Lawrence P. Stadulis

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

A Striking Shot Across the Bow: New Jersey Launches Uniform Fiduciary Standard Rulemaking

New Jersey can be credited as the first state to take up a uniform fiduciary standard applicable to broker-dealers and investment advisers in the wake of Regulation Best Interest and the rest of the Securities and Exchange Commission’s (SEC) major standard of care proposal. On October 15, the New Jersey Bureau of Securities (Bureau) announced, in the form of a notice of pre-proposal, that it is soliciting comments on whether to adopt rule amendments to require that broker-dealers, agents, investment advisers, and investment adviser representatives be subject to an express fiduciary duty. The rule amendments likely would apply to all persons who conduct brokerage services in New Jersey, including federally registered broker-dealers. It likely would also apply to state-registered investment advisers, but it is not clear whether the rule amendments would apply to SEC-registered investment advisers.

According to the notice, while investment advisers already owe a fiduciary duty to their clients under case law,1 broker-dealers are held only to a suitability standard2 (i.e., broker-dealers and their agents are required to have a reasonable basis to believe a recommended transaction or investment strategy involving securities is suitable for the customer).3 The notice expresses concern that investors remain without adequate protection from broker-dealers who, under the suitability standard, are permitted to consider their own interests ahead of their client’s interests when making investment recommendations.4 In particular, the notice warns that investors are often unaware of whether and to what extent those they trust to make financial recommendations are receiving undisclosed financial benefits in exchange for steering their clients to certain products.

The pre-proposal does not include specific regulatory language, but the notice indicates that 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.” The Bureau contemplates a uniform standard that would protect investors against the abuses that can result when financial professionals place their own interests above those of their customers, but does not set out the precise scope of the duties that would apply.

By opening up a comment period before issuing a rule proposal, and holding two public hearings in November, New Jersey appears to recognize the complexities associated with a uniform fiduciary rule. Specifically, the Bureau is seeking comment on:

  1. The legal and factual bases for applying a fiduciary standard to all financial services professionals;
  2. The scope of the duty in terms of duration and when it arises;
  3. The types of recommendations that would trigger the duty; and
  4. The scope of the duty in terms of to whom it is owed.

Comments should be sent by December 14, 2018, to: Christopher W. Gerold, Bureau Chief, Bureau of Securities, PO Box 47029, Newark, New Jersey 07101, or electronically.

The Bureau will also host two “informal conferences to take testimony from interested parties to gather facts to inform a rulemaking and to afford ample opportunity for the receipt of public comment from the regulated communities, industry representatives, and the public at large.” These conferences will take place on November 2 and November 19 from 9:30 am – 4:30 pm at 124 Halsey Street, 6th Floor, Morris Room, Newark, NJ 07101.

We expect that, following its consideration of public comments, the Bureau will issue a formal rule proposal, which will be subject to notice and comment.

A copy of the pre-proposal can be found here.

This is not the first time New Jersey has waded into these waters post-Department of Labor (DOL) fiduciary rule. Earlier this year, the New Jersey Senate considered a bill that would impose a disclosure obligation on “non-fiduciary investment advisors,” including broker-dealers, that would consist of a Plain English declaratory statement that those entities do not owe fiduciary duties to their clients. This legislation has since stalled. A nearly identical bill was introduced in the New York Assembly and has similarly stalled.

New Jersey Governor Phil Murphy, a Democrat, announced last month that the Bureau would initiate a rulemaking that “would impose a fiduciary duty on all New Jersey investment professionals, requiring them to place their clients’ interests above their own when recommending investments.” While the October 15 pre-proposal merely solicits comments on what a uniform fiduciary standard should look like under New Jersey law, it comes at a time when the SEC is currently working to address federal standards of conduct. As we noted recently, the SEC could issue a final rule in the first half of next year. Though it remains to be seen how the SEC will ultimately address the numerous concerns stakeholders have over Regulation Best Interest and other aspects of the rulemaking, the Governor and the Bureau are not waiting for the SEC to address these concerns.

