The Bureau of Securities within the Division of Consumer Affairs of the State of New Jersey on Wednesday held a lengthy hearing to gather additional feedback on its sweeping proposed fiduciary rule reforms.
The hearing came about a month after the close of the public comment period on the regulations and prior to the Bureau’s release of a formal response, which is expected to be published in a Notice of Adoption sometime in the fall. Upon publication of the Notice of Adoption, the rule becomes final and will take effect in 90 days.
At the hearing, Jason Berkowitz, chief legal and regulatory affairs officer at the Insured Retirement Institute (IRI), testified that the New Jersey regulation should be postponed until state officials can evaluate the “recently finalized, comprehensive federal investor protections” being implemented by the Securities and Exchange Commission. For context, the IRI represents the interest of the entire supply chain of insured retirement strategies, including life insurers, asset managers, and distributors such as broker/dealers, banks and marketing organizations. According to its leadership, IRI members account for more than 95% of annuity assets in the U.S. and serve the interests of millions of Americans.
Berkowitz recalled that, on June 5, the U.S. Securities and Exchange Commission (SEC) issued a final regulation, dubbed Regulation Best Interest or “Reg BI,” that in his eyes “strengthens consumer and investor protections beyond current law, imposes significant new regulatory and implementation burdens on industry and relies on rigorous federal enforcement mechanisms to protect consumers.”
Berkowitz further testified that the SEC explicitly considered imposing a fiduciary standard on broker/dealers (B/Ds) akin to the approach taken by the Bureau but declined to embrace it.
“The adopting release for Reg BI clearly explains that, while a uniform fiduciary standard would produce greater consistency between B/Ds and investment advisers, it would have an adverse impact on investor choice, cost, and investor access in the market for financial advice,” Berkowitz said. “To avoid this result, Reg BI recognizes and seeks to preserve the important and valuable distinctions between different types of financial professionals. B/Ds simply have different relationships with their clients than investment advisers, and, as such, investors have different expectations depending on whether they are working with a B/D or an investment adviser.”
This favorable interpretation of the SEC’s Reg BI is by no means universal in the investment community. For example Laura Posner, formerly the top securities regulator in the state of New Jersey and now a partner at Cohen Milstein Sellers & Toll, says the fiduciary regulations issued in New Jersey can be seen as a direct response to a lackluster conflict of interest mitigation approach being taken by the SEC under President Donald Trump. According to Posner and others, the SEC’s Regulation Best Interest will likely fall far short of its stated goal of reducing conflicts of interest that cause brokers or advisers to not always act in their clients’ best interest. This is why states like New Jersey have issued their own, much stricter rules applying to financial professionals operating in their jurisdiction.
Summarized in simple terms, the main argument of the camp supporting the New Jersey rule and other similar regulations issued in such states as Nevada and Massachusetts is that the SEC rules allow for conflicts of interest to persist—especially for brokers/dealers—so long as they are disclosed to consumers. New Jersey’s rule, on the other hand, actually prohibits specific types of potentially conflicted transactions and sales practices.
Addressing this argument, Berkowitz testified to the effect that Reg BI will achieve the New Jersey Securities Bureau’s goals of protecting consumers from bad-actor brokers and advisers without the need for further rulemaking.
“Moreover, it does so in a manner that will preserve investor choice and access to the products and services they need to achieve their financial goals,” Berkowitz stated, referencing the argument made by opponents of the New Jersey regulation which suggests that consumers who prefer to pay commissions rather than asset-based or flat fees could be forced out of their preferred products and strategies.
“For the Bureau to create a separate regulatory structure that destroys the distinction between brokerage and advisory services is, at its best, misguided, and at worst, antithetical to the SEC’s policy decision to protect the distinction between broker/dealers and investment advisers in an effort to promote investor choice, contain cost, and ensure investor access to financial advice,” Berkowitz said. “We fear that the proposal will drive firms to significantly scale back their offerings in New Jersey or potentially even discontinue operating in New Jersey, not driven by a fear of stronger regulation, but rather by simple economics. If this comes to pass, the citizens of New Jersey will ultimately lose access to the wide variety of products and services available to other Americans to help them achieve their financial goals.”
Witnesses at the hearing also included David Bellaire, executive vice president and general counsel at the Financial Services Institute (FSI), a trade association representing independent financial advisers and independent financial services firms. Among other points of emphasis, Bellaire pointed out that many of FSI’s members are dual registrants—meaning they are able to provide investors the support they need either as a broker/dealer in exchange for a commission or as an investment adviser in exchange for an asset management fee.
“The proposal contemplates holding a broker/dealer who also provides investment advice to a customer, to an ongoing fiduciary duty standard,” he testified. “The fiduciary duty would be applicable to the broker/dealer’s entire relationship with the customer, regardless of the type of account that the customer holds. The proposal permits transaction-based compensation only if it is the best of the available fee options and presumes a breach of the duty of loyalty for certain recommendations that are not the so-called ‘best’ of the reasonably available options.”
According to Bellaire, due to the increased costs associated with demonstrating compliance with the proposed New Jersey fiduciary standard, a broker/dealer would be discouraged from providing one-time or occasional investment advice to its brokerage clients even if such advice is in the clients’ best interest.
“As a result, we believe the proposal will deprive investors of the opportunity to choose the services and account type that best suits their needs and investment objectives,” he said. “In addition, New Jersey investors with a smaller amount of investable assets may lose access to their chosen financial professional who can no longer afford to serve them. Each of these outcomes is contrary to the best interest of New Jersey investors.”
Witnesses at the hearing testified that many of the state-based efforts to strengthen fiduciary standards for advisers and brokers are being driven by a desire to revive the Department of Labor (DOL) fiduciary rule vacated last year by a federal appeals court.
“The New Jersey proposal incorporates one of the most problematic elements of the DOL rule—the requirement that B/Ds make recommendations ‘without regard to the financial or any other interest of the broker-dealer,’” Bellaire said. “In the adopting release for Reg BI, the SEC explained that it avoided this ‘without regard to’ phrasing out of a concern that it ‘would be inappropriately construed to require a broker/dealer to eliminate all of its conflicts when making a recommendation (i.e., require recommendations that are conflict free), which we believe could ultimately harm retail investors by reducing their access to differing types of investment services and products and by increasing their costs.”
To avoid this outcome, Bellaire said, the SEC chose a different formulation, which states that brokers/dealers must make their recommendations “without placing the financial or other interest … ahead of the interest of the retail customer.” This construction, according to Bellaire, recognizes that while a broker/dealer will inevitably have some financial interest in a recommendation, the broker/dealer’s interests cannot be placed ahead of the retail customer’s interest.