Financial Advisor IQ

Fiduciary Battle Spreads To New Jersey, Massachusetts And Nevada

Financial Advisor IQ — June 18, 2019

By Rita Raagas De Ramos

The battle over the fiduciary standard is far from over.

Various states are moving ahead with plans to fill the void they believe was left when the Department of Labor was forced to vacate its fiduciary rule and the SEC failed to meet their expectations with Regulation Best Interest.

The comment period for New Jersey's proposed fiduciary rule ended Friday, but was later extended to July 18, one day after a public hearing on the proposal will be held, according to law firm Stradley Ronon. Also on Friday, Massachusetts proposed its own fiduciary standard for broker-dealers and other financial professionals. Meanwhile, Nevada is working on the fiduciary rule it proposed in January.

Tens of thousands of brokers and registered representatives stand to be affected by these pending state initiatives. There were 4,949 broker-dealer branches in New Jersey, 3,625 in Massachusetts and 1,278 in Nevada as of 2017, the latest data released by self-regulator Finra. Combined, those three states made up 6% of the total broker-dealer branches in the U.S. in 2017.

Supporters and critics of New Jersey's proposal — Fiduciary Duty of Broker-Dealers, Agents, Investment Advisers and Investment Adviser Representatives — incorporated the SEC's recently approved Reg BI in their arguments.

The New Jersey proposal requires all investment professionals registered with its Bureau of Securities to act as fiduciaries to their customers when providing investment advice or recommending an investment strategy; the opening of or transfer of assets to any type of account; or the purchase, sale or exchange of any security.

Investor protection groups threw their support behind the New Jersey proposal. Several aspects of the proposal are "vastly more protective of investors" than Reg BI, according to a comment letter submitted by 17 investor protection groups, including the Alliance for Retired Americans, Americans for Financial Reform Education Fund, the Consumer Federation of America and New Jersey Citizen Action.

The groups say New Jersey's proposal offers better investor protection because it applies a uniform fiduciary standard across an "appropriately broad range of advisory activities."

The proposal also has a specific formulation of the fiduciary standard, which would ensure investment advice given by broker-dealers and advisors is not tainted by conflicts of interest, the groups add.

But the uniform fiduciary standard applied by the proposal to brokers and advisors is among the main problems concerning critics of the New Jersey proposal.

As far as the Financial Services Institute is concerned, imposing a fiduciary duty for broker-dealers "will detrimentally blur the meaningful distinctions between brokerage services and advisory services in New Jersey," Robin Traxler, FSI's deputy general counsel, says in a comment letter.

"A broker-dealer's relationship with its customers is fundamentally different from that of an investment adviser's relationship with its clients," adds FSI, a lobby group for independent financial advisors and independent financial services firms.

That argument is in line with the SEC's explanation that it wanted Reg BI to preserve the broker-dealer model and investor choice.

Broker-dealers provide retail clients with a range of services — from execution-only to personalized investment advice in the form of recommendations of securities transactions or investment strategies involving securities, FSI notes. And because of this range of services, the broker-dealer model is particularly useful to low- and middle-income investors who may not be able to afford financial advice and services provided by advisors, according to FSI.

"Imposing a fiduciary duty on a customer's relationship with its broker-dealer is artificial and confuses the fundamental purpose of the brokerage relationship with that of an advisory relationship," FSI says. "The proposal will serve to disadvantage the basic brokerage model and result in harm to New Jersey's retail investors," especially the low- to middle-income retail investors.

New Jersey's goal of achieving a uniform fiduciary standard will create "divergent" standards for New Jersey investors because it will be easier for the "mega-wealthy" to access broker-dealers, FSI says. The proposed rule is for broker-dealers and other financial professionals who service retail customers, partly defined in the proposal as those with account sizes below $50 million.

"All New Jersey residents should be treated equally under bureau regulations," Christopher Iacovella, CEO of the American Securities Association, a lobby group for middle-market financial services firms, says in a comment letter.

"Preserving financial advice for the wealthy while leaving the middle class to fend for itself or unnecessarily use more expensive account options is a bad outcome for New Jersey. It unfairly disadvantages those in the state who are most vulnerable to our nation's savings crisis," Iacovella adds.

Both the ASA and FSI are also against the use of specific language in the proposed rule. The proposal requires broker-dealers to recommend investments "without regard to" the financial interest of the broker-dealer, representatives or third parties.

Those three words — "without regard to" — originate from the Dodd-Frank Wall Street Reform and Consumer Protection Act but has since been clarified by the SEC with Reg BI, according to FSI.

The SEC notes that the Dodd-Frank Act didn't intend to require broker-dealers to provide conflict-free recommendations, FSI explains.

Instead, the SEC omitted "without regard to" from Reg BI. In its place, the SEC requires broker-dealers to "act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer."

Also in Reg BI, the SEC notes that the "without regard to" language "could ultimately harm retail investors by reducing their access to differing types of investment services and products and by increasing their costs."

ASA argues that the "without regard to" standard reflects an approach to consumer protection that has been proven to hurt the very people it attempts to help — the same standard used in the now-vacated DOL rule, ASA adds.

"Our concerns of consumer harm are not theoretical," ASA says. "The SEC found that there was a significant reduction in retail investor access to brokerage services, and ... available alternative sources were higher priced in many circumstances once firms began implementing the DOL's fiduciary rule."

In supporting the New Jersey proposal, the 17 investor protection groups are saying it's right for broker-dealers to be held to a fiduciary standard because they market themselves as if they are indeed being held to that standard.

"There are myriad ways in which broker-dealers seek to persuade the investing public that they are providing objective, trustworthy investment advice rather than mere sales pitches," the groups say in their comment letter.

For example, broker-dealers and their registered representatives "routinely market themselves as financial advisors, financial consultants or wealth managers, giving the impression of specialized advisory expertise. They commonly describe their services as investment advice or retirement planning and market those services as designed to serve customers' best interests," the groups say.

"In holding themselves out as impartial experts, they seek to occupy positions of trust and confidence with their customers ... The harm to investors is immense when they reasonably, but mistakenly believe they are getting advice that's in their best interest based on a trusted relationship with their financial professional," the groups add.

The investor protection groups also commended the New Jersey proposal for addressing concerns related to companies dually registered as broker-dealers and advisors.

"Hat switching occurs when a dual registrant provides both brokerage and investment advisory services to the same customer," the groups say. "Because the firm and financial professional are regulated under different standards for the different accounts they serve, switching hats can confuse investors about the services they are being provided and the duties they are owed for each account."

New Jersey wants to adopt a more rigorous approach to hat switching by requiring dual registrants to comply with an ongoing fiduciary duty when dealing with a customer who has both brokerage and advisory accounts with the firm, the groups say.

The end of New Jersey's comment period came just as the Massachusetts Securities Division released for preliminary comment a proposed regulation to apply a fiduciary standard — which is based on the common law fiduciary duties of care and loyalty — on broker-dealers, agents, investment advisors and investment advisor representatives when dealing with customers and clients.

In August last year, William Galvin, Secretary of the Commonwealth of Massachusetts, wrote in a comment letter: "If the Commission does not adopt a strong and uniform fiduciary standard, Massachusetts will be forced to adopt its own fiduciary standard to protect our citizens from conflicted advice by broker-dealers."

In January, Nevada proposed a rule that requires a broker or sales representative who provides investment advice to clients, manages assets, performs discretionary trading, uses a title advisor or adviser, financial planner or financial consultant, retirement consultant/retirement planner, wealth manager, counselor or other "appropriate" related titles to act as fiduciaries.

Meanwhile, the DOL is going to take another shot at crafting a new fiduciary rule since its previous attempt was struck down last year by the U.S. Court of Appeals for the Fifth Circuit. This time, the DOL is collaborating with the SEC on the new fiduciary rule, according to DOL Secretary Alexander Acosta.

Copyright 2019 Hearst Communications, Inc.

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