States Start Knitting a Patchwork of Best Interest Fiduciary Regulations

With the judicial defeat of the Obama-era DOL fiduciary rule hanging in the air, individual states are moving to establish their own best interest regulations for the sale and service of investment products; attorneys warn that more piecemeal regulation is likely, as are lawsuits to test some complex ERISA preemption issues.

A key New York State financial services industry regulator has approved a new “best interest” standard applying to all investment professionals licensed to sell life insurance and annuity products to state residents.

The regulations were specifically adopted by the State Department of Financial Services (DFS), which says it has issued the new rules intentionally in the wake of the failure of the Department of Labor’s own attempt to strengthen conflict of interest standards at the federal level. According to Financial Services Superintendent Maria Vullo, action is needed now to protect New York State consumers from conflicted financial advice.

In a statement summarizing the regulation, Vullo says New York will henceforth require insurers to “establish standards and procedures to supervise recommendations by agents and brokers to consumers with respect to life insurance policies and annuity contracts issued in New York State so that any transaction with respect to those policies is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer at the time of the transaction.”

Providers of annuity products will not exactly be thrilled to see themselves singled out by the New York regulations, especially given that they continue to face challenges in the wake of transaction processing disruptions caused by the now-vacated DOL fiduciary rule. Some experts anticipate sales to recover as business processes normalize and newer product types come to market, but piecemeal regulations coming out from more states could obviously disrupt any annuity market rebound. 

“As the federal government continues to roll back essential financial services regulations, New York once again is leading the way so that consumers who purchase life insurance and annuity products are assured that their financial services providers are acting in their best interest when providing advice,” Vullo adds. “Given the key role insurance products play in providing financial security to middle class New Yorkers, it is essential that a provider adhere to a high standard of care and only recommend insurance and annuity products that are in the consumer’s best interests and not be influenced by a producer’s financial incentives.”

Technically, this regulation amends New York’s current “suitability regulation,” which provides for a best interest standard of care for all sales of life insurance and annuity products, including both in the specific context of retirement planning, when recommendations are made prior to the sale of an insurance product or after the sale but during the servicing of the product for the consumer.  Under the regulation, a transaction is considered in the best interest of a consumer “when it is in furtherance of a consumer’s needs and objectives and where only the interests of the consumer are considered in making the recommendation.”

Vullo further clarifies: “A producer’s financial compensation or incentives may not influence the recommendation. Insurers would also be required to develop and maintain procedures to prevent financial exploitation of consumers. The regulation will fill in regulatory gaps to protect New York consumers from the elimination of the federal Department of Labor’s Conflict of Interest Rule, which the Trump Administration failed to protect on appeal after a ruling from the U.S. Fifth Circuit Court of Appeals and also supplements existing consumer protections that already exist in New York, including setting reasonable limits on compensation and compensation transparency for the sale of a life insurance or annuity product in New York State.”

The full text of the regulation is available here.

New York is not alone

With this move, New York joins a growing number of left-leaning and more centrist states to establish their own best interest regulations. Some of the states, like New York, are specifically targeting the annuity market, while others, such as Nevada, are taking a broader approach and creating regulations applying widely to advisers and brokers, regardless of their specific product set. 

As noted by David Kaleda, principal in the fiduciary responsibility practice group at Groom Law Group, it’s already been more than a year since the governor of Nevada signed into law a bill that requires advisers to be subject to a fiduciary standard under that state’s securities regulations. Interestingly, that law was signed at a point when the future of the DOL fiduciary rule was far from certain. 

Kaleda warns that the requirements, as they come into effect, may prove challenging for firms with advisers in multiple states. Such firms have to properly identify those advisers who provide investment advice in any state with its own specific set of rules, and then possibly apply an entirely separate (and documented) compliance program that is different than that which would be applied in other states or under federal law.

“Firms that provide advice over the internet or by similar means—e.g., robo-advisers—may face even greater challenges because it may be difficult to identify when investment advice is provided in [Nevada, New York, etc.],” Kaleda adds.

Specifically in Nevada, firms and their advisers are subject to financial liability under that state’s law.

“Advisers need to consider whether they will provide services to clients in Nevada under these circumstances and, if so, how they will comply while still meeting the state’s obligations under Securities and Exchange Commission (SEC) and Department of Labor regulations,” Kaleda concludes. 

At a high level, Kaleda feels the moves by Nevada, New York and others raise important conflict of laws and federal pre-emption issues, “the former being a procedural dilemma calling for a court to sort out conflicting applicable laws of different jurisdictions, and the latter being the problem of whether, in this instance, federal law overrides the state’s.”