As with some other states and public officials, the Governor may be holding up the DOL fiduciary rule as a model. He charged the DOL with “abandoning” its controversial fiduciary rule by not appealing the decision of the Fifth Circuit Court of Appeals to vacate the rule. It is possible that this apparent affinity for the DOL rule could presage what a final New Jersey rule could look like.

It is also possible that other states will move forward with disparate fiduciary standards and duties before the SEC has the chance to publish a final rule. Ever since the President’s Inauguration, a handful of blue states have cast the Trump Administration as being adverse to Main Street investors, even though both SEC Chairman Jay Clayton and DOL Secretary Alex Acosta have solicited state participation. Nevertheless, several state bills, including those of Illinois, Massachusetts and New York (nearly all of which failed), attempted to address the different standards of conduct of investment advisers and broker-dealers. Enforcement efforts, particularly out of Massachusetts, have also been active during this period.

Not all state efforts in imposing a uniform fiduciary standard, however, have stalled. Nevada, for instance, amended its financial planner statute in 2017 to impose a fiduciary standard on broker-dealers. As we previously noted, Nevada’s amended law raises a number of material interpretive issues, which were supposed to have been addressed in a regulation. To date, no such regulation has been proposed.

Standards of care applicable to broker-dealers and investment advisers remain an entirely fluid area at the federal and state levels. We expect ongoing state regulatory and enforcement developments while the SEC continues to work on its own rulemaking, with the DOL most likely awaiting a final SEC rule before issuing any new guidance in this area. The question then becomes not if a major fiduciary standard of care development will occur in the near future, but by whom and when.

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1 A fiduciary duty for investment advisers has been implied under the Investment Advisers Act of 1940. See Transamerica Mortgage Advisors v. Lewis, 444 U.S. 11, 17 (1979); SEC v. Capital Gains Research Bureau, 375 U.S. 180 (1963).

2 In fact, available case law in New Jersey, following precedent from other states, says that broker-dealers generally are not fiduciaries, but do have fiduciary duties if they have investment discretion. See McAdam v. Dean Witter Reynolds, 896 F.2d 750, 767 (3d Cir. 1990); Estate of Parr v. Buontempo Insurance Services, 2006 WL 2620504, at *5 (N.J. Super. Ct. App. Div. 2006) (unpublished opinion).

3 Both New Jersey and FINRA rules require securities recommendations to meet a suitability standard. See N.J. Admin. Code § 13:47A-6.3(a)(3); FINRA Rule 2111.

4 Although the notice states that broker-dealers can consider their own interests ahead of their client’s interests when making investment recommendations, FINRA has stated that the suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests. FINRA Regulatory Notice 12-25 (May 2012).

George Michael Gerstein advises financial institutions on the fiduciary and prohibited transaction provisions of ERISA. As co-chair of the fiduciary governance group, he assists clients with tracking, and understanding, the numerous fiduciary developments at the federal and state levels, including the rules and regulations of governmental plans. He also advises clients with respect to the fiduciary duty implications of ESG investing.

Watch yesterday’s Fiduciary Governance Group webcast on the SEC Standards of Conduct proposal

On Thursday, October 4th, Investment Company Institute Associate General Counsel Sarah A. Bessin, Fidelity Investments Senior Vice President & Deputy General Counsel Helen E. Rizos, David Grim and I presented a webcast titled “The Latest on the SEC Standards of Conduct Initiative.” Watch a replay of the webcast here:

 

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

Register for a webinar on October 4: The Latest on the SEC Standards of Conduct Initiative

Join industry leaders for a 60-minute webinar on Thursday, October 4, 2018 at 11 a.m. (EDT) to discuss the potential impact of the SEC’s Best Interest Proposals on the fund industry. Topics will include:

  • Overview of the Proposals, Including Regulation Best Interest
  • Key Themes in the Comment Letters
  • Impact on Fund Distributors, Dealers and Funds, including Non-Cash Compensation and Other Distribution Practices
  • Evolving Process and Future Suitability Concerns

Speakers:

Helen E. Rizos, Senior Vice President & Deputy General Counsel, Fidelity Investments

Sarah A. Bessin, Associate General Counsel, Investment Company Institute

David W. Grim, Partner, Stradley Ronon, Former Director of the U.S. SEC’s Division of Investment Management

Lawrence P. Stadulis, Partner & Co-Chair, Fiduciary Governance, Stradley Ronon

Register to view the webcast here.

