SIFMA CEO Kenneth E. Bentsen, Jr. and several trade associations criticized the fiduciary conduct standard proposed by the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth (the "Division"). In addition, they urged the Division to defer to the SEC-approved Regulation Best Interest Standard (see previous coverage).

As previously covered, the Division proposed a fiduciary conduct standard for broker-dealers, agents, investment advisers and investment adviser representatives ("entities"). Specifically, the amendments would:

  • apply a uniform fiduciary conduct standard to entities when dealing with customers and clients in certain situations;

  • deem entities that fail to comply with the fiduciary standard of utmost care and loyalty as demonstrating "unethical or dishonest conduct or practices";

  • adopt a "flexible, principles-based" approach when applying the standard of conduct to entities, contingent upon the scope of the relationship with the client; and

  • clarify the existing suitability standard.

In testimony provided on behalf of SIFMA at the Division's public hearing on the proposed amendments, Mr. Bentsen noted that:

  • the Division is "premature" in its assumption that the SEC's Reg. BI would not sufficiently protect retail investors;

  • the fiduciary duty imposed on brokerage accounts would restrict "cost-conscious" choices for investors such as brokerage services;

  • the proposal would have an adverse effect on Massachusetts's municipal and corporate markets; and

  • the proposal poses various legal issues, most notably those involving preemption.

Separately, SIFMA, the American Council of Life Insurers, the American Securities Association, the Association for Advanced Life Underwriting, the Chamber of Commerce, the Institute for Portfolio Alternatives, the Financial Services Institute, the Insured Retirement Institute, the Life Insurance Association of Massachusetts, the National Association of Insurance and Financial Advisors ("NAIFA"), the Small Business Investor Alliance, the National Association for Fixed Annuities, and NAIFA Massachusetts expressed their "serious concerns" with the proposal. In a joint comment letter, they argued that the proposal:

  • creates higher costs and restricted opportunities for investors;

  • prematurely deems the SEC's Reg. BI Standard as inadequate to protect investors;

  • is unclear as to whether the amendments apply to SEC-registered advisers and their representatives;

  • imposes ongoing monitoring requirements that are inconsistent with the current brokerage model and could lead to limiting consumer choice;

  • includes an "Avoid Conflicts" requirement that is "ambiguous" and conflicts with federal law;

  • uses language that is "unworkable," namely the requirement to "make recommendations and provide investment advice without regard to the financial or any other interest of any party other than the customer or client";

  • should provide a clear exemption for commodities and insurance products;

  • should include additional clarification concerning the language of the principal transaction;

  • implements a "Disclosure Obligation" providing that disclosure alone does not demonstrate the duty of loyalty, which should be modified to account for instances where disclosure alone is sufficient;

  • raises preemption and other related legal concerns; and

  • should establish an appropriate future effective date and "provide for a sufficient implementation period."

Commentary

The competition among the states to outdo the federal government - and each other - in promulgating rules to protect financial consumers will have real economic consequences.

The likely result is increased pressure on the "full service" broker-dealer models, where broker-dealers provide both investment recommendations and trade execution to customers. See, e.g., Choose One - Best Interest or Full Service. For customers that do not want to pay - or do not have sufficient assets to pay - an assets under management fee, this would be a bad outcome. It will also likely result in broker-dealers steering customers away from individual securities, and particularly from smaller companies, into funds or bigger name issuers. Individual investors will be steered into "safer" investments but also away from those that might have a greater upside (as well as greater risk). Smaller companies will have a harder time raising funding.

To date, the state regulators seem unwilling to acknowledge that there are potential negative consequences to their proposed regulations, that those consequences should be taken into account, or, more generally, that broad proscriptions should weigh potential detriments.

That said, in politics, as with markets, sometimes you can't fight the tape.