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Fiduciary Rule Still Looms Over Brokers … One State at a Time

By Rita Raagas De Ramos November 27, 2018

Brokers who thought they escaped a requirement to be held to fiduciary standards aren’t in the clear yet, with New Jersey being the latest state to take over where the Department of Labor left off.

Governor Phil Murphy expects New Jersey to be “among the first states to adopt a uniform fiduciary standard,” signaling others are expected to follow suit.

Last year, Nevada and Connecticut also took investor protection matters into their own hands. Nevada imposed a statutory fiduciary duty on brokers and advisors who give advice to Nevada-based clients. Connecticut passed a bill requiring service providers for 403(b) plans of Connecticut-based public education organizations, some non-profit employers, cooperative hospital service organizations and self-employed ministers not covered by the Employee Retirement Income Security Act of 1974 to disclose conflicts of interest to a plan’s fiduciaries starting January 1, 2019.

In California, Missouri, South Carolina and South Dakota, brokers are already held by courts to fiduciary standards in varying degrees, according to multiple sources, including a Connecticut legislative research report.

On the flip side, courts in 14 states have expressly held – as of last year – that a fiduciary duty does not exist between a client and a broker, according to the Connecticut legislative research report. The 14 states are Arizona, Arkansas, Colorado, Hawaii, Massachusetts, Minnesota, Mississippi, Montana, New York, North Carolina, North Dakota, Oregon, Washington and Wisconsin.

“The implementation of a fiduciary rule applicable to all financial professionals will finally reconcile investors’ current expectations with the law.”
Christopher Gerold
New Jersey Bureau of Securities

There is flexibility in Minnesota and Wisconsin, where a broker doesn’t owe a fiduciary duty to clients unless there is a special agreement between the parties, according to the report.

And in an August 7 comment letter to the SEC about the proposed Regulation Best Interest, William Galvin, Secretary of the Commonwealth of Massachusetts, says: “If the Commission does not adopt a strong and uniform fiduciary standard, Massachusetts will be forced to adopt its own fiduciary standard to protect our citizens from conflicted advice by broker-dealers.”

The latest initiative from the New Jersey Bureau of Securities is a proposed rule that would impose a fiduciary duty on all investment professionals in the Garden State, requiring them to place their clients’ interests above their own when recommending investments.

“The roles, duties and obligations of investment advisors and broker-dealers are confusing to investors under current federal regulations,” Christopher Gerold, chief of the New Jersey Bureau of Securities, said in a statement when the planned rulemaking was announced in September. “The implementation of a fiduciary rule applicable to all financial professionals will finally reconcile investors’ current expectations with the law.”

The New Jersey Division of Consumer Affairs published a pre-proposal notice in October and is seeking comments. Two “informal” conferences were held in November to discuss the pre-proposal and testimonies were given by interested parties.

“The Bureau is considering making it a dishonest or unethical business practice for failing to act in accordance with a fiduciary duty when recommending to a customer an investment strategy, or the purchase, sale, or exchange of any security or securities, or providing investment advisory services to a customer,” according to the notice.

“We believe states have an important role to play to fill in the gaps in investor protections at the federal level.”
Barbara Roper
Consumer Federation of America

The planned amendments to the rules will “require that broker-dealers, agents, investment advisors, and investment advisor representatives be subject to a fiduciary duty,” the notice adds.

Barbara Roper, Pueblo, Colo.-based director of investor protection at the Consumer Federation of America, welcomes New Jersey’s initiative and hopes other states also make up for what she considers a failure on the part of the SEC when it comes to the proposed Regulation Best Interest.

“We believe states have an important role to play to fill in the gaps in investor protections at the federal level and to ensure all financial professionals, including insurance agents, are held to a common law fiduciary standard when providing investment advice. The SEC proposal doesn’t achieve that for investment advice regarding securities,” Roper says.

“We are hopeful that New Jersey can develop a strong, pro-investor approach that could serve as a model to other states,” she adds.

The states’ fiduciary rules will matter a lot to brokers because many of them service clients in various locations, and they must pay attention to the rules in those locations, John Anderson, Oaks, Pa.-based head of practice management solutions at SEI Advisor Network, told FA-IQ previously. He says the residence of the clients determines where the clients will likely file a lawsuit against an advisor.

“If I’m an advisor in Pennsylvania and my client is in Connecticut or Nevada, am I going to have to pay attention to their fiduciary rules? The answer is yes, because the way they are writing it is not necessarily under the Investment Adviser Act [of 1940] but under local or state rules,” he adds.

Speaking before an informal conference last week, a representative of the National Association of Insurance & Financial Advisors – New Jersey asked the Garden State to delay considering new rules related to fiduciary standards while the SEC is still working on its own proposed Reg BI.

New Jersey would be making a mistake and would be creating a crisis if it moves ahead with crafting a fiduciary rule before the SEC completes its own rulemaking process.
Dennis Cuccinelli
National Association of Insurance & Financial Advisors – New Jersey

New Jersey “would be making a mistake” and “will be creating a crisis” if it moves ahead with crafting a fiduciary rule before the SEC completes its own rulemaking process, according to Dennis Cuccinelli, a trustee and past president of NAIFA NJ.

“What are advisors to do when federal and state requirements conflict with each other and they are placed in the difficult, if not impossible, position of deciding how to comply with the differing and conflicting requirements?” Cuccinelli asks.

The American Retirement Association backs up his argument.

“Although ARA strongly supports a fiduciary standard, its application as a function of state law is very problematic for Erisa plans and their professional service providers. This is due to the very real potential for conflicting standards between state law and those set forth in Erisa,” ARA says in its comment letter to the New Jersey Bureau of Securities.

“For example, although not determined at this time, regulations could potentially impose new and different disclosure requirements than are presently applicable under Erisa,” ARA adds.

The CFA’s Roper says states need to step in because “investors deserve advice that truly serves their best interests and doesn’t just give lip service to that concept. That will only be achieved through a rule that reins in practices that encourage and reward advice that is not in the customer’s best interests.”

However, Cuccinelli says the New Jersey Bureau of Securities is “at great risk of pre-emption” under the National Securities Markets Improvement Act of 1996.

“This act expressly pre-empts states that impose new or different recordkeeping standards,” he says.

Cuccinelli also appealed on behalf of clients, whom he says will also be harmed by New Jersey’s initiatives.

“A fiduciary rule would limit access to financial products as well as the advice and services of financial professionals. A fiduciary rule could push advisors into a fee rather than commission compensation arrangements,” Cuccinelli says.

“Most fee-only advisors have minimum asset requirements of $250,000, $500,000 or more. NAIFA members’ clients generally do not have this level of assets, so where will they get advice and service from?” he adds.

CFA’s Roper counters Cuccinelli’s argument by saying “the only products and services a strong fiduciary standard denies investors access to are those that can’t be sold under a best interest standard.”

Roper notes that the sale of high-cost annuities and non-traded REITs declined in the wake of the DOL rule’s adoption, which she saw as “a sign that the rule was working.”

The rebound in annuity sales since the DOL rule was vacated is “further evidence that industry views the SEC proposal as weak and ineffective – in other words, very much to their liking,” she says.

From April to June, sales in annuities totaled $59.5 billion, the highest since late 2015, according to data from the Limra Secure Retirement Institute.

New Jersey is in the early stages of its rulemaking process and is still accepting comments, while the SEC is finalizing its proposed Reg BI.

Individuals familiar with the progress of the Reg BI rulemaking say the rule is expected to be completed next year, potentially before a September 2019 final action date posted with the database of the Office of Information and Regulatory Affairs within the Office of Management and Budget.