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

SEC Rulemaking Package Would Impose Best Interest Standard of Conduct

On April 18, the Securities and Exchange Commission (“SEC”) released for public comment a package of rulemaking proposals on the standards of conduct and required disclosures for broker-dealers and investment advisers who provide services to retail investors. The release of the long-awaited proposals was approved by a 4 – 1 vote of the Commissioners, with Commissioner Kara Stein dissenting. However, all of the Commissioners expressed some concerns with the proposals, suggesting that the rulemaking will likely need to evolve before it can be approved.

The Dodd-Frank Act authorized the SEC to adopt rules on the standards of care for broker-dealers, investment advisers, and their associated persons,1 and the SEC staff in 2011 issued a study recommending that the SEC engage in rulemaking to adopt and implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.2 The SEC did not propose a uniform fiduciary standard, however, but instead proposed a best interest standard for broker-dealers that it characterized as an enhancement to existing standards but separate and distinct from the fiduciary duty applicable to investment advisers. The SEC also proposed a new requirement for both broker-dealers and investment advisers to provide a brief relationship summary to retail investors, and it published for comment a proposed interpretation of the standard of conduct for investment advisers.

Regulation Best Interest

The SEC proposed to adopt rule 15l-1, titled “Regulation Best Interest,” which would require broker-dealers and their associated persons who are natural persons to act in the “best interest” of a retail customer3 at the time a recommendation4 of a securities transaction or investment strategy involving securities is made to that customer, without placing the financial or other interest of the broker-dealer or associated person ahead of the interest of the customer.5 The proposed best interest obligation draws from principles underlying and reflects the underlying intent of many of the recommendations of the 2011 staff report and also generally draws from underlying principles similar to the principles underlying the Department of Labor’s best interest standard. This “best interest” duty would be discharged if the broker-dealer or associated person complies with multiple obligations, specifically:

Disclosure Obligation

The broker-dealer or associated person must reasonably disclose to the retail customer in writing the material facts relating to the scope and terms of the relationship, including all material conflicts of interest associated with the recommendation.

Care Obligation

The broker-dealer or associated person must exercise reasonable diligence, care, skill and prudence to:

  • understand the potential risks and rewards associated with the recommendation and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers;
  • have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; and
  • have a reasonable basis to believe that a series of recommended transactions is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.

Conflict of Interest Obligations

The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and then to:

  • at a minimum disclose, or eliminate, material conflicts of interest associated with the recommendation; and
  • disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with the recommendation.

The SEC states that Regulation Best Interest is not intended to create any new private right of action or right of rescission.  It remains to be seen, however, whether it would have an effect on existing rights of action.

Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles

The SEC also proposed to require both broker-dealers and investment advisers to provide retail investors6 with information intended to clarify the relationship via the proposed Form CRS Relationship Summary.7 Form CRS would be limited to four pages, with a mix of tabular and narrative information, and contain sections covering:

  • the relationships and services the firm offers to retail investors;
  • the standard of conduct applicable to those services;
  • the fees and costs that retail investors will pay;
  • comparisons of brokerage and investment advisory services (for standalone broker-dealers and standalone investment advisers);
  • conflicts of interest;
  • where to find additional information, including whether the firm and its financial professionals currently have reportable legal or disciplinary events and who to contact about complaints; and
  • key questions for retail investors to ask the firm’s financial professional.

Form CRS would be provided to investors, filed with the SEC, and available online. The form would not supersede the Form ADV Part 2 brochure, which investment advisers would continue to prepare and provide to clients. The SEC has provided mock-ups of Form CRS that would be used by standalone broker-dealers, standalone investment-advisers, and dually-registered firms.

