State AGs’ Lawsuit Just One Part of Broader Fiduciary Fight

There is an all-out regulatory tug of war going on between consumer groups, the brokerage industry, the states and the SEC.

Eight state attorneys general filed a lawsuit this week seeking to block the implementation of the U.S. Securities and Exchange Commission’s (SEC)’s Regulation Best Interest rulemaking package.

The Regulation Best Interest package, finalized earlier this year, has been subject to both praise and criticism from different stakeholders across the financial services landscape. Generally speaking, advisory and brokerage entities subject to the rulemaking package have spoken favorably about “Reg BI’s” disclosure-based approach to mitigating conflicts of interest.

On the other hand, consumer advocates and Democratic officials have called the package weak and ineffective. They suggest the Trump Administration should mirror the approach taken by the Obama-era Department of Labor (DOL), which attempted but ultimately failed to implement a strict new fiduciary standard to be enforced by the DOL through powers bestowed directly by Congress via the Employee Retirement Income Security Act (ERISA).

According to the states’ new lawsuit, filed in the Southern District of New York, Reg BI fails to meet basic investor protections that Congress demanded to be established within the 2010 Dodd-Frank Act. In a statement published alongside the lawsuit, New York Attorney General Letitia James says Reg BI is a “watered-down” conflict of interest rule that “puts brokers first.”

“The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place,” she says. “Despite the SEC’s refusal to do its job, New York will continue to lead the charge to protect the millions of individuals investing in their futures, including the millions of Americans saving for retirement.”

Indeed, the state of New York is acting in other ways to address what its political leaders see as inadequate action by the SEC and DOL. New York is among a group of at least five states which have advanced efforts to create advisory industry conflict of interest mitigation regulations despite the SEC’s finalization of Reg BI. New York’s expanded “best interest” standard took effect on August 1st for annuity contracts and will take effect February 1, 2020, for life insurance policies. In a recent decision, a New York state trial court ruled the expansion is “a rational and reasonable movement towards consumer protection.”

This interpretation is debated by some retirement industry advocates. Wayne Chopus, president and CEO of the Insured Retirement Institute (IRI), is firmly in the camp critical of the states’ individual efforts to create their own fiduciary standards. He commends the position of wanting to protect insurance, advice and brokerage services consumers from bad actors, but he warns creating “50 shades of fiduciaries” will result in significant unintended consequence. 

“The Insured Retirement Institute has long supported the principle that those who provide professional financial advice should do so in their clients’ best interest,” he says. “After the controversial fiduciary regulation adopted by the U.S. Department of Labor was vacated by a federal court last year, the SEC forged ahead and crafted a rigorous new standard, which was announced in June. Reg BI significantly enhances existing federal investor protections through substantial new regulatory requirements on financial services companies, broker/dealers, and other financial advice professionals.”

Chopus says the SEC protections and requirements have “considerable teeth because they are backed by extensive federal enforcement powers.” He also points out that, later this year, the National Association of Insurance Commissioners (NAIC) is expected to finalize similar enhancements to its standards for annuity recommendations to complement Reg BI.

“At the very least, states should assess how well Reg BI would fit within the broader tapestry of regulations governing financial professionals’ conduct before deciding if further regulatory action is needed,” Chopus suggests. “But as some states choose to ignore this recommendation, they edge closer to inviting disruption to millions of Americans who rely on professional financial services to meet their retirement income needs. While the state proposals to date have some similarities, they also include significant differences that cannot be easily reconciled. And while a handful of states may cause ample disruption, this will exponentially worsen if more states follow.”

Expert ERISA attorneys suggest this broad fiduciary battle will inevitably be won and lost in the courts. Lawsuits are already pending seeking to declare the New York (and other states’) fiduciary rule as being “preempted by ERISA.” 

In the meantime, there is some evidence emerging to show that insurance firms are finding it difficult to comply with New York’s new standards. Published reports suggest for example that Jackson National Life Insurance Co., among the highest volume providers in the U.S. of individual annuities, has suspended sales of fee-based annuities in New York. Such reports suggest other insurers are also considering ceasing annuity sales in the state.