New Jersey is emerging as the state to watch (at least for now) in terms of fiduciary developments. In September of last year, Governor Phil Murphy marked “the 10-year anniversary of the 2008 global financial crisis by announcing plans to issue a rule strengthening the standards for investment professionals in New Jersey to better protect residents seeking to invest their life savings and to close a regulatory gap in federal oversight that helped fuel the economic meltdown a decade ago.” The Bureau of Securities quickly followed suit by proposing a far-reaching regulation that would impose stringent fiduciary duties on broker-dealers for various communications with retail investors. Meanwhile, New Jersey Senator Patrick Diegnan, Jr. has introduced legislation (S 735) in the Senate that would impose disclosure obligations on broker-dealers that are not subject to fiduciary duties (an identical bill has also been introduced in the General Assembly). We have previously noted the similarities of the proposed New Jersey legislation with a bill introduced in New York.
It’s unclear whether the New Jersey legislation is on a separate track and, therefore, could pass or fail irrespective of whether the Bureau of Securities moves forward with its own regulation. If the proposed legislation and regulation are viewed by New Jersey as more of a package, then one wonders how they should interact, if at all. A few points:
- The proposed regulation clearly reflects a skepticism of disclosure as a way to address investor confusion and conflicts of interest. In fact, the regulation says that there is no presumption “that disclosing a conflict of interest in and of itself shall satisfy the duty of loyalty.” As we indicated in our analysis, “The Bureau was dismissive of the value of disclosures, citing evidence that simply disclosing conflicts does not provide adequate protection and does not shield investors from potential financial harm of conflicted advice. This approach is notably different from that of the federal Investment Advisers Act of 1940, which casts its fiduciary duty in disclosure terms.”
- Yet, the legislation is almost entirely disclosure-based. As proposed, broker-dealers not subject to a fiduciary duty would be compelled “to make a plain language disclosure to clients orally and in writing at the outset of the relationship that ensures that individual investors are aware of potential conflicts of interest. The required disclosure shall state the following: “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.”
- For all practical purposes, the legislation assumes somewhat of a fixed fiduciary status, yet the regulation would attach to some communications/conduct, and not others. True, the legislation could in theory apply on a communication-by-communication basis, but is that realistic? You decide. The legislation states: “Any investment advisor that is subject to a fiduciary duty under law or applicable standards of professional conduct with respect to certain types of investment advice, but not others, shall:(1) make a plain language disclosure to clients orally and in writing at the outset of the relationship that ensures the individual investors are aware of the extent to which the fiduciary duty does and does not apply; and (2) comply with the other requirements of this section in any investment advice situation in which a fiduciary duty does not apply.”
- Should the regulation ultimately include a safe harbor for following the disclosure rules in the legislation (assuming the legislation is passed)?
The Bureau of Securities explicitly stated that it believed “that the SEC Regulation Best Interest does not provide sufficient protections for New Jersey investors.” Similar statements have been made by public officials in the state. New Jersey is clearly motivated. It seems unlikely, then, that New Jersey will view SEC Regulation Best Interest, and even complementary guidance/rules from the Department of Labor, as sufficient. The regulation, and even possibly the legislation, seems poised to more forward.
But the legislation and regulation operate in the same universe. How will they interact with each other and be revised, as necessary, to address the concerns for retail investor protection, while also remaining practically and efficiently implemented and enforced?
The comment period for the proposed regulation closes on June 14.
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.