New Jersey Latest State to Issue Fiduciary Regulations

Brokers who were happy to see a federal-level uniform fiduciary rule rejected by an appeals court last year may now be rethinking their stance as a patchwork of state-level rules comes to the fore.

New Jersey Attorney General Gurbir Grewal and the Bureau of Securities within the Division of Consumer Affairs this week proposed a new rule to strengthen investor protections in the state by requiring all investment professionals registered with the Bureau to place their customers’ interests above their own when recommending securities or providing investment advice.

According to Attorney General Grewal, the proposed rule requires 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 to any type of account, or the purchase, sale, or exchange of any security.”

Conduct falling short of this fiduciary duty would, under the proposed rule, constitute a “dishonest and unethical practice.”

Advisory industry analysts and lobbyists have been watching out for this development. Back in October 2018, the New Jersey Bureau of Securities issued a notice of pre-proposal to solicit comments on whether to adopt rule amendments that would require broker/dealers, sales agents, investment advisers and investment adviser representatives to be subject to “an express fiduciary duty.” The preliminary notice highlighted concerns that investors are “often unaware of whether and to what extent those they trust to make financial recommendations are receiving undisclosed financial benefits in exchange for steering their clients to certain products.” 

The 2018 pre-proposal did not include specific rule language, but the Bureau did indicate it was considering “making it a dishonest or unethical business practice for failing to act in accordance with a fiduciary duty when recommending to a customer, an investment strategy, or the purchase, sale, or exchange of any security or securities, or providing investment advisory services to a customer.”

With the publication of the proposed rule language, Attorney General Grewal had some strong words for non-fiduciary financial professionals operating in his state: “If the federal government won’t act to protect investors, then we will. Today, we are fulfilling Governor Murphy’s promise to strengthen financial protections for New Jersey residents. The rule we’re proposing will provide important safeguards for New Jersey’s families when they invest, save, and plan for their future.”

The proposed new “N.J.A.C. 13:47A-6.4” rule sets forth the following conditions:

  • It is a dishonest or unethical business practice for an adviser, broker/dealer, or its agent, to fail to act in accordance with a fiduciary duty to a customer when making a recommendation or providing investment advice. The proposed rule applies to recommendations of an investment strategy, the opening of or transfer of assets to any type of account, or the purchase, sale, or exchange of any security.
  • In accordance with the common law definition of fiduciary duty, both the duty of care and duty of loyalty must be satisfied.
  • For purposes of the duty of care, the broker/dealer, agent, or adviser must make reasonable inquiry, including risks, costs, and conflicts of interest related to the recommendation or investment advice, and the customer’s investment objectives, financial situation, and needs, and any other relevant information.
  • The recommendation or the advice provided to the customer must be made without regard to the financial or any other interest of the broker-dealer, agent, adviser, any affiliated or related entity, and its officers, directors, agents, employees or contractors, or any other third-party.
  • When a broker-dealer or its agent makes a recommendation, the fiduciary duty obligation extends through the execution of the recommendation and shall not be deemed an ongoing obligation.
  • Transaction-based fees are allowed in certain circumstances provided that the fee is reasonable and is the best of the reasonably available fee options for the customer, and the duty of care is satisfied.
  • To address the concerns over dual registrants “switching hats” when dealing with the same customer and the resulting investor confusion, the fiduciary duty obligation shall be applicable to the entire relationship with the customer on an ongoing basis.
  • Harmful incentives, such as sales contests, that encourage and reward conflicted advice are presumptively invalid.
  • There is no presumption that disclosing a conflict of interest in and of itself will satisfy the duty of loyalty.

“The rule we’re proposing codifies a standard that most investors believe they are already receiving from their financial professionals,” adds Christopher Gerold, Chief of the New Jersey Bureau of Securities. “We believe we have crafted a sound, sensible rule that not only fulfills our duty to safeguard investors, but also protects the integrity of the financial markets.”

Notably, there will be a 60-day public comment period during which stakeholders have an opportunity to submit written comment on the proposed rule. After the close of the public comment period on June 14, 2019, the Bureau of Securities will review all comments. According to the state officials, a summary of the public comments and the Bureau’s response to them will be published in a Notice of Adoption “expected sometime in the fall.” Then, upon publication of the Notice of Adoption, the rule becomes final and will take effect in 90 days.

Information on how to submit and view public comments is available here.

Context for the New Jersey rulemaking

Generally speaking, according to attorneys with Stradley Ronon, state-based fiduciary rule implementation timelines across the U.S. could be either extended or accelerated in 2019, depending on if and when the Securities and Exchange Commission (SEC) finalizes its own advisory standards reform effort. Back in April 2018, the SEC released a “Regulation Best Interest” proposal aimed at creating a unified conflict of interest mitigation standard for all brokers and advisers—not just those working under ERISA. During a recent speech, SEC Char Jay Clayton said the investment market regulator has made it a priority to finish work on its Regulation Best Interest proposal during 2019.

Another factor that could impact states’ timelines, according to Stradley Ronon attorneys, is that state legislatures reshaped to favor Democrats in the 2018 elections could choose to move faster in the direction of strengthening conflict-of-interest regulations. As an example, they point to New York Assemblyman Jeffrey Dinowitz and his previous, unsuccessful introduction of the Investment Transparency Act.

Apart from New York and New Jersey, the attorneys say, two other states worth watching this year are Nevada and Maryland, which have each moved towards a similar standard as has been codified by the New Jersey proposed rule.