Two Weeks Left to Comment on N.J. Fiduciary Rule

All eyes might be on the SEC’s pending vote on Regulation Best Interest, but ERISA attorneys with Stradley Ronon suggest New Jersey is now “the state to watch” for advisers and brokers tracking the development of conflict of interest regulations.

George Michael Gerstein and Lawrence Stadulis, co-chairs of the fiduciary governance team at Stradley Ronon, often write and speak about developing issues having to do with the fiduciary standard of care required by the Employee Retirement Income Security Act (ERISA).

In the last several years, the pair of ERISA experts has turned to monitoring the growing amount of state-based activity when it comes to mitigating conflicts of interest in the advisory and brokerage industries. Currently, Gerstein and Stadulis are paying particular attention to ongoing regulatory developments in New Jersey, which is on track to implement one of the strictest conflict of industry mitigation regimes in the U.S.

Notably, the attorneys explain, advisers and brokers with concerns about the New Jersey proposal—and indeed those who wish to voice their support—have until June 14 to submit their comments to the Bureau of Securities within the state’s Division of Consumer Affairs. New Jersey Attorney General Gurbir Grewal has called for both detailed and high-level commentary on the fiduciary rule reforms he hopes to see enacted in the state.

In short, the proposed New Jersey rules require 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 rules, constitute a “dishonest and unethical practice.”

According to a new fiduciary governance blog post by Gerstein and Stadulis, New Jersey is “emerging as the state to watch (at least for now) in terms of fiduciary developments.” They note how Governor Phil Murphy backs the proposed reforms and sees them as necessary to “close a regulatory gap in federal oversight that helped fuel the economic meltdown of [the Great Recession] a decade ago.”

Gerstein and Stadulis point out that New Jersey Senator Patrick Diegnan, Jr. has introduced legislation known as “S 735” in the New Jersey State Senate that would impose disclosure obligations on broker/dealers that are not subject to fiduciary duties. An identical bill has also been introduced in the New Jersey General Assembly, Gerstein and Stadulis note.

“It’s unclear whether the New Jersey legislation is on a separate track and, therefore, could pass or fail irrespective of whether the Bureau of Securities moves forward with its own regulation,” the attorneys explain. “If the proposed legislation and regulation are viewed by New Jersey as more of a package, then one wonders how they should interact, if at all.”

Reached for a supplementary interview on the New Jersey regulations and the broader regulatory outlook advisers and brokers are contending with, Gerstein told PLANADVISER the proposed regulations in New Jersey clearly reflects a skepticism of disclosure as a way to address investor confusion and conflicts of interest.  Yet, the legislation introduced by Senator Diegnan is almost entirely disclosure-based. Besides this apparent discrepancy, another issue that may be worth commenting on by industry stakeholders, in Gerstein’s estimation, is that for all practical purposes, the legislation assumes “somewhat of a fixed fiduciary status, yet the regulation would attach to some communications/conduct, and not others.”

“I think the open comment period is an opportunity to impress upon the Bureau the need to take into account not only federal statues and rules, but also their state’s own pending legislation,” Gerstein said. “There is always a risk that, not only could some of these state-based fiduciary developments create an unworkable patchwork of regulations across the country—but they could also potentially create uncertainty within their own states.”

Gerstein stressed that he does not profess to be an expert on the political dynamics of New Jersey or any other individual state. But, he said, this whole process of regulations potentially conflicting with legislation reflects the natural tension that exists between different branches of government.

“This is not just an issue at the federal level,” Gerstein said. “In New Jersey’s case, I think the regulation and the legislation could be shaped to work effectively together, but there has to be real coordination for this to occur. I expect that the regulations would have to be tailored to fit with whatever disclosure regime the legislature moves forward with and passes. Of course, we don’t know at this stage if there are the necessary votes required to pass this legislation. I’ve heard a very similar bill in New York might have the necessary votes, but that’s also unclear at this stage.”

Asked for his take on the issue of ERISA preemption of state-based fiduciary rules, Gerstein said this will soon be an issue for the courts to address.

“The courts are going to decide this issue, that’s virtually inevitable,” Gerstein said. “The reason we haven’t seen it addressed or resolved in any actual decisions yet is that we are still at the proposed stages. As soon as one of these rules becomes final and is enforceable, the ripeness issue will be resolved from the legal standing viewpoint, and then plaintiffs can purse their arguments.”

For their part, states like New Jersey have floated a variety of arguments for why they don’t see ERISA preemption as an issue.

“Personally, I don’t know if their arguments will be successful in front of a court, but there will be detailed arguments coming from both sides,” Gerstein said. “Also, keep in mind that we don’t know to what extent the Securities and Exchange Commission will address preemption issues in its own Regulation Best Interest, which is expected to be voted on in final form next week. That’s yet another wrinkle that will need to be smoothed out before we have the clear picture here. One other thing to add is that New Jersey seems to be quite motivated. Barring some extraordinary strengthening of the proposed Regulation Best Interest being adopted by the SEC next week, there’s no reason to think that New Jersey or Nevada will turn back at this point.”

Gerstein also reflected on recent media reports that have suggested Labor Secretary Alexander Acosta is being basically sidelined by SEC Chairman Jay Clayton in terms of driving advisory and brokerage industry conflict of interest reforms. In short, Gerstein said he thinks such suggestions are missing the mark.

“I’m happy to be on the record saying that I think that Jay Clayton and Alex Acosta are working together behind the scenes. They are coordinating, or are being coordinated; it’s your choice of how to see it,” Gerstein said. “What they have consistently said publicly, and what they have told Congress, suggests they are working together and are not stepping on each other’s toes. My sense is that Acosta is allowing the SEC to take the reins on this in order to be consistent with the 5th Circuit’s view of who should be running this effort. And I do expect the DOL to issue guidance on the topic this year that fits with what the SEC does. Importantly, the DOL’s effort will not likely be anywhere near as ambitious as the Obama-era rule expansion that was tossed out by the 5th Circuit.”

In terms of what he expects from the SEC’s scheduled vote next week on the Regulation Best Interest package, Gerstein said they appear to be prepared to vote to adopt an updated interpretation of what advisers’ duties are under the Advisers’ Act. The SEC will also seemingly be moving forward with some version of Form CRS.

“Whether it’s a longer or shorter customer relationship summary than the proposed version, we’re not sure yet,” Gerstein said. “Finally, we expect them to address what has been called the ‘solely incidental’ issue for dual-registrants.”