The SEC also proposed (A) to require broker-dealers and investment-advisers to prominently disclose their registration status; and (B) to restrict standalone broker-dealers and their financial professionals from using the terms “adviser” and “advisor” as part of their name or title. These proposed changes are part of greater scrutiny by federal and state regulators over the titles financial professionals use that could confuse investors as to the nature of the relationship, which has been the focus of a number of state legislatures.

Notice of Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation

The third element of the package is a proposed interpretive release on the fiduciary duty that investment advisers owe to their clients.8 Existing enforcement proceedings and SEC interpretations hold that the Investment Advisers Act of 1940 establishes a federal fiduciary standard for investment advisers.  The proposed interpretation is intended to summarize the SEC’s understanding of that fiduciary duty and put the market on notice of the SEC’s views.

The release also includes a request for comments on areas where the current broker-dealer framework provides investor protections that may not have counterparts in the investment adviser context. The SEC intends to consider these comments in connection with any future proposed rules or other proposed regulatory actions with respect to these matters. Accordingly, the SEC requests comment on whether there should be federal licensing and continuing education requirements for personnel of SEC-registered investment advisers; whether registered investment advisers should be required to provide account statements, either directly or via the client’s custodian; and whether registered investment advisers should be subject to financial responsibility requirements along the lines of those that apply to broker-dealers.

The Path Forward

Each of the Commissioners expressed reservations, to varying degrees, with the proposals (and complained about their heft – in aggregate, they take up almost 1,000 pages) at the SEC open meeting at which their issuance was approved. It became clear during the open meeting that the Commissioners have concerns, including with the proposals’ clarity, the appropriate comparison to existing broker-dealer suitability standards, and the cost-benefit analysis. Public comments will weigh heavily as the SEC considers these proposals, and for this reason interested parties may wish to submit a comment letter in response to the numerous questions the SEC posed.

Comments on the proposals will be due 90 days after their publication in the Federal Register, which will likely occur at some point in the next month.  The SEC will then need time to consider what are likely to be a large number of comments.  We should not expect consideration of final rules much before the end of 2018, and final action could be considerably later.


1 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 913, 124 Stat. 1376, 1824 – 30 (2010).

2 Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011),
https://www.sec.gov/news/studies/2011/913studyfinal.pdf.

3 A “retail customer” is proposed to be defined under Regulation Best Interest as a person who receives a recommendation and uses it primarily for personal, family, or household purposes.

4 “Recommendation” is not defined but is proposed to be interpreted consistent with existing FINRA rules, under which factors that have historically been considered in the context of broker-dealer suitability obligations include whether the communication “reasonably could be viewed as a ‘call to action’” and “reasonably would influence an investor to trade a particular security or group of securities.”

5 Regulation Best Interest, Release No. 34-83062 (Apr. 18, 2018), https://www.sec.gov/rules/proposed/2018/34-83062.pdf.

6 For purposes of the Form CRS delivery requirement, a “retail investor” is proposed to be defined as a prospective or existing client or customer who is a natural person, including a trust or other similar entity that represents natural persons.

7 Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles, Release Nos. 34-83063, IA-4888 (Apr. 18, 2018), https://www.sec.gov/rules/proposed/2018/34-83063.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-a.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-b.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-c.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-d.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-e.pdf;
https://www.sec.gov/rules/proposed/2018/34-83063-appendix-f.pdf.
“CRS” stands for “Customer Relationship Summary.”

8 Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation, Release No. IA-4889 (Apr. 18, 2018), https://www.sec.gov/rules/proposed/2018/ia-4889.pdf.

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

The SEC Proposals: Standards of Conduct for Investment Advisers and Broker-Dealers

During an open meeting this Wednesday, the Securities and Exchange Commission (SEC) is expected to unveil proposals on (1) new and amended rules and forms to require registered investment advisers and registered broker-dealers to provide a brief relationship summary to retail investors, (2) establishing a standard of conduct for broker-dealers and natural persons who are associated persons of a broker-dealer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, and (3) an SEC interpretation of the standard of conduct for investment advisers.

