Compliance February 21, 2020

Ready to Comply With the Massachusetts Fiduciary Rule?

The new regulations, which go into effect on March 6, will require broker/dealers and their agents to provide investment advice and recommendations 'without regard to the interests of anyone but the customer.'

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Back in early December, Massachusetts Secretary of the Commonwealth William Galvin signed off on the final version of a proposed rule that would impose a fiduciary conduct standard for broker/dealers, their agents, investment advisers and their representatives working in the commonwealth.

Today, Galvin formally filed the regulations, meaning the new uniform fiduciary standard will go into effect on March 6—just two weeks from now.

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“Since the U.S. Securities and Exchange Commission [SEC] has failed to enact a meaningful conduct rule to protect working families from abusive practices in the brokerage industry, it has been left to my office to apply a real fiduciary standard on broker/dealers and agents in Massachusetts,” Galvin says in a statement issued with the filing announcement. “Enacting this rule will provide stronger protections for Massachusetts investors by imposing a heightened duty of care and loyalty on broker/dealers and agents.”

Supporters of the Massachusetts rule say the state-based regulations will be far more effective in tamping down on financial services industry conflicts of interest compared with the national Regulation Best Interest (Reg BI) currently being implemented by the SEC. Their arguments, shared by supporters of fiduciary rules in other states such as New Jersey and New York, are based on the fact that Reg BI focuses on the disclosure of potential conflicts by brokers. Advisers, under both the SEC rule and the state-based proposals, are required to act in a genuine fiduciary capacity.

Various industry groups say the states are overstepping their authority and will cause more harm than good for consumers by implementing a uniform fiduciary standard applying to brokers and advisers. Skeptical groups include the Financial Services Institute (FSI) and the Insured Retirement Institute (IRI), which argue that investor choice will be harmed by the states’ uniform approach.

One provision included in the final Massachusetts regulations that agrees with Reg BI is a prohibition on sales contests. But the Massachusetts sales contest prohibition, in banning all such contests, goes beyond the SEC’s regulations, which bans only those contests which are product-specific or limited to particular securities in particular time periods, Galvin says. He adds that changes made to the final regulations “reflect the feedback provided by members of the public and industry during the comment periods.” The text of the final regulations may be found on Galvin’s website: www.sec.state.ma.us/sct.

Now that the Massachusetts fiduciary standard is set to become law, expert Employee Retirement Income Security Act (ERISA) attorneys suggest this broad fiduciary battle will soon be tried in the federal courts. Lawsuits are already pending seeking to declare the Massachusetts, New Jersey and New York fiduciary rules as being “preempted by ERISA.” In the meantime, there is some evidence emerging to show that some insurance firms are finding it difficult to comply with New York’s new standards, in particular.

Compliance February 21, 2020

Government Plaintiffs Clear Dismissal Hurdle in Reliance Trust Lawsuit

The Department of Labor brought the underlying case and has argued successfully in opposition to the defendants’ dismissal motion, which has now been denied.

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A new Employee Retirement Income Security Act (ERISA) lawsuit ruling has been issued in a case filed by the acting U.S. Secretary of Labor, alleging the Reliance Trust Co. violated the act’s fiduciary standards during its facilitation of an employee stock ownership plan (ESOP) transaction.

The order, issued in the U.S. District Court for the District of Arizona, sides against the defendants’ dismissal motion, which sought to bar the lawsuit based on a failure to state an actionable claim, per the Federal Rule of Civil Procedure 12(b)(6). In addition to the Reliance Trust Co., defendants in the case include a mix of individual, trust and corporate entities, including RVR Inc., a management consulting company that engaged its co-defendant, among other entities, to effectuate an ESOP transaction.

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Collectively, RVR and the individual and trust defendants sought dismissal of five claims detailed in the underlying complaint, which alleges various failures and points of wrongdoing associated with sale of company stock to employees.

In sum, the Department of Labor (DOL) alleges that the individual defendants breached their fiduciary duty to monitor the plan trustee (i.e., Reliance Trust Co.), as imposed by ERISA; that the individual defendants are liable for Reliance’s breaches as co-fiduciaries pursuant to ERISA; and that the individual defendants are liable for their allegedly knowing participation in Reliance’s breaches of its fiduciary duty, regardless of their own respective fiduciary statuses. These specific alleged fiduciary breaches stem from the overarching allegation that Reliance, as trustee, caused the ESOP to pay “tens of millions of dollars too much” to the individual defendants for all of the then-outstanding stock of RVR. According to the DOL, the transaction which the individual defendants negotiated with the trustee resulted in them maintaining their positions as controlling officers and sole members of the board of RVR—despite the ESOP having allegedly paid a control premium for RVR.

For their part, the defendants argue that each of these three claims is infirm for the same reason—because the plaintiff has failed to allege sufficient facts that would show their knowledge that a certain ESOP transaction was illegal under ERISA.

As explained in the text of the ruling, in basic terms, a dismissal under Rule 12(b)(6) for failure to state a claim can be based on either the lack of a cognizable legal theory or insufficient facts to support a cognizable legal claim. At the same time, when analyzing a complaint for failure to state a claim for relief under Federal Rule of Civil Procedure 12(b)(6), well-pled factual allegations are taken as true and construed in the light most favorable to the nonmoving party—though legal conclusions couched as factual allegations are not entitled to the assumption of truth.

In reasoning through the factual allegations in this case, the District Court has determined that dismissal at this early stage would be inappropriate. Its rationale is explained as follows: “From these allegations, taken as true and viewed in the light most favorable to plaintiff, the court can draw an obvious inference that the individual defendants, controlling RVR and its actions and communicating directly with trustee Reliance and appraiser SRR, controlled and therefore knew of the information both Reliance and SRR received in valuing the company and evaluating the fairness of stock price for the plan. … The court can infer that defendants knew how the information was being used and the price their shares ultimately would fetch. And the court can infer from the allegations that the individual defendants, as the senior officers, sole directors and sole shareholders of RVR, knew its approximate value at least.”

The decision continues: “The court can infer from the allegations that the transaction was rushed and completed according to the individual defendants’ dictated timeline, that there was inadequate review and scrutiny of the transaction by the trustee and its agent appraiser. These inferences, drawn from the allegations in the complaint, would establish the actual knowledge of circumstances demonstrating breach by the trustee. The allegations are thus adequate to state a claim for breach of a fiduciary’s duty to monitor. Whether the evidence ultimately developed supports these allegations and inferences at the summary judgment stage or at trial is a wholly different question and one this court does not approach.”

The same explanation is given for why the other claims should proceed, and, in closing, the ruling states that RVR is a necessary party to these proceedings and therefore cannot be dismissed as a defendant.

The full text of the ruling is available here.

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