Regulatory Outlook | 09.02.20
Had Enough Of Reg BI Yet? Meet 'The Massachusetts Rule'
The U.S. Securities and Exchange Commission isn’t expected to bring any hammers down upon broker-dealers found to have run afoul of conduct standards set forth in its Regulation Best Interest; not this year, anyway.
As for the enforcement of the Massachusetts Securities Division's new, more onerous fiduciary rule (which went into effect September 1), industry members, particularly within the state but also outside of it, will be watching and waiting. Early indications suggest it could already be hammer time.
Meanwhile, many broker-dealers are becoming increasingly consternated over a confusing regulatory patchwork, as feared, now shaping up. And if you happen to find yourself supervising a BD team in the Bay State, well, don't even think about staging a sales contest.
Massachusetts’ new fiduciary rule affects broker-dealer firms and their agents when making investment recommendations to retail clients. The rule was announced last summer in direct response to the SEC’s "Reg BI" rules package deemed by critics (such as Massachusetts Secretary of the Commonwealth, William Galvin) as failing to provide meaningful investor protections.
The Massachusetts rule covers recommendations concerning securities but does not explicitly apply to advice on commodities or insurance products.
Unlike Reg BI, the rule explicitly applies a “fiduciary” obligation to brokers.
Additionally, the Massachusetts rule prohibits sales contests, period.
Reg BI, on the other hand, merely requires brokers to implement policies and procedures to eliminate certain types of sales contests such as those that take place during a finite period of time or involving specific securities or types of securities.
Just last week, TD Ameritrade, on behalf of Scottrade (acquired by TD Ameritrade in 2018) settled, without admitting or denying any findings, improper-sales-contest-related supervision failure allegations. The charges were brought against Scottrade in 2017 by Galvin, who is Massachusetts' top securities regulator, and who at the time was making a stand against the Trump Administration's move to squash a new fiduciary standard for BDs scheduled to be imposed by the Department of Labor. Applying to certain situations, i.e., when BDs advised IRA accounts, the standard came to be known as the “fiduciary rule” and was eventually vacated by the courts.
Ben Marzouk, an attorney with Washington, D.C.-based Eversheds Sutherland, noted that “it’ll be interesting to see how Massachusetts enforces compliance with their new fiduciary rule, specifically the sales-contest prohibition, in light of the preemptive potential of federal law and Reg BI in this area.”
The SEC's Reg BI rules-set, which includes a host of provisions, most notably a “best interest standard” for BDs, was meant to clarify and harmonize conduct standards, taking them from a suitability-based threshold to something more akin to a legal fiduciary but not quite.
The Massachusetts rule has renewed cries of regulatory disharmony, with critics contending Galvin is moving the goalposts in terms of what it means to do right by regulators when giving financial advice to clients. Some nationally foot-printed firms seeking to make sure they do not run afoul of any state – and seeing the direction of the winds, blowing more toward a stricter standard – just might seek to take steps to bite the bullet and just go ahead and get compliant with the stricter Massachusetts rule. This is similar to how some firms are treating California’s data privacy rules as a nationwide standard not to be flouted regardless of jurisdiction.
Moving to a Massachusetts standard is a heavier lift. There are some other big differences between Reg BI and the Massachusetts rule.
Take, for example, conflicts of interest.
Under Reg BI, brokers are generally required to identify and disclose most conflicts and mitigate or eliminate certain others. What specifically gets done about the conflicts is not prescribed; instead, that’s left up to the purview of each firm on a case-by-case basis.
But under the Massachusetts rule, brokers are required to avoid, eliminate, or mitigate conflicts i.e. disclosure alone is insufficient.
Other states, including Nevada, New Jersey and Maryland, are also considering adopting their own rigorous standards for broker-dealers.
Key Questions Abound
"Massachusetts is really charting its own path down the fiduciary road,” Marzouk noted. “And it’ll be challenging for financial services firms to chart a path to compliance with multiple layers of federal and state standards of conduct to understand.”
Valerie Mirko, a partner in Baker McKenzie’s Financial Regulation and Enforcement Practice Group, told ThinkAdvisor that Massachusetts’ fiduciary rule, in addition to creating another compliance layer for many firms, will be watched closely by an industry that has shown it is not shy about fighting regulators in court.
“One of the key questions under the Massachusetts rule is whether the fiduciary standard is episodic, meaning that it only applies at the time of the recommendation, or whether there is an ongoing duty that extends beyond the time of the recommendation,” Mirko said.
All eyes are on what happens, in this regard, as the Massachusetts rule takes effect, Mirko said. “I would expect other states to look toward how Massachusetts implementation and enforcement plays out,” she said.
The state next in line to potentially approve a rule is New Jersey.