Stradley Ronon’s Fiduciary Governance Group will host a webcast on Monday, April 23 at 1:00 p.m. (EDT) to discuss these proposals and preliminary reactions. Speakers: David Grim, Larry Stadulis, John Baker and George Michael Gerstein

Register to attend the webcast here.

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

Fiduciary Governance 2.0

We are pleased to introduce Stradley Ronon’s new Fiduciary Governance Group, comprised of federal and state securities, banking, insurance and ERISA/governmental plan law attorneys who help clients determine (1) whether one becomes a fiduciary or assumes a similar role under common law and applicable regulatory regimes, (2) how to comply with such fiduciary or similar duties under each set of laws and identify daylight between them, and (3) ways to leverage existing compliance procedures under one regime to comply with other applicable regimes. Whether it’s the Department of Labor (DOL) Fiduciary Rule, a new Securities and Exchange Commission (SEC) fiduciary standard, or emerging state investment advice laws implicating broker-dealers and SEC-registered investment advisers, the Fiduciary Governance Group helps guide financial institutions on ways to address compliance risk in a holistic fashion and, where possible, create harmonized procedures that satisfy multiple applicable fiduciary rules and standards. Commentary from the group on fiduciary topics will be available through client alerts and on its blog at fiduciarygovernanceblog.com.

Here Today, Gone Tomorrow?

In one fell swoop, the 5th Circuit Court of Appeals dropped the hammer on the DOL Fiduciary Rule, tossing out the expanded scope of fiduciary “investment advice” and the related exemptions, including the Best Interest Contract Exemption. Barring a petition for rehearing or appeal, the court’s ruling will go into effect in early May, at which point the 1975 DOL regulation defining investment advice via a five-part test would re-emerge.

Nevertheless, until there is certainty that there will be no rehearing or appeal, we caution against any major changes to compliance, even though the DOL has told the press that it will not enforce the rule until further notice. But now might be a good time to consider a post-DOL Fiduciary Rule world by:

  • Inventorying the type and nature of typical communications with retirement investors (e.g., other fiduciaries, plan participants, IRAs, etc.) and tagging those that might satisfy all five prongs of the 1975 regulation: (1) providing advice as to the value of securities or other property, or making recommendations as to the advisability of investing in, purchasing, or selling securities or other property; (2) on a regular basis; (3) pursuant to a mutual agreement, arrangement, or understanding with the plan or a plan fiduciary; that (4) the advice serves as a primary basis for investment decisions with respect to plan assets; and that (5) the advice is individualized based on the particular needs of the plan or IRA.
  • Identifying any representations, disclosures or statements regarding fiduciary status that were made in light of the Fiduciary Rule’s scope, which may at some point need correction.
    Re-examining what changes were made to internal policies and procedures to account for the DOL Fiduciary Rule, and considering whether to retain such changes even if no longer legally required, particularly in light of the fact that federal and state regulators could seek enforcement against institutions for failing to follow these policies and procedures.
  • Reconsidering any revisions to contracts in order to satisfy the DOL’s guidance on 408(b)(2) disclosures that it issued last August. Recall that the DOL said: “In the case of a service provider who is providing or reasonably expects to provide fiduciary investment advice services within the meaning of the currently applicable Fiduciary Rule and whose contract with or disclosures to an ERISA pension plan client include a statement that the service provider is not a fiduciary or is not providing fiduciary services, the Department would not treat the service provider as having furnished the plan with an accurate and complete description of the services that will be performed under the contract or arrangement until a revised contract or disclosure is provided that removes or corrects that affirmatively incorrect statement.” Because these same services may no longer be fiduciary in nature post-Fiduciary Rule, and recognizing the uncertainty service providers face at this time, rethinking these changes may make sense.
  • Re-evaluating whether to continue excluding small plans and IRAs from investing in private funds, if that determination had been made to prevent a fund manager from inadvertently becoming an investment advice fiduciary to an IRA investor or small plan during the sales and subscription process.
    We do not think it is a foregone conclusion that the 1975 five-part test of what it means to be an investment advice fiduciary under ERISA will be reinstated and that the DOL Fiduciary Rule has begun its ride into the sunset. We do believe, however, it is reasonable to begin considering tasks that will be necessary to transition to a post-DOL Fiduciary Rule world.

SEC’s New Best Interest Standard … Coming (Very) Soon?

Regardless of whether the DOL seeks to preserve its Fiduciary Rule, Jay Clayton, the Chair of the SEC, has made clear that he expects the SEC to propose its own uniform standard of conduct for investment advisers and broker-dealers who provide personalized investment advice about securities. The 2010 Dodd-Frank Act authorized the SEC to adopt a uniform standard for broker-dealers and investment advisers to act in the best interest of the customer without regard to the financial or other interest of the entity providing the advice. We understand that the SEC is working on a rule proposal. Following the 5th Circuit decision on the DOL rule, Clayton reiterated that he hopes to get a proposal out as soon as possible, which we understand could be in a matter of weeks.

One likely aspect of the SEC proposal will be a requirement to deliver a summary disclosure document that will describe services, fees, conflicts, product offerings and other pertinent information. Such a document has been in the wings since the SEC staff’s 2012 study on financial literacy among investors, which found that investors prefer, wherever possible, the use of a summary document containing key information about an investment product or service. The proposal may not expressly use the term “fiduciary,” but will most likely impose a uniform duty to act in the “best interests” of clients and prohibit, or at least limit, the use by broker-dealers of certain titles, such as “financial adviser,” in marketing and sales materials.

As a general principle, we expect the SEC to use as its base the federal fiduciary standard applicable to investment advisers, as laid out in Capital Gains Research, where the U.S. Supreme Court noted:

[t]he Investment Advisers Act of 1940 reflects a congressional recognition of the delicate fiduciary nature of an investment advisory relationship as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.

As such, the federal fiduciary duty that flows from being registered under the Advisers Act provides that advisers have “an affirmative obligation of utmost good faith and full and fair disclosure of all facts material to the client’s engagement of the adviser to its clients, as well as a duty to avoid misleading them.”

State Action: Already Several Shots Across the Bow

We have been closely tracking the state developments on retail investment advice. Much has been reported on Nevada’s newly revised financial planner law, which went into effect last summer. Our conference call last fall came on the heels of our attendance at the Nevada Security Division’s Workshop on the new law and prospective regulations. As things stand, federally regulated investment advisers, broker-dealers and sales representatives that render financial planning services are now newly-minted “financial planners” under Nevada law, and as a result are subject to:

  • The “duty of a fiduciary toward a client” and;
  • A time-of-sale disclosure of “any gain the financial planner may receive, such as profit or commission, if the advice is followed” and;
  • A duty to undertake a “diligent inquiry of each client to ascertain initially, and keep currently informed concerning, the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.”

Importantly, Nevada’s financial planner law provides for a private right of action for breaches of “any element” of this fiduciary duty, or when the financial planner is “grossly negligent in selecting the course of action advised, in the light of all the client’s circumstances known to the financial planner.” There could also be civil litigation for violations of “any law of this State in recommending the investment or service.”

The Nevada Securities Division has enforcement authority, as well as the authority to “[d]efine or exclude an act, practice or course of business of a broker-dealer, sales representative, investment adviser or representative of an investment adviser as a violation of the fiduciary duty toward a client,” via regulations, which are expected to be proposed over the next couple of months. When proposed, the regulations will have to account for, and address, serious concerns that enforcement of this newly amended law may be preempted by The National Securities Markets Improvement Act of 1996 (NSMIA) and other federal law. Nevada Democratic Senate Majority Leader Aaron Ford, the sponsor of the legislation (who subsequently announced his intention to run for state attorney general), said in an interview that he is “confident” the law will “comport with what the federal government may do,” specifically referencing the DOL Fiduciary Rule. It remains to be seen whether the preemption concerns involving NSMIA are being carefully considered.

