United States: Recent Developments Toward A Fiduciary Standard For Brokers

Much has happened since we last reported on the Department of Labor's Fiduciary Rule.  The compliance deadline was extended 18 months to July 1, 2019.  A federal appellate court vacated the Fiduciary Rule in its entirety.  The U.S. Securities and Exchange Commission finally issued its own proposed "best interest" standard for brokers.  And several state legislatures, frustrated by the lack of progress at the federal level, have picked up the baton of reform with their own proposals.

These efforts – aimed at bringing more clarity and transparency to the industry – continue to create confusion for investment professionals and clients, and to raise challenging questions both legally and politically about whether and how to protect investors while preserving their access to a range of investment products and services.

The DOL Fiduciary Rule

The DOL's Fiduciary Rule was originally scheduled to be phased in from April 10, 2017, to January 1, 2018.  When President Trump took office, he issued a memorandum asking for a review of the Fiduciary Rule, including an economic and legal analysis of its potential impact.  This prompted the DOL to consider delaying implementation of the Fiduciary Rule.  The DOL solicited input during a brief public comment period, after which, it officially delayed implementation by only 60 days.  It cited concerns that further delay would contradict previous findings of ongoing injury to retirement investors.  While the DOL stated publically that the Fiduciary Rule would not be delayed beyond June 9, 2017, it reopened the public comment period for another 30 days on June 30, 2017.  A few weeks later, the DOL proposed an 18-month delay to the Fiduciary Rule's compliance deadline.  The delay was approved, shifting the final deadline for compliance from January 1, 2018, to July 1, 2019. 

This long path toward full implementation of the Fiduciary Rule took another detour on March 15, 2018, when the U.S. Court of Appeals for the Fifth Circuit sitting in New Orleans vacated the Fiduciary Rule in its entirety.  The Chamber of Commerce, along with several other interested industry groups and national associations, sued the DOL on grounds that it exceeded its authority in promulgating the Fiduciary Rule.  Writing for the majority, Circuit Judge Edith Jones held that the DOL acted unreasonably, arbitrarily, and capriciously in expanding a 40-year-old definition of "investment advice fiduciary," and therefore, was not entitled to the deference typically shown to federal agency action.  She added that it was "not hard to spot regulatory abuse of power when an agency claims to discover in a long-extant statute an unheralded power to regulate a significant portion of the American economy." 

After the ruling, the DOL stated that it would not enforce the Fiduciary Rule pending further review.  It had until April 30, 2018, to appeal the Fifth Circuit's decision to the U.S. Supreme Court.  Because it chose not to take action, the Fiduciary Rule will cease to have effect when the Fifth Circuit issues its mandate sometime in mid-May.  It was not at all certain that the U.S. Supreme Court would have granted certiorari because there is not a clear split among the Circuit Courts of Appeals. 

The Fifth Circuit's decision could have a broader impact beyond just the DOL's efforts to impose a fiduciary duty on brokers.  Its ruling rested squarely on the long-recognized distinction between ordinary sales conduct and investment advice, the latter giving rise to heightened duties based on the existence of a special relationship of trust that is the hallmark of a "fiduciary" under the common law.  That same rationale would apply to efforts by the SEC and state legislatures to impose heightened standards on the brokerage industry to protect investors and to mitigate conflicts of interest.

The SEC's Regulation Best Interest

On April 18, 2018, the SEC voted 4-1 in favor of releasing its package of proposed rulemakings and interpretations, which according to an SEC press release, are "designed to enhance the quality and transparency of investors' relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products."  Many have speculated that the SEC felt compelled to accelerate hitting this milestone – eight years in the making – in response to the Fifth Circuit's ruling.

While it might seem absurd to call something that has taken eight years to complete "rushed," that was the reaction by many stakeholders, including Commissioners on both sides of the political aisle.  Even SEC Chairman Jay Clayton acknowledged that criticisms of the proposal "effectively illustrate the complexities we face as we move forward" toward a final set of rules, and "represent the need for public comments."

Republican Commissioner Hester Peirce expressed her reservations that the proposed "best interest" standard of conduct for broker-dealers was an impossible standard that needs more clarity because "whether a particular recommendation is in a customer's best interest is a value-laden judgment."

Under the proposed Regulation Best Interest, a broker-dealer making a recommendation to a retail customer as to any securities transaction or investment strategy involving securities 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 interest of the broker-dealer ahead of the retail customer.  By design, this falls short of the DOL Fiduciary Rule's stricter fiduciary standard and attempts to maintain the distinction between broker-dealers and investment advisers in light of their different relationships with clients.

