Last month, Bates described a New Jersey proposal to apply uniform fiduciary standards to broker-dealers and investment advisers for recommendations and advice they may give to New Jersey investors. At the time of its introduction, the state proposal was positioned—quite explicitly by Governor Phil Murphy and Attorney General Gurbir Grewal—as a challenge to the anticipated adoption of a proposed federal standard. In this respect, the New Jersey proposal followed in the footsteps of other states, including Maryland, Nevada and New York, in making the case for a higher standard of care as applied to broker-dealer recommendations and in asserting the authority of the state to protect resident investors from harm.
Two weeks ago, the SEC adopted the long-awaited Regulation Best Interest (“Reg BI”), a package of rules and interpretive guidance affecting both broker-dealers and investment advisers and directing broker-dealers to act in the “best interest” rather than under a uniform fiduciary standard of care toward a retail client. (See here for a summary of the provisions of Reg BI and for some early reactions.) The SEC action has not stopped the states from pursuing their own higher standards. Last week, Massachusetts became the latest state to propose a uniform fiduciary standard for broker-dealers and advisers when dealing with its residents. This article takes a closer look at the Massachusetts proposal and the federal/state power struggle.
On June 14, 2019, the Massachusetts Securities Division solicited public comments on a proposal to establish statewide fiduciary conduct standards for broker-dealers, agents, investment advisers, and investment adviser representatives. In a broadside against Reg BI, Secretary of the Commonwealth William Galvin listed his problems with the Reg BI package, including its: (i) failure to establish a strong and uniform standard, (ii) failure to define key terms like “best interest” and setting “ambiguous requirements” for addressing “longstanding conflicts,” (iii) failure to prohibit known problematic practices in the securities industry, and (iv) alleged contradiction of “years of data gathered by studies and reports on disclosure and the conduct standards applicable to broker-dealers.”
The proposed Massachusetts fiduciary standard would apply to “recommendations, advice, and to the selection of account types,” including “recommendations to open IRA roll-over accounts, as well as recommendations to open accounts involving asset-based or transaction-based remuneration.” Further, the proposed conduct standard “allows for the payment of transaction-based remuneration if the remuneration is reasonable, it is the best of the reasonably available remuneration options, and the care obligation is satisfied.” The comment period runs until July 26, 2109.
NASAA remains cautious in its response to the adoption of Reg BI, deferring a public conclusion until after additional membership discussion and additional review “against our comment letters.” In its first comment letter, dated August 23, 2018, NASAA noted its “members’ shared responsibility with the SEC for oversight of the firms and individuals that will be impacted by the Proposals,” and the need for the SEC to “clarify and expand the scope of the new conduct standard for broker-dealers, specifying the types of practices that would be prohibited under the new broker-dealer standard, establishing clearer lines of demarcation between investment advisory and broker-dealer activities, preserving investor rights and remedies, improving the effectiveness of proposed Form CRS, and expanding how the Commission proposes to move forward on the use of certain professional titles.”
As NASAA reminded in a 2017 filing (see Enclosure 2) on a matter before the Massachusetts Office of the Secretary of the Commonwealth Division of Securities: “the intersections of federal and state securities laws and the scope of federal preemption of state securities regulatory authority are complex and, in some areas, unsettled.” Preemption would “strip the Division of its legitimate regulatory authority over broker-dealers operating in the Commonwealth of Massachusetts and potentially do damage to the ability of other states to exercise their legitimate police powers as preserved by Congress.”
In a comment letter on the New Jersey rulemaking, SIFMA, a strong supporter of Reg BI, makes the case that “A state-by-state approach…would result in an uneven patchwork of laws that would be duplicative of, different than, and possibly in conflict with federal standards.” SIFMA urged the Bureau “to pause its rulemaking process, review Reg BI, and reevaluate its proposal before deciding whether it is necessary to proceed with an additional state regulation.” Further, SIFMA warned that “the proposal would generally incentivize firms to curtail their brokerage services in New Jersey. Earlier this year, some broker-dealers expressed similar concerns over Nevada’s fiduciary duty proposal, arguing that “the liabilities and compliance costs associated with an ongoing fiduciary duty would make it impractical to offer the basic brokerage services favored by low- and middle-income investors.”
A group of trade associations have also expressed concerns regarding the New Jersey proposal, joining SIFMA in "encouraging the Bureau to pause its process and reevaluate its Proposal in light of Reg BI." New Jersey has since called a public hearing, and the comment period for the proposal has been extended to July 18th, reportedly following "70 requests from industry groups opposing the New Jersey measure."
In a supplemental comment to the Reg BI proposal, and in response to a SIFMA request that the SEC take up the issue of preemption, NASAA successfully urged the SEC to decline “to weigh-in on the scope of federal preemption of state regulatory authority in any final Commission Reg BI rulemakings,” further arguing that the issue is “more properly reserved for the courts.” The SEC did not take up the preemption issue in its final rule adoption.
The Massachusetts proposal (and other state proposals) are significant obstacles on the road to acceptance of Reg BI as the final word. While it is likely that the issue of federal preemption will be resolved in court, any final outcome is not self-evident. Bates will keep you apprised.