The forthcoming regulations from the Nevada Securities Division are subject to final approval by the “Legislative Counsel Bureau” (also referred to as the “Legislative Commission”), on which Ford and other legislators sit. In an interview, Ford intimated that he and others would not hesitate to send the Securities Division back to the drawing board if the regulation does not reflect (enough) of their legislative intent. He also vowed, “We’ll be back again in 2019” should the law be struck down by a court on preemption grounds.

With less fanfare, Connecticut passed a law last summer affecting financial planners, though, unlike Nevada, it did not expressly shoehorn broker-dealers and investment advisers into its scope. Rather, Connecticut defines financial planner as “a person offering individualized financial planning or investment advice to a consumer for compensation where such activity is not otherwise regulated by state or federal law.” A reasonable (though not certain) reading of that definition is that federally regulated broker-dealers and advisers are not included at this. The law establishes a number of new requirements for financial planners, including a duty to disclose “whether they have a fiduciary duty with regard to each recommendation they make” upon request.

New York and New Jersey have introduced very similar bills that take a different approach than Nevada. New York’s Investment Transparency Act, for example, applies to “investment advisors currently not subject to a fiduciary standard under existing state and federal laws or regulations or by any applicable standards of professional conduct,” or, as the bill calls them, “non-fiduciary investment advisors.” Specifically, “non-fiduciary investment advisors” includes those who identify themselves as “brokers,” “dealers,” “investment advisors,” “financial advisors,” “financial planners,” “financial consultants,” “retirement planners,” “retirement brokers,” “retirement consultants,” or any other term that is suggestive of investment, financial planning or retirement planning knowledge or expertise. These entities will need to make a “plain language disclosure orally and in writing” at the start of the relationship that reads: “I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns for you.” Both the New York and New Jersey bills require that “non-fiduciary investment advisors” maintain as a record the written acknowledgment signed by the client that the disclosure was in fact made. As of the date of this alert, the New York bill sits with the Committee of Codes and the New Jersey bill is pending technical review by the Legislative Counsel, after being re-introduced at the start of 2018.

Meanwhile, Maryland and Illinois are a tale of two different legislative approaches. The Maryland legislature attempted to take a Nevada-like approach, before reportedly sidelining its legislative efforts until the SEC unveils its best interest proposal. As introduced, the Maryland bills specifically imposed a fiduciary standard on broker-dealers and required a diligent inquiry of each client to determine the financial circumstances and obligations of the client, including an inquiry into the client’s present and anticipated obligations to his or her family and “for the client’s family and goals for the client’s family.” Illinois, in contrast, seems to be following more in the footsteps of New York and New Jersey: in early February, the Investment Advisor‎ Disclosure Act was introduced in the General Assembly, and while we are not aware of any text that has been proposed yet, its name suggests mandated disclosures on lack of fiduciary status could be in order.

Whether more states will act in response to the 5th Circuit’s decision on the DOL Fiduciary Rule is anyone’s guess. We know that a number of state legislatures have pointed to skepticism over rulemaking by the DOL and SEC as a basis for their own legislative and regulatory efforts. With the DOL’s own rule seemingly on life support, and the SEC’s yet to be unveiled, it is impossible to forecast if other states, which are currently on the sidelines, will move forward with their own legislative or regulatory initiatives. We are continuing to monitor this evolving situation.

It is also unclear how state enforcement agencies will respond to the 5th Circuit decision. Just in February, prior to the court decision, the Massachusetts Securities Division filed an administrative complaint against Scottrade alleging that Scottrade violated the DOL Fiduciary Rule’s “impartial conduct standards,” and, therefore, violated state law. Massachusetts was effectively seeking to enforce the DOL rule. Consider whether state securities regulators may attempt again to bring a state enforcement action that is predicated on imputing the DOL Fiduciary Rule’s “impartial conduct standards” into its own blue sky laws, even if those same standards are extinguished because the DOL Fiduciary Rule is (ultimately) abandoned. Moreover, if the SEC incorporates some aspect of the impartial conduct standards into its new proposal, would that encourage or discourage more of these state enforcement actions? In light of the Massachusetts complaint lodged against Scottrade, it is especially important for each firm to review its written policies and procedures – especially those amended to address the DOL Fiduciary Rule – to ensure that their terms are always followed, and if they are no longer legally compelled, to consider removing them from the policies and procedures, as flagged above.