The term "best interest" is not defined.  Instead, the SEC offered guidance as to how broker-dealers may comply with the new standard:  disclose to retail customers the key facts about their relationship, including material conflicts of interest; exercise reasonable diligence, care, skill, and prudence to form a reasonable basis to believe that the investment recommendation is in the retail customer's best interest; and to establish, maintain, and enforce policies and procedures reasonably designed to identify and to mitigate conflicted financial advice. 

It is not clear how the "best interest" standard differs from the suitability standard that applies to broker-dealers now, or how broker-dealers can be certain that they satisfy the compliance requirements without more clarity on what it means to mitigate conflicts in a particular situation. 

The SEC's proposal also requires a new short-form disclosure document of no more than four pages with simple and easy to understand information about the nature of the relationship between investors and their investment professionals.  This would be in addition to, not in lieu of, existing disclosure requirements, and would include disclosures about fees and costs.  It is not the SEC's intent, however, to prohibit broker-dealers from having conflicts when making recommendations.

The SEC's proposal will be open for a 90-day comment period after its published in the Federal Register.  The only consensus seems to be that a lot of work will have to be done to reach a consensus on the language of a final rule.  Implementation of a final rule will not happen any time soon. 

State Legislative Efforts

Several states are tired of waiting, and in recent months have enacted legislation or proposed regulations that require investment advisers to disclose conflicts of interest and/or to act in their clients' best interests.  A bill in New Jersey would require non-fiduciary advisers to disclose to clients that they are not required to act in the clients' best interest.  Nevada is drafting regulations to implement a law enacted in 2017, which imposes a fiduciary duty on brokers, sales representatives, and investment advisers who give investment advice.  A proposed rule in New York would impose a best interest standard on sellers of life insurance and annuity products as investment vehicles.  A Connecticut law already in effect requires administrators of state-run retirement plans to disclose certain investment fees and fees paid to investment advisers.  The multiplicity of different standards at the state level,  as well as concerns that they could run afoul of federal preemption laws, at least with respect to retirement advice, will likely only complicate matters.

In Maryland, opponents of a proposed fiduciary standard for brokers succeeded in having it removed from both the House and Senate versions of the Financial Consumer Protection Act of 2018.  The proposed fiduciary duty language broadly defined anyone who engages in the business of effecting transactions in securities in a client account as a fiduciary "who has a duty to act primarily for the benefit of its clients."  It also would have required such fiduciaries to disclose, "at the time advice is given, any gain, profit or commission the person may receive if the advice is followed," and to disclose disciplinary actions "material to an evaluation of the person's integrity or ability to meet contractual commitments to clients." 

The Financial Services Institute, an advocacy organization representing independent broker-dealers and financial advisers, lobbied against both the House and Senate bills and argued that states should refrain from enacting their own laws or regulations that could conflict with the SEC's proposal and make compliance difficult, if not impossible. 

The Senate version of the bill, without the fiduciary duty language, directs the Maryland Financial Consumer Protection Commission to study the DOL's Fiduciary Rule and SEC actions in dealing with conflicts of interest of broker-dealers through a heightened standard of care.  Governor Larry Hogan has until the end of May to sign the bill into law or veto it.

Conclusion

These recent developments will not put an end to the debate over whether the brokerage industry needs heightened standards and disclosure requirements.  Opponents and supporters of a fiduciary standard will battle on.  Concerned that the DOL would not act by the April 30th deadline to appeal the Fifth Circuit's decision, AARP and the Attorneys General of the States of New York, California, and Oregon filed motions to intervene requesting leave to file petitions for rehearing en banc.  The Fifth Circuit denied those motions without an opinion in less than one week on May 2, 2018.  The AARP is an ardent supporter of a heightened fiduciary standard for all investment professionals.  Other industry groups have also come out in favor of a uniform fiduciary standard, including the Certified Financial Planner Board of Standards, Inc., the Financial Planning Coalition, and the National Association of Personal Financial Advisors.

The Financial Services Institute, Financial Services Roundtable, Insured Retirement Institute, and Securities Industry and Financial Markets Association stated that they would oppose any motion to intervene this late in the case.  They did not have to because of the Fifth Circuit's denials.  The National Association of Fixed Annuities, which filed a separate lawsuit against the DOL in federal court in the District of Columbia, voluntarily dismissed its case in light of the Fifth Circuit's ruling, stating that it vindicated its concerns and rendered its case moot. 

Still, other interested parties think the best course of action is for the DOL to step aside and let the SEC take the lead.  It has a broader statutory authority to regulate brokers than the DOL and was specifically tasked by Congress under the Dodd-Frank Act to determine what standards should apply to brokers and investment advisers. 

In the end, state and federal regulators and legislators (and perhaps the courts) will have to grapple with the difficult task of providing a clear and practical set of rules that define an investment professional's roles and responsibilities to clients if changes to the current standards are to be effective and efficient.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Cadwalader, Wickersham & Taft LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions