Risk & Reward

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

On Monday, April 23, Dave Grim, Larry Stadulis, John Baker and I presented a webcast titled “The SEC Proposals: Standards of Conduct for Investment Advisers and Broker-Dealers.” Watch a replay of the webcast here:

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),

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;
“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.

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.

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.

New York Proposes Best Interest Requirements on Insurance Product Recommendations

Just over a month ago, the U.S. Department of Labor (DOL) partly explained an 18-month extension of its fiduciary rule by saying the additional time was necessary to allow for ample opportunity for input from, and, ideally, coordination with, the U.S. Securities and Exchange Commission (SEC) and state regulators. Just a few days ago, however, the state of New York announced proposed changes to its rules governing the sales of insurance and annuity transactions involving both retirement and nonretirement accounts. If implemented, these changes could have a significant effect on New York insurance agents and brokers. Though the revised rule was styled as merely “clarifying” the duties and obligations of producers when making recommendations to consumers, New York Governor Andrew Cuomo tied this proposal to the delay of the DOL fiduciary rule when he said, “As Washington continues to ignore and roll back efforts to protect Americans, New York will continue to use its role as a strong regulator of the financial services and insurance industries to fight for consumers and help ensure a level playing field.”

Here are our observations:

  • The proposed changes to New York’s annuity suitability rule would require that any “recommendation” to a consumer by an insurance agent or broker regarding a proposed or in-force “policy” be “based on an evaluation of the suitability information of the consumer that reflects the care, skill, prudence, and diligence that a prudent person familiar with such matters would use under the circumstances without regard to the financial or other interests of the producer, insurer or any other party.” The insurer would need to make this best interest determination if “no producer is involved.” This best interest requirement is in addition to the existing determination of suitability under New York law.
  • As is always the case, the devil is in the details. The proposed regulation, like the DOL fiduciary rule, broadens the types of communications that give rise to a “recommendation”: namely, “one or more statements or acts” by a broker or agent that either “reasonably may be interpreted by a consumer to be advice,” which results in “a consumer entering into or refraining from entering into a transaction” in accordance with the recommendation, or where the communication “is intended by the producer, or an insurer where no producer is involved, to result in a consumer entering into or refraining from entering into a transaction.” A “policy” means a “life insurance policy, annuity contract, or a certificate issued by a fraternal benefit society or under a group life insurance policy or group annuity contract.” As with the existing rule, policies used to fund ERISA or other plans, such as governmental plans, are exempted.
  • There are a number of other proposed changes, including a need to disclose, at the time of the recommendation, “all relevant suitability considerations and product information, whether favorable or unfavorable, that provide the basis for any recommendations,” as well as a prohibition against any recommendation stating or implying “that a recommendation to enter into a transaction is a part of financial planning, financial advice, investment management or related services unless the producer has a specific certification of professional designation in that area.” There would also be a new requirement to establish and maintain procedures “designed to prevent financial exploitation and abuse” and additional disclosures.
  • The proposed amendments to the New York annuity regulation differ from what is currently being contemplated by the National Association of Insurance Commissions (NAIC), which is in the process of adopting its own updated model suitability rule (on which the New York regulation was based). This means that, barring changes by either NAIC or New York, there may be material differences among the states regarding when a duty of best interest is required for the sale of insurance products, and what specific obligations flow from the best interest duty.
  • The New York regulation, as proposed and already in effect, along with similar regulations of other states, is generally considered coterminous with the DOL fiduciary rule, meaning that advisers are subject to both. The DOL recognized as much when it stated in the preamble to the final version of its fiduciary rule: “The Department’s obligation and overriding objective in developing regulations implementing ERISA (and the relevant prohibited transaction provisions in the Code) is to achieve the consumer protection objectives of ERISA and the Code. The Department believes the final rule reflects that obligation and objective while also reflecting that care was taken to craft the rule so that it does not require people subject to state banking, insurance or securities regulation to take steps that would conflict with applicable state statutory or regulatory requirements. The Department notes that ERISA section 514 expressly saves state regulation of insurance, banking, or securities from ERISA’s express preemption provision.”
  • New York’s best interest proposal comes on the heels of the passage of Nevada’s revisions to its financial planner law, which now imposes fiduciary duties on, and creates a cause of action against, advisers and broker-dealers. The Nevada securities regulator is still due to issue regulations sometime this year on the specific requirements of the amended financial planner law. Other states, meanwhile, have either introduced their own laws that would tighten the screws around investment advice or are contemplating doing so. The states seem committed to updating their standards as if anticipating a significant rollback of the DOL fiduciary rule. Leadership at both the DOL and the SEC appear to recognize the importance of working with the states to avoid an unwieldy maze of regulations governing the same conduct. Only time will tell whether New York’s and Nevada’s actions will expedite the DOL’s or SEC’s timetables.
  • The proposed amendments to the New York regulation are subject to a comment period that closes on Feb. 26, 2018.