George Michael Gerstein advises financial institutions on the fiduciary and prohibited transaction provisions of ERISA. As co-chair of the fiduciary governance group, he assists clients with tracking, and understanding, the numerous fiduciary developments at the federal and state levels, including the rules and regulations of governmental plans. He also advises clients with respect to the fiduciary duty implications of ESG investing.

SEC Feels ‘Sense of Urgency’ on Fiduciary Standards

One of our newest colleagues, Dave Grim, former Director of the SEC’s Division of Investment Management, was interviewed by Ignites discussing the SEC’s new sense of urgency surrounding the fiduciary rule. (subscription required)

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

Is title reform the answer to the fiduciary debate?

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

Would reforming use of the title ‘adviser’ mesh with the DOL fiduciary rule?

George Michael Gerstein advises financial institutions on the fiduciary and prohibited transaction provisions of ERISA. As co-chair of the fiduciary governance group, he assists clients with tracking, and understanding, the numerous fiduciary developments at the federal and state levels, including the rules and regulations of governmental plans. He also advises clients with respect to the fiduciary duty implications of ESG investing.

The DOL, the SEC and the States: Fiduciary Law Developments

On Oct. 17, Stradley Ronon Partner Lawrence Stadulis and Counsel George Michael Gerstein held a conference call, “The DOL, the SEC and the States: Fiduciary Law Developments,” to discuss the latest on the Department of Labor (DOL) Fiduciary Rule, the prospect of a uniform standard by the Securities and Exchange Commission (SEC) and the recent emergence of states developing their own fiduciary laws (most notably, Nevada). An audio recording of the briefing can be found here. For convenience, they have prepared this summary for those who wish to simply gather a high-level overview of these developments.

  • The president officially nominated Preston Rutledge as an assistant secretary of labor, Employee Benefits Security Administration, which could have a significant impact on the DOL’s re-examination of the Fiduciary Rule. Rutledge most recently served as senior tax and benefits counsel on the Majority Tax Staff of the Senate Finance Committee. Rutledge would need to be confirmed by the Senate.
  • Representative Ann Wagner (R-Mo.) introduced in the House of Representatives the Protecting Advice for Small Savers (PASS) Act. This bill would repeal the DOL Fiduciary Rule while creating a best-interest standard for broker-dealers and requiring broker-dealers to disclose compensation they receive and any conflicts of interest that exist.
  • Jay Clayton, the chairman of the SEC, has confirmed during his recent testimonies before Congress that one of the SEC’s top priorities is to put forth a uniform fiduciary standard, and that staff are currently working on a new rule while coordinating with the DOL and the states.
  • Several states are now considering laws that could impose their own fiduciary duties on federally regulated broker-dealers and advisers. Nevada passed a law on July 1 that imposes significant requirements on broker-dealers and advisers, though the contours of these requirements will be defined in regulations, which have yet to be promulgated. Unfortunately, the lack of regulations has created significant compliance uncertainty in the industry. The Nevada Securities Division recently held a workshop in Las Vegas on the new law, and Lawrence Stadulis attended; unfortunately, little guidance was offered. Separately, various states have introduced bills, including New York, New Jersey and Massachusetts.
  • The DOL is expected to finalize the proposed delay of the transition period with respect to the Fiduciary Rule’s associated exemptions. Should the proposal be adopted, the transition period would extend from January 1, 2018 to July 1, 2019. The DOL has also confirmed that it is drafting a proposed class exemption, which would be aimed at products and services that present fewer conflicts of interest and greater fee transparency. It is not yet clear when this new exemption will be proposed.

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.