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How New Jersey’s Proposed Uniform Fiduciary Standard Will Impact Brokers/Financial Advisors
Author: Scarinci Hollenbeck, LLC
Date: May 8, 2019
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New Jersey is Poised to Become the First State in the Country to Enact a Uniform Fiduciary Standard for All Financial Advisors…
New Jersey is poised to become the first state in the country to enact a uniform fiduciary standard for all financial advisors, including both investment advisors and broker-dealers. The new rule proposal, N.J.A.C. 13:47A-6.4, is now open for public comment.
According to the Bureau of Securities (Bureau) within the Division of Consumer Affairs, “the proposed new rule is necessary to ensure that persons involved in the securities markets are uniformly held to a high standard in their dealings with the general public and is necessary to ensure the welfare of New Jersey investors.” The Bureau further maintains that “the proposed new rule will establish a uniform standard for financial professionals and rectify investor confusion that results from the lack of uniformity.”
Prior Fiduciary Duty Proposals
Investment advisors (Series 65/66 license) owe their customers a fiduciary duty, which includes duties of loyalty and care. Broker-dealers (Series 7) are subject to a less-stringent ‘suitability standard’, which requires having reasonable grounds to believe that the strategy, transaction, or recommendation is suitable for the customer, based upon reasonable inquiry concerning the customers’ investment objectives, financial situation, and needs, and any other relevant information known by the broker-dealer.
Since the 2008 financial crisis, there were increasing calls for a uniform investment advice rule that applies to both investment advisors and broker-dealers. However, there was little agreement on the best path forward to a unitary standard. The Department of Labor (DOL) finalized its fiduciary rule in 2016, which redefined who is a “fiduciary” under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code). After a series of implementation delays, the U.S. Fifth Circuit Court of Appeals officially vacated the rule as of June 21, 2018.
The Securities and Exchange Commission (SEC) also proposed its own Regulation Best Interest (“Regulation BI”). Under the SEC proposed rule, which was slow to advance through the regulatory approval process, a broker-dealer making a recommendation to a retail customer would have a duty to act in the ‘best interest’ of the retail customer at the time the recommendation is made, without putting the financial or other interests of the broker-dealer ahead of the retail customer.
Notably, New Jersey’s proposed fiduciary standard would be more stringent than the SEC’s Regulation BI. As several commenters to the NJ proposal noted, the SEC Regulation BI standard is greater than that of the suitability rule but less than that of a fiduciary duty, the Bureau stated in its rule summary. “The Bureau believes that the SEC Regulation BI does not provide sufficient protections for New Jersey investors.”
New Jersey’s Proposed Uniform Fiduciary Standard
New Jersey’s proposed fiduciary rule requires all registered financial services professionals to act in accordance with the fiduciary duty to their customers when providing investment advice or recommending to a customer an investment strategy, the opening of or transfer of assets to any type of account, or the purchase, sale, or exchange of any security. Conduct falling short of this fiduciary duty would constitute a “dishonest and unethical practice.”
As outlined by the Bureau, below are several other key provisions of N.J.A.C. 13:47A-6.4:
- In accordance with the common law definition of fiduciary duty, both the duty of care and duty of loyalty must be satisfied.
- For purposes of the duty of care, the broker-dealer, agent, or advisor must make reasonable inquiry, including risks, costs, and conflicts of interest related to the recommendation or investment advice, and the customer’s investment objectives, financial situation, and needs, and any other relevant information.
- The recommendation or the advice provided to the customer must be made without regard to the financial or any other interest of the broker-dealer, agent, advisor, any affiliated or related entity, and its officers, directors, agents, employees or contractors, or any other third-party.
- When a broker-dealer or its agent makes a recommendation, the fiduciary duty obligation extends through the execution of the recommendation and shall not be deemed an ongoing obligation.
- Transaction-based fees are allowed in certain circumstances provided that the fee is reasonable and is the best of the reasonably available fee options for the customer, and the duty of care is satisfied.
- To address the concerns over dual registrants “switching hats” when dealing with the same customer and the resulting investor confusion, the fiduciary duty obligation shall be applicable to the entire relationship with the customer on an ongoing basis.
- Harmful incentives, such as sales contests, that encourage and reward conflicted advice are presumptively invalid.
- There is no presumption that disclosing a conflict of interest in and of itself will satisfy the duty of loyalty.
What’s Next?
New Jersey’s proposed rule is now subject to a 60-day public comment period during which stakeholders will have an opportunity to submit written comment on the proposed rule. The deadline is June 14, 2019. A summary of the public comments and the Bureau’s response to them will be published in a Notice of Adoption expected sometime in the fall. Upon publication of the Notice of Adoption, the rule becomes final and will take effect in 90 days.
If enacted, New Jersey’s uniform fiduciary standard is likely to face legal challenges by the financial industry. Critics contend that the state has exceeded its authority and must wait for the SEC to act. The SEC’s final rule is expected late summer/early fall, although the agency has not publicly committed to a specific timeline.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.
- Practices: Corporate Transactions & Business, Investment Banking
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How New Jersey’s Proposed Uniform Fiduciary Standard Will Impact Brokers/Financial Advisors
Author: Scarinci Hollenbeck, LLC
New Jersey is Poised to Become the First State in the Country to Enact a Uniform Fiduciary Standard for All Financial Advisors…
New Jersey is poised to become the first state in the country to enact a uniform fiduciary standard for all financial advisors, including both investment advisors and broker-dealers. The new rule proposal, N.J.A.C. 13:47A-6.4, is now open for public comment.
According to the Bureau of Securities (Bureau) within the Division of Consumer Affairs, “the proposed new rule is necessary to ensure that persons involved in the securities markets are uniformly held to a high standard in their dealings with the general public and is necessary to ensure the welfare of New Jersey investors.” The Bureau further maintains that “the proposed new rule will establish a uniform standard for financial professionals and rectify investor confusion that results from the lack of uniformity.”
Prior Fiduciary Duty Proposals
Investment advisors (Series 65/66 license) owe their customers a fiduciary duty, which includes duties of loyalty and care. Broker-dealers (Series 7) are subject to a less-stringent ‘suitability standard’, which requires having reasonable grounds to believe that the strategy, transaction, or recommendation is suitable for the customer, based upon reasonable inquiry concerning the customers’ investment objectives, financial situation, and needs, and any other relevant information known by the broker-dealer.
Since the 2008 financial crisis, there were increasing calls for a uniform investment advice rule that applies to both investment advisors and broker-dealers. However, there was little agreement on the best path forward to a unitary standard. The Department of Labor (DOL) finalized its fiduciary rule in 2016, which redefined who is a “fiduciary” under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code of 1986 (Code). After a series of implementation delays, the U.S. Fifth Circuit Court of Appeals officially vacated the rule as of June 21, 2018.
The Securities and Exchange Commission (SEC) also proposed its own Regulation Best Interest (“Regulation BI”). Under the SEC proposed rule, which was slow to advance through the regulatory approval process, a broker-dealer making a recommendation to a retail customer would have a duty to act in the ‘best interest’ of the retail customer at the time the recommendation is made, without putting the financial or other interests of the broker-dealer ahead of the retail customer.
Notably, New Jersey’s proposed fiduciary standard would be more stringent than the SEC’s Regulation BI. As several commenters to the NJ proposal noted, the SEC Regulation BI standard is greater than that of the suitability rule but less than that of a fiduciary duty, the Bureau stated in its rule summary. “The Bureau believes that the SEC Regulation BI does not provide sufficient protections for New Jersey investors.”
New Jersey’s Proposed Uniform Fiduciary Standard
New Jersey’s proposed fiduciary rule requires all registered financial services professionals to act in accordance with the fiduciary duty to their customers when providing investment advice or recommending to a customer an investment strategy, the opening of or transfer of assets to any type of account, or the purchase, sale, or exchange of any security. Conduct falling short of this fiduciary duty would constitute a “dishonest and unethical practice.”
As outlined by the Bureau, below are several other key provisions of N.J.A.C. 13:47A-6.4:
- In accordance with the common law definition of fiduciary duty, both the duty of care and duty of loyalty must be satisfied.
- For purposes of the duty of care, the broker-dealer, agent, or advisor must make reasonable inquiry, including risks, costs, and conflicts of interest related to the recommendation or investment advice, and the customer’s investment objectives, financial situation, and needs, and any other relevant information.
- The recommendation or the advice provided to the customer must be made without regard to the financial or any other interest of the broker-dealer, agent, advisor, any affiliated or related entity, and its officers, directors, agents, employees or contractors, or any other third-party.
- When a broker-dealer or its agent makes a recommendation, the fiduciary duty obligation extends through the execution of the recommendation and shall not be deemed an ongoing obligation.
- Transaction-based fees are allowed in certain circumstances provided that the fee is reasonable and is the best of the reasonably available fee options for the customer, and the duty of care is satisfied.
- To address the concerns over dual registrants “switching hats” when dealing with the same customer and the resulting investor confusion, the fiduciary duty obligation shall be applicable to the entire relationship with the customer on an ongoing basis.
- Harmful incentives, such as sales contests, that encourage and reward conflicted advice are presumptively invalid.
- There is no presumption that disclosing a conflict of interest in and of itself will satisfy the duty of loyalty.
What’s Next?
New Jersey’s proposed rule is now subject to a 60-day public comment period during which stakeholders will have an opportunity to submit written comment on the proposed rule. The deadline is June 14, 2019. A summary of the public comments and the Bureau’s response to them will be published in a Notice of Adoption expected sometime in the fall. Upon publication of the Notice of Adoption, the rule becomes final and will take effect in 90 days.
If enacted, New Jersey’s uniform fiduciary standard is likely to face legal challenges by the financial industry. Critics contend that the state has exceeded its authority and must wait for the SEC to act. The SEC’s final rule is expected late summer/early fall, although the agency has not publicly committed to a specific timeline.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Paul Lieberman, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.