DOL Fiduciary Rule Transition Period Extended to July 1, 2019

An early holiday gift to many, the U.S. Department of Labor (DOL) on November 27 formalized an extension of the transition period of the Best Interest Contract (BIC) Exemption, the Principal Transactions Exemption, and certain conditions of Prohibited Transaction Exemption 84-24. The transition period will now end on July 1, 2019 rather than January 1, 2018. Investment advice fiduciaries are expected to adhere to the “impartial conduct standards,” among other conditions (depending on the applicable exemption) during the transition period. As a reminder, the impartial conduct standards impose a duty on fiduciaries to make recommendations in accordance with ERISA’s long-standing stringent duties of prudence and loyalty, to charge no more than reasonable compensation for their services, and to avoid making any misleading statements to the retirement investor. Absent any changes or further delays from the DOL, firms and individuals who provide fiduciary investment advice in need of an exemption will be subject to all conditions of these exemptions, including (among others) the controversial duty to enter into an enforceable contract with IRA investors, as well as a requirement to adopt numerous exacting policies and procedures, starting on July 1, 2019.

The DOL stated that its decision to extend the transition period gives it “time necessary to consider public comments submitted pursuant to the Department’s July Request for Information, and the criteria set forth in the Presidential Memorandum of Feb. 3, 2017, including whether possible changes and alternatives to exemptions would be appropriate in light of the current comment record and potential input from, and action by the Securities and Exchange Commission, state insurance commissioners and other regulators.”

The Fiduciary Rule itself determines whether one becomes a fiduciary by reason of providing non-discretionary investment advice to retirement investors. Generally, if one obtains fiduciary status, and earns compensation in connection with its fiduciary responsibilities, a prohibited transaction occurs and an exemption is needed. The aforementioned exemptions are the primary exemptions under the Fiduciary Rule. The Fiduciary Rule went into effect on June 9, 2017 and is not subject to this (or any) delay; the transition period (and extension thereof) only relates to certain conditions of the exemptions. This means that firms and individuals should continue to ascertain (i) whether they are making “recommendations,” including with respect to roll-overs and distributions, in the first place (ii) whether an applicable “exception” to the Fiduciary Rule is available, and (iii) if necessary, which exemption to rely upon. Here are some additional observations:

  • Firms, to the extent they are relying on these exemptions, are expected to evaluate and upgrade, as necessary, their adherence to the impartial conduct standards. Given that the DOL is allowing for compliance flexibility, firms should consider seizing the opportunity to tailor their approach to the impartial conduct standards. The DOL has been clear that good faith compliance is essential; DOL Secretary Alex Acosta confirmed as much when he told Congress recently that the DOL would initiate enforcement against firms for willful non-compliance. There could also be excise taxes imposed for non-exempt prohibited transactions.
  • The DOL opted for the transition period to end on a date-certain (July 1, 2019) rather than upon the occurrence of a particular event (e.g., a formal pronouncement by the DOL that it would not propose any changes to the Fiduciary Rule) on the basis that the former would provide the market greater certainty and avoid needless compliance costs.
  • The DOL confirmed that it plans to propose a new class exemption, which will likely be aimed at market innovation and transparency, “in the near future.” The DOL did not rule out the possibility that this new exemption could be proposed before year-end.
  • We remain somewhat optimistic that the DOL, the SEC and the states will coordinate on a rulemaking to avoid duplicative and inconsistent regulatory obligations. The DOL alluded to this need for harmonization in its decision to extend the transition period. SEC Chair Jay Clayton has also expressed a desire to coordinate with the DOL and the states on a uniform standard, the latter a necessary stakeholder because of recent state developments seeking to impose their own obligations on firms and individuals who provide investment advice, as we described previously.
  • DOL staff continue to comb through the Fiduciary Rule for ways to wring out unnecessary regulatory costs and increase access of retirement investment advice by “Mr. and Mrs. 401(k)” (to use the artful phrase of SEC Chair Jay Clayton). As noted above, soon after President Trump took office, he ordered the DOL to conduct this analysis and propose changes to address these concerns.
  • Speaking of the DOL, a number of personnel changes are afoot. Preston Rutledge was nominated by the President to serve as Assistant Secretary. He already had his confirmation hearing and it appeared to go smoothly. It is an open question, however, whether he will be confirmed before the end of the year. In the interim, Jeanne Klinefelter Wilson will serve as Acting Assistant Secretary (and, ultimately, Deputy Assistant Secretary). She is well-regarded by many ERISA lawyers. It is not entirely certain what role these individuals will have on the DOL’s current re-examination of the Fiduciary Rule.

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.