New Jersey Bureau of Securities Proposes New Rule to Create State-Level Fiduciary Duties For Broker-Dealers, Associated Persons, Investment Advisers and Investment Adviser Representatives
On April 15, 2019, the New Jersey Bureau of Securities, within the Division of Consumer Affairs, proposed a new state-level rule requiring 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 of any type of account, or the purchase, sale, or exchange of any security. Under the proposed rule, any conduct falling short of this fiduciary duty would constitute a “dishonest and unethical practice.”
Under current federal standards, only investment advisers subject to the Investment Advisors Act of 1940 and their representatives operate subject to a fiduciary duty standard. Among other differences from their investment adviser counterparts, broker-dealers and their associated persons typically receive only commissions for transactions they facilitate and for selling financial products – not compensation for financial planning, discretionary trading or investment portfolio advice and management. New Jersey proposes a substantial expansion of regulatory requirements on broker-dealers and their associated persons conducting business within the State of New Jersey.
The Proposed Rule
Dishonest or Unethical Practices
The proposed regulation, N.J.A.C. 13:47A-6.3 and N.J.A.C. 13:47A-6.4, seeks to impose a uniform, state-level duty of care and loyalty for both investment advisers and their representatives as well as broker-dealers and their associated persons doing business within the State. The State’s proposal is a product of its dissatisfaction with the pace of meaningful change to the federal regulatory framework following the United States Department of Labor’s failed Fiduciary Rule* and the scope of the United States Securities and Exchange Commission’s proposed Regulation Best Interest**, to promulgate a new, uniform federal interest ahead of the customer’s interest; (ii) act with diligence, care, skill and prudence; and (iii) disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with the recommendation. Regulation Best Interest does not apply a fiduciary standard to broker-dealers or its associated persons. In addition, Regulation Best Interest allows some duty of loyalty conflict of interests to be mitigated through disclosure to the customer.
Expanded Reach and Duration
As proposed, the fiduciary duty would apply to recommendations to purchase, sell or hold securities and to recommendations about investment strategy, the opening of an account or the transfer of assets to any type of account. Further, the new duty would also apply to contractual and discretionary fiduciaries in addition to investment advice fiduciaries. Moreover, if investment advice is provided, the new fiduciary duty rule would impose an ongoing fiduciary duty for the entire relationship. In other words, dual registered persons who provide both brokerage recommendations and investment advice to a retail customer would be subject to the fiduciary duty for the life of the relationship***
Creating New and Rejecting Old Presumptions
The proposed rule also creates a new presumption that the investment adviser, its representative, the broker-dealer or its associated person breaches the duty of loyalty for any recommendation concerning the opening of, or transfer of assets to a specific type of account, or the purchase, sale or exchange of a specific security “that is not the best of the reasonably available options.” According to the State, the payment of transaction-based fees to broker- dealers or associated persons will not itself be deemed a breach of fiduciary duty, however, so long as “the fee is reasonable and is the best of the reasonably available fee options and the duty of care is satisfied.”
The regulation, if adopted in current form, disallows a presumption that disclosing a conflict of interest satisfies the duty of loyalty.
The proposed regulation applies to retail customer only, i.e., not banks, savings and loan associations, insurance companies, investment advisers, broker-dealers, fiduciaries to employee benefit plans, its participants or beneficiaries, or individuals with at least $50 million in assets.
Books and Records Requirements
Ostensibly to avoid federal preemption, the State’s proposal does not require any new or additional capital, custody, margin, financial responsibility, making and keeping of records, bonding or financial or operational reporting requirements on broker-dealers beyond those already required by federal law.
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If you have any questions about the issues addressed in this Broker-Dealer Regulation Alert, if you would like a copy of any of the materials mentioned in it or if you would like to continue to receive Broker-Dealer Regulation Alerts, please do not hesitate to call or email Securities and Commercial Litigation and Securities Regulatory Practice Partner Daniel Scott Furst at (646) 810-2185 or sfurst@srf.law ****
*The Department of Labor’s rule was to be implemented starting April 10, 2017, however, on or about June 21, 2018, the United States Fifth Circuit Court of Appeals vacated the rule, effectively killing it.
***Broker-dealer associated persons who act in a broker-only capacity, however, would be subject to the fiduciary duty only through the transaction’s execution.
**The final rulemaking of Regulation Best Interest was approved in a 3-to-1 vote by the Commission on June 5, 2019. Regulation Best Interest is effective 60 days after publication in the Federal Register, and the anticipated implementation date is June 30, 2020. Regulation Best Interest would create a national, heightened standard of conduct for broker-dealers. Regulation Best Interest provides that when a broker- dealer or its associated person recommends securities transaction or investment strategy, the broker-deal or associated person must: (i) act in the customer’s best interest, without placing its financial or other standard applicable to investment advisers and broker-dealers. Specifically, the proposed regulation would define a “dishonest or unethical practice” to include: recommending to a customer, an investment strategy, the opening of, or transfer of any assets to, any type of account, or the purchase, sale, or exchange of any security or securities without reasonable grounds to believe that such strategy, transaction, or recommendation is suitable for the customer based upon reasonable inquiry concerning the customer’s investment objectives, financial situation, and needs, and any other relevant information known by the broker-dealer[.]
****This Broker-Dealer Regulation Alert is for general information purposes only of interest to New Jersey broker-dealers and is not intended to advertise our services, solicit clients or represent our legal advice.
