Secretary of the Commonwealth Galvin has announced that he is moving forward with proposing a rule for fiduciary duty conduct standard for broker-dealers, agents, investment advisers and investment adviser representatives. We expect this proposal (the "Massachusetts Proposal") to be published in the Register for Massachusetts rulemaking on December 13, 2019, based on the Secretