform national market and legal code for retirement plans.

Free Speech

Lastly, the SIFMA case argues that Missouri cannot require financial professionals to make “politically charged statements” that are not factual without violating the First Amendment. An adviser considering non-financial objectives does not mean that are “not solely focused on maximizing financial return,” which the state-scripted consent form reads and would essentially require advisers to say, even if they believe that certain environmental or social goals are consistent with maximizing financial return.

The suit seeks declaratory and injunctive relief under the NSMIA, ERISA, and the First and 14^th Amendments.

SIFMA is represented by the Jefferson City, Missouri office of Armstrong Teasdale LLP along with the law firm of Morgan, Lewis & Bockius LLP.