Thursday, November 15, 2018

New Jersey Fiduciary Regulation

Facing looming retirement crises, some states have begun to do more.  Notably, Nevada recently passed a state fiduciary statute.  I cheered the legislation's passage because it mostly puts in place the legal protections that most savers now mistakenly believe that they already have.  New Jersey also recently began to solicit comments on the issue as well.  For the New Jersey process, written comments are due on December 14th.

As it moves forward, New Jersey will likely have to contend with the financial services industry doggedly lobbying to protect a stockbroker's right to sell clients the wrong products.  Much of the campaign will likely be led by the Securities Industry and Financial Markets Association (SIFMA).  SIFMA touts itself as "the voice of the nation's securities industry."  It came up with some creative concerns about the Nevada fiduciary statute and will likely raise similar concerns with New Jersey. 

One SIFMA argument struck me as particularly interesting in its implications:

We remain concerned that any new fiduciary duties under the Nevada law would impose additional recordkeeping requirements that would violate the National Securities Markets Improvement Act of 1996 (“NSMIA). As you well know, NSMIA precludes states from enacting regulations relating to the making and keeping of records “that differ from, or are in addition to, the requirements in those areas established under [the Exchange Act].” We are hard pressed to envision a scenario in which new duties do not require the creation of a new record.

For example, under the new law, broker-dealers and their agents are subject to NRS 628A.020. This provision states:

“A financial planner has the duty of a fiduciary toward a client. A financial planner shall disclose to a client, at the time advice is given, any gain the financial planner may receive, such as profit or commission, if the advice is followed. A financial planner shall make diligent inquiry of each client to ascertain initially, and keep currently informed concerning the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.” 

Both the disclosure and information collection requirements would need to be done in writing, or verbally followed by the creation of a written record to document compliance with and ensure adequate supervision of these obligations. In our view, even if the Division does not require that a new form be filled out, the broker-dealer would still have to create a new record to demonstrate compliance, which violates NSMIA. We encourage you to continue to explore options that do not create additional books and records issues.

In essence, SIFMA appears to be arguing that states cannot regulate conduct within state borders if it would require incidental paperwork.  Curiously, SIFMA's testimony omitted the statute's next sentence which says that the "[SEC] shall consult periodically the securities commissions (or any agency or office performing like functions) of the States concerning the adequacy of such requirements as established under this chapter."  If Congress intended to strip the states of the power to regulate conduct, it seems odd that the statute would direct the SEC to check with the states to make sure that its books and records rules were adequate.  If a court read the statute the way SIFMA seems to, it would mean that a state could not require a financial adviser to inform the client about how much money she would make off selling a particular product.  It would also mean that the states could not regulate conduct if it might ever require anyone to write something down.

The argument also seems to stretch too far because it would interfere with state authority to prohibit fraud.  When Congress passed the NSMIA, it took pains to explicitly preserve the states' power to enforce their anti-fraud laws.  If state law creates a disclosure duty to inform the customer about a conflict, it would likely be a fraudulent omission for a broker-dealer to make sales without disclosing the conflict.  

It'll be interesting to watch this issue to see what happens.

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