Following the October 15, 2018 issuance of a Notice of Pre-Proposal, the New Jersey Bureau of Securities (the “Bureau”) held two public hearings to solicit comment on the proposed uniform fiduciary standard applicable to all investment advisers and broker-dealers doing business in the state.
Proponents of the fiduciary rule, such as the Consumer Federation of America, favor a state standard because they believe that the SEC’s proposed Regulation Best Interest (“Reg BI”) does not sufficiently protect investors. They argue that Reg BI may “do little more than rebrand the existing FINRA suitability standard as a best interest standard.”
Others such as, Richard Barry, the former Enforcement Chief of the Bureau, assert that while there may be a variety of products that are technically “suitable” for the investor based on the client’s risk profile, current standards do not require the broker to disclose that (i) there may be lower cost options available or (ii) the broker’s recommendation may be driven by potential incentives creating a conflict of interest.
Those like Tamar Frankel, Professor of Law Emerita, Boston University School of Law, therefore push for adopting a duty of loyalty that includes “fully and fairly disclosing the nature of the conflicts of interest so that the client can either reject the broker’s recommendation or provide a written, informed client consent.”
Trade groups representing the financial services industry also support a uniform standard of care, but consider New Jersey’s proposed rule to be premature. They advocate for the Bureau to wait until the SEC and Department of Labor (“DOL”) finalize their rulemaking before deciding whether to move forward with the adoption of a uniform fiduciary standard. The delay would be temporary as the DOL announced plans to issue a revised final fiduciary rule in tandem with the SEC’s final release of Reg BI by September 2019.
Those favoring deferral of the state rulemaking, such as the Financial Services Institute (“FSI”), submit that a patchwork state standard would (i) confuse investors by creating duplicative legislation and different and conflicting state standards; (ii) create undue costs on investors; and (iii) reduce consumer choice and access to investment guidance and products.
Securities Industry and Financial Markets Association (“SIFMA”) contends that Reg BI addresses current concerns and already contains “all the hallmarks of a fiduciary standard, as specifically tailored to the broker-dealer model.” Reg BI imposes obligations at the time of the recommendation that are generally consistent with the fiduciary obligation imposed on an investment adviser. Reg BI proposes that at the point of sale, a broker-dealer must (i) act in the client’s best interest, without placing their financial or other interests ahead of the client’s interest; (ii) act with diligence, care, skill and prudence and weigh the cost of the security in determining whether to make the recommendation; and (iii) disclose and mitigate or eliminate material conflicts of interest.
FSI and the U.S. Chamber of Commerce also caution that creating a state fiduciary duty will lead to unintended and adverse consequences, such as causing harm to the very investors that the rule is intended to protect. The rule may lead to increased costs that will ultimately be passed down to Main Street investors and limitations on market access. This warning was substantiated by a Deloitte & Touche study that found that in response to the DOL fiduciary rule, 53% of the 21 firms surveyed had adopted plans to discontinue offering certain commission based retirement planning services.
The National Association of Insurance & Financial Advisors – New Jersey (“NAIFA NJ”) likewise maintains that a fiduciary rule could push brokers into denying access to commission based accounts for those who hold small account balances. A fiduciary standard may result in middle-income New Jersey residents being driven towards online brokerage services and losing out on quality investment guidance since some fee-based accounts have high minimum asset thresholds.
A New Jersey fiduciary rule could face preemption challenges. The American Retirement Association cautions that the rule may be preempted by Employee Retirement Security Act of 1974 (“ERISA”) § 514(a), if the proposed rule creates fiduciary obligations on qualified ERISA retirement plans. The National Securities Markets Improvement Act of 1996 (“NSMIA”) also expressly preempts a state’s ability to impose record keeping requirements on broker-dealers that differ from those under the Exchange Act. Some commentators however note that NSMIA contains a broad savings clause that permits state enforcement action with respect to “fraud or deceit” and breach of a fiduciary duty may constitute constructive fraud.
Although N.J.S.A. § 49:3-67(a) provides the Bureau Chief with rulemaking powers that are “reasonably necessary to carry out the provisions” of the New Jersey Uniform Securities Laws, the proposed fiduciary rule may also be met with constitutional challenges. Similar to the recent constitutional challenge brought by the National Association of Insurance and Financial Advisors for New York State (“NAIFA-NYS”) against the New York Department of Financial Services’ (“NYDFS”) “best-interest” regulation (Regulation 187, 11 N.Y.C.R.R. § 224), a proposed fiduciary rule that sidesteps the legislative process may be found to be ultra vires if it lacks a state constitutional or statutory predicate.
The opportunity for stakeholders to comment on the Pre-Proposal closes on December 14, 2018. Once the rule is proposed, the public will have an additional 60-day period to comment. We will update this Alert once the Bureau issues its proposed rule.