News

Massachusetts Supreme Judicial Court Upholds Massachusetts Fiduciary Rule

• September 28, 2023 • News

By: Lawrence P. Stadulis and Kevin O’Connell

On Aug. 25, 2023, the Massachusetts Supreme Judicial Court unanimously upheld the Massachusetts Fiduciary Rule (the March 2020 Rule), which holds broker-dealers to the same fiduciary standard as investment advisers. This holding is the first of its kind as the Securities and Exchange Commission and other states do not hold broker-dealers to the same high fiduciary standards investment advisers must meet. This is because broker-dealers, unlike investment advisers, typically do not provide personalized advice on an ongoing basis. The Supreme Judicial Court decision reverses a March 2022 lower-court ruling invalidating the March 2020 Rule, stating that Secretary of the Commonwealth of Massachusetts William Galvin had overstepped his authority in promulgating the March 2020 Rule under the Massachusetts Uniform Securities Act (MUSA) and lacked the authority to adopt it.

The original case was brought in April 2021 by Robinhood Financial LLC (Robinhood), an online brokerage firm, after Robinhood was the subject of Massachusetts’ first enforcement action brought under the March 2020 Rule for targeting and taking advantage of inexperienced investors. Robinhood sought to have the March 2020 Rule reversed. The Suffolk County Superior Court held that the March 2020 Rule conflicted with common law, which held that broker-dealers are not fiduciaries when they simply execute trades without providing investment advice.

Following the Suffolk County Superior Court’s ruling that found that Galvin had overstepped his authority in promulgating the March 2020 Rule, the state’s Supreme Judicial Court was required to review challenges to government agency regulations.

Upon review, the Supreme Judicial Court held that “[William Galvin’s] determination that the fiduciary duty rule was necessary for that purpose is owed deference, where, as here, the conclusion is supported by the extensive regulatory record.” Under the MUSA, Galvin has the power to define “unethical or dishonest conduct practices” as he deems appropriate.

Furthermore, the court held that Galvin considered various factors before implementing the rule, including his securities division’s experience, empirical studies and public comments.

Robinhood reported that in light of the Massachusetts Supreme Judicial Court’s decision, it is currently evaluating its potential options.

Biden Vetoes Anti-ESG Measure

• March 31, 2023 • News

By: Katrina L. Berishaj, Sara P. Crovitz and Kevin O’Connell

On March 20, 2023, President Joseph R. Biden issued his first presidential veto to reject the recent joint Congressional resolution that would have repealed the U.S. Department of Labor’s (DOL) January 2023 “ESG Rule.” Just a few days later, on March 23, the U.S. House of Representatives failed to override the veto, meaning that, for now, the DOL’s ESG Rule remains intact.

Summary of the DOL’s ESG Rule
The DOL’s ESG Rule, which became effective on January 30, 2023, provides a principles-based approach with respect to fiduciary investment decision-making processes. Consistent with ERISA, the regulation requires that ERISA plan fiduciaries focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries to objectives unrelated to the provision of benefits under the plan. The ESG Rule allows fiduciaries to determine which factors are relevant to risk and return analyses without mandating consideration of any factors in particular. The regulation makes it clear that risk and return factors may include the economic effects of climate change and other environmental, social or governance factors.

Other Attacks on the ESG Rule
Notwithstanding President Biden’s veto, there are two ongoing lawsuits attacking the ESG Rule. In January 2023, 25 state attorneys general joined by a fossil-fuel company, a fossil-fuel advocacy group and a Manhattan Institute fellow are suing the DOL in the Northern District of Texas in an attempt to block the ESG Rule on the grounds that the regulation violates the Administrative Procedures Act and that the DOL exceeded its statutory authority in promulgating the rule. In February 2023, two Wisconsin-based 401(k) plan participants filed a lawsuit in the Eastern District of Wisconsin on similar grounds.

In addition, certain Republican members of the U.S. House of Representatives have indicated that they are working on legislation to amend ERISA to make it more difficult to consider ESG factors with respect to plan investments.

Key Considerations
These developments highlight just how politicized ESG has become. Nevertheless, even in the absence of a DOL regulation that specifically contemplates ESG factors, to the extent that the economic effects of climate change and other environmental, social or governance factors bear on the risk and return analysis of an investment, the ERISA duties of prudence and loyalty would permit consideration of such factors with respect to investment decisions.

In addition to addressing ESG considerations, the ESG Rule also underscores that a fiduciary’s duty to manage plan assets includes the appropriate exercise of shareholder rights related to those shares, including the right to vote proxies. In effect, fiduciaries should vote proxies unless there are good reasons not to.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2023 Stradley Ronon Stevens & Young, LLP. All rights reserved.

U.S. Department of Labor Proposes Substantial Amendments to QPAM Exemption

• August 1, 2022 • News • Tags: ,

By: Katrina L. Berishaj and Mustafa K. Almusawi

Introduction

On July 27, 2022, the U.S. Department of Labor’s Employee Benefits Security Administration proposed significant amendments to the Prohibited Transaction Class Exemption 84-14 for qualified professional asset managers, also known as the “QPAM Exemption.”

The proposed amendments (the Proposal) are summarized below. Comments are due to the DOL by Sept. 26, 2022.

Background

The prohibited transaction rules of Title I of the Employee Retirement Income Security Act of 1974 (ERISA) generally prohibit most transactions between an ERISA plan and a “party in interest.”1 Prohibited transaction exemptions allow for an ERISA plan to engage in otherwise prohibited transactions.

The QPAM Exemption provides broad relief from the prohibited transaction rules. Where a QPAM complies with the terms and conditions of the Exemption, the QPAM is permitted to transact on behalf of a plan or IRA without having to verify whether a counterparty is a party in interest. Because of the broad relief that the Exemption provides, it has become common practice for managers to make representations regarding their QPAM status in agreements with clients and service providers.

Summary of the Proposed Amendments

The proposed amendments would:

  1. Require that a QPAM Notify DOL of their Reliance on the Exemption
    The Proposal would require a QPAM to notify the DOL, by email, of the legal name of each business entity relying upon the Exemption and any name the QPAM may be operating under. QPAMs would be required to update the notification if there are any changes in the information.
  2. Limit the Scope of Transactions for which the Exemption is Available
    The proposed amendments state that the Exemption would provide relief only in connection with an account managed by the QPAM that is established primarily for investment purposes. The DOL explains in the preamble that the Exemption is unavailable in connection with non-investment transactions, such as, for example, hiring a party in interest to provide services to a plan.

    In addition, the Exemption would not provide relief for any transaction that has been “planned, negotiated, or initiated by a Party in Interest, in whole or in part, and presented to a QPAM for approval.” Currently, there is no such limitation in the Exemption.

  3. Expand Disqualifying Conduct to Include Foreign Crimes and “Participating in Prohibited Misconduct”

    Foreign Crimes
    The Proposal would make explicitly clear that a QPAM would be disqualified from relying on the Exemption if the QPAM or any affiliate was convicted in a foreign jurisdiction of crimes that are substantially equivalent to the U.S. federal or state crimes enumerated in the Exemption.

    “Prohibited Misconduct”
    The Proposal would add a new category of misconduct that would disqualify a QPAM from relying on the Exemption. “Participating in Prohibited Misconduct” would include: any conduct that forms the basis for a non-prosecution or deferred prosecution agreement that – if successfully prosecuted – would have led to a disqualifying conviction of any of the crimes enumerated in the Exemption (and any foreign equivalents); engaging in a systemic pattern of practice of violating the conditions of the Exemption; intentionally violating the conditions of the Exemption; and the provision of materially misleading statements to the DOL in connection with the Exemption.
    The Proposal also sets forth an administrative procedure by which the DOL would be able to disqualify a QPAM that participated in Prohibited Misconduct. The DOL would first issue a warning and then provide the QPAM an opportunity to be heard, subject to certain timelines.

  4. Required Contractual Terms – Hold Harmless and Indemnification of Plan Clients in Connection with Disqualification
    The amendments would also require that a QPAM state, in writing, to plan clients that, if the QPAM is disqualified from relying on the Exemption (and for ten years thereafter), the QPAM:

    • agrees not to restrict the ability of a plan client to terminate or withdraw from its arrangement with the QPAM
    • will not impose fees, charges, or penalties on plan clients in connection with the plan client’s decision to terminate the QPAM
    • agrees to indemnify, hold harmless and promptly restore actual losses to each plan client for certain damages arising out of the failure of the QPAM to remain eligible for relief under the QPAM Exemption
    • will not employ or knowingly engage any individual that participated in the disqualifying conduct
  5. Require a One-Year Wind-Down Period
    The Proposal would require that a disqualified QPAM be subject to a mandatory one-year wind-down period. This is intended to provide existing plan clients with time to decide whether to terminate the QPAM and to transition plan assets from the QPAM to another manager, if necessary.

    The wind-down period would not provide relief for any new transactions or for transactions with respect to new plan clients of the QPAM. Within 30 days of its disqualification, the QPAM would be required to provide a notice of its disqualification to its plan clients and to the DOL stating that the QPAM has failed to comply with the Exemption, the start of the one-year winding-down period, the clear and objective description of the facts underlying the disqualifying conduct, and the Exemption’s required contractual terms (as summarized in 4 above).

  6. Individual Exemption Process
    The Proposal provides that a QPAM who becomes disqualified or anticipates becoming disqualified may apply for an individual exemption. This provision explains that the QPAM should anticipate the same conditions as provided in the most recently granted individual exemptions involving similar relief. To the extent that a QPAM requests any deviations therefrom, it must explain in detail why such variation is necessary and in the interest and protection of the affected plans, plan participants and beneficiaries and/or IRA owners. The application would also be required to quantify the specific cost or harms, if any, that the client plans would suffer if the firm could not rely on the Exemption after the winding-down period.
  7. Require that Records be Kept for 6 Years and Available for Inspection
    Consistent with other prohibited transaction exemptions, the Proposal would require a QPAM to retain for six years records sufficient to demonstrate the QPAM’s compliance with the Exemption. The Proposal would require that the records be available for inspection by certain relevant people, including the DOL, IRS, plan fiduciaries, plan sponsors, plan participants, and IRA owners.
  8. Increase AUM and Equity Thresholds to Qualify as a QPAM
    The Proposal would make the following adjustments with respect to AUM and equity thresholds:
  • For registered investment advisers, increase the assets under management threshold from $85 million to $135.87 million and the owners’ equity threshold from $1 million to $2.04 million.
  • For banks, savings and loan associates, and insurance companies, increase the owners’ equity threshold from $1 million to $2.72 million.

The DOL would be able to make annual adjustments for inflation to the thresholds.

Key Takeaways

These amendments would significantly impact entities that rely on the QPAM Exemption, as well as plans, plan fiduciaries, counterparties to transactions involving QPAMs and others. The amendments would impose significant compliance burdens and costs on QPAMs, including the need to amend existing agreements to comply with the conditions. Additionally, the indemnification and hold harmless provisions are likely to increase the potential liabilities of a QPAM that becomes disqualified. The DOL proposes that a final rule would become effective 60 days after publication in the Federal Register. Interested parties should consider submitting comments to the DOL.

1 Similar prohibitions apply with respect to individual retirement accounts under Section 4975 of the Internal Revenue Code. The QPAM Exemption is available for transactions on behalf of such accounts, as well.

“Fat-Free” ESG: SEC Proposes Rule Changes Related to Fund Names and Fund and Adviser Disclosure Related to ESG Investment Strategies

• August 2, 2022 • News • Tags:

Introduction

On May 25, 2022, the U.S. Securities and Exchange Commission (SEC), in 3-1 votes, proposed (1) amendments to Rule 35d-1 (the Names Rule) under the Investment Company Act of 1940 (the Names Rule Proposal) and (2) disclosure requirements for registered investment funds and investment advisers related to environmental, social and governance (ESG) investment strategies (the ESG Proposal). The Names Rule Proposal would expand the scope of terms subject to the Names Rule to include those that suggest that a fund focuses on investments that have, or investments whose issuers have, particular characteristics, would set limitations on the ability of a fund to depart from its investment policy under the Names Rule, and would modify certain other requirements of the Rule. The ESG Proposal mandates certain prospectus and/or annual report disclosure for investment companies and Form ADV disclosure for investment advisers that consider ESG as a part of their investment process. The SEC generally proposes a one-year transition period to come into compliance with the rules if adopted. Public comments on the Names Rule Proposal and the ESG Proposal must be received 60 days after publication of each Proposal in the Federal Register. Full article…

George Michael Gerstein to present to Boston sustainability group on new DOL rule proposal

• November 16, 2021 • News • Tags: , ,

George Michael Gerstein will present a webinar to BASIC – Building A Sustainable Investment Community – Boston on the new US Department of Labor ESG and proxy voting rule proposal. This webinar will be available via Zoom.

Time: November 18, 2021 11:00 AM Eastern Time (US and Canada)

Click here to register.