Activist States Move Forward with Fiduciary Standards for Broker-Dealers and Investment Advisers

April 03, 2018

Although the U.S. Securities and Exchange Commission (SEC) staff is currently drafting proposed rules relating to the standard of conduct for broker-dealers and investment advisers1, several states have decided not to wait for the SEC’s action. Nevada and other states began taking action following the Department of Labor’s (DOL’s) announcement that it had delayed full implementation of the Best Interest Contract Exemption and other aspects of the DOL’s fiduciary rules until July 1, 20192. The state requirements, as with the expected SEC rulemaking, apply to taxable as well as retirement accounts. As discussed below, it is not clear whether the SEC proposed rulemaking to establish a uniform standard of conduct for certain broker-dealers and investment advisers, which we expect to see this quarter, will deter or pre-empt the states from adopting their own rules.

To date, legislation on this topic has been enacted in two states (Connecticut and Nevada) and is pending in another state (New Jersey). In addition, regulations are pending in New York that would impose a fiduciary duty on certain broker-dealers, investment advisers and other financial professionals. As discussed below, the substance of the laws (or proposed laws or rules) varies.3 The following is a summary of these states’ initiatives. 

Connecticut 

On July 5, 2017, Governor Dannel P. Malloy signed into law An Act Protecting the Interests of Consumers Doing Business with Financial Planners (Connecticut Act).4 The Connecticut Act requires financial planners that are not subject to a fiduciary duty to disclose that fact to clients, upon request. The Connecticut Act also requires financial planners that are subject to a fiduciary duty to disclose that duty to clients, when requested. 

A "financial planner" is defined in the Connecticut Act 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.” “Fiduciary duty” is defined in the Connecticut Act as “a duty to act with prudence in the best interests of a consumer with undivided loyalty to such consumer.” 

Beginning July 5, 2017, financial planners offering financial planning or investment advisory services to Connecticut consumers have been required to disclose to consumers, upon request, whether or not the financial planner has a fiduciary duty to the consumer with regard to each recommendation that is made. 

Nevada 

On June 2, 2017, Governor Brian Sandoval signed into law Nevada Senate Bill 383 (Nevada Law).5 Effective July 1, 2017, the Nevada Law revised the definition of “financial planner” in the Nevada Revised Statutes to include broker-dealers, sales representatives, and investment advisers who, for compensation, advise others regarding the investment of money or provision for future income, or who holds himself or herself out as qualified to perform either of those functions.6 While Nevada imposes a fiduciary duty on financial planners, previously broker-dealers, sales representatives and investment advisers had been excluded from the definition of financial planner. 

The Nevada Law also amended Chapter 90 of the Nevada Revised Statutes to prohibit a broker-dealer, sales representative, investment adviser, or representative of an investment adviser (Securities Professionals) from violating the fiduciary duty toward a client imposed by Nevada law on a financial planner. The Nevada Law further authorizes Nevada’s securities administrator (The Administrator of the Nevada Securities Division, Office of the Secretary of State) to define the scope of the fiduciary duty of Securities Professionals, and to impose regulations that are reasonably designed to prevent Securities Professionals from violating their fiduciary duty.7 The Nevada securities administrator is currently drafting implementing regulations. 

New Jersey 

On January 9, 2018, two identical bills entitled An Act Concerning Non-Fiduciary Investment Advisors were introduced in both chambers of the New Jersey state legislature (New Jersey Bills). One bill was introduced in the New Jersey Assembly by Assemblywoman Pinkin (D-Middlesex) and Assemblyman Chiaravalloti (D-Hudson).8 The second bill was introduced in the New Jersey Senate by Senator Diegnan (D-18).9 

The New Jersey Bills would require a “non-fiduciary investment adviser” (as described below) to provide written disclosure (Disclosure) to individual investors at the inception of the relationship, stating that the investment adviser does not have a fiduciary relationship with the client. The Disclosure also would have to be provided subsequently, together with advertising materials and oral investment advice. In addition, the New Jersey Bills would require that the client provide a written acknowledgment of the Disclosure. 

A “non-fiduciary investment adviser” would be defined as “any individual or institution that advertises or uses in self-identification any term that is suggestive of investment, financial planning, or retirement planning knowledge or expertise, including a broker, dealer, investment adviser, financial advisor, financial planner, financial consultant, retirement planner, retirement broker, or retirement consultant.” Investment advisers subject to a fiduciary duty under federal or state law or regulation, or by applicable standard of professional conduct, would be exempt. 

The Disclosure must state: “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.” 

Exempt advisers would be required to: (1) disclose to clients, in plain English, orally and in writing, at the outset of the relationship the extent to which their fiduciary duty does, and does not, apply; and (2) provide the Disclosure in any investment advice situation when the fiduciary duty does not apply. 

Violation of the statutes would be punishable by a fine of up to $5,000. 

The New Jersey Bills are currently pending in their respective legislative committees, the Assembly Financial Institutions and Insurance Committee and the Senate Commerce Committee. 

New York 

On December 27, 2017, the New York Department of Financial Services (DFS) proposed a “best interest” standard for life insurance and annuity transactions to supplement existing consumer protections in the state of New York.10 The proposed rule would require those licensed to sell life insurance and annuity products to act in the consumer’s best interest when making a recommendation. According to DFS’s proposed standard, a transaction is in the best interests of a consumer when the transaction is: (i) in furtherance of a consumer’s needs and objectives; (ii) suitable; and (iii) recommended to the consumer without regard to the financial interest of the product seller. Importantly, the proposal expands the definition of “recommendation” and formally defines “suitable.” 

“Recommendation” is proposed to be defined as “one or more statements or acts by a producer or by an insurer … that reasonably may be interpreted by a consumer to be advice and that results in a consumer entering into or refraining from entering into a transaction in accordance with that advice….” Further, insurers would be required to develop and maintain procedures to protect consumers from financial exploitation. 

A recommendation or transaction is proposed to be “suitable” when it is in “furtherance of a consumer’s needs and objectives under the circumstances then prevailing, based upon the suitability information provided by the consumer and all available products, services, and transactions.” “Consumer” is proposed to be defined as “the owner or prospective purchaser of a policy,” with “policy” proposed to be defined as “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.” 

The 60-day comment period ended on February 26, 2018. 

Conclusion 

Notwithstanding this surge of activity at the state level, one question that has not been addressed is whether states have the authority to enact separate requirements in light of the SEC’s anticipated uniform standard of conduct rulemaking. Section 913(g) of the Dodd-Frank Act (which amended Section 15(k) of the Securities Exchange Act of 1934) authorized (but did not require) the SEC to “promulgate rules to provide that, with respect to a broker or dealer, when providing personalized investment advice about securities to a retail customer (and such other customers as the [SEC] may by rule provide), the standard of conduct for such broker or dealer with respect to such customer shall be the same as the standard of conduct applicable to an investment adviser under Section 211 of the Investment Advisers Act of 1940.”11 

Further, recent case law supports the view that Congress, through the Dodd-Frank Act, specifically conferred upon the SEC the authority to uniformly regulate brokers and dealers.12 Additional pre-emption arguments may be available, including that state standards are pre-empted by Section 15(i) of the Securities Exchange Act of 1934, which was added by the National Securities Markets Improvement Act of 1996. Moreover, if the SEC were to exercise its rulemaking authority under Section 913 of the Dodd-Frank Act, a preemption argument could be advanced based on the theory that the SEC has already “occupied the field” in its anticipated uniform standard of conduct rulemaking. The uncertain future of the DOL fiduciary rules after the recent Fifth Circuit decision vacating the rules in their entirety adds to questions about the states’ authority.13 

Footnotes 

1) See, e.g., Steve Garmhausen, SEC’s Clayton on Fiduciary Rule: “The Sooner the Better”, Barron’s (March 19, 2018); Mark Schoeff Jr., SEC Chairman Jay Clayton Outlines Goals for a New Fiduciary Standard, Investment News (Feb. 23, 2018); Office of Information and Regulatory Affairs, Office of Management and Budget: View Rule (Fall 2017).
2) DOL, 18-Month Extension of Transition Period and Delay of Applicability Dates; Best Interest Contract Exemption (PTE 2016-01); Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs (PTE 2016-02); Prohibited Transaction Exemption 84-24 for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, and Investment Company Principal Underwriters (PTE 84-24) (Nov. 24, 2017), available at Federal Register.
3) Bills imposing a fiduciary duty on broker-dealers and investment advisers were introduced in both chambers of the Maryland legislature in February 2018 (Maryland Senate Bill 1068 and House Bill 1634); however, both chambers removed the relevant provisions from later versions of the bills.
4) CT Pub. Act 17-120.
5) NV SB383.
6) Notably, agents of investment advisers had always been included in the definition of “financial planner.”
7) If the regulations implemented by the Nevada securities administrator impose books and records requirements on investment advisers that are registered with the SEC or another state, or on broker-dealers that are registered with the SEC or FINRA, those regulations might be pre-empted by the National Securities Markets Improvement Act of 1996.
8) 2018 NJ A335.
9) 2018 NJ S735.
10) NYS DFS Proposed First Amendment to 11 NYCRR 224 (Insurance Regulation 187).
11) Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376, 1828 (2010).
12) See U.S. Chamber of Commerce v. DOL, No. 17-10238, 2018 WL 1325019, at *42 (5th Cir. Mar. 15, 2018).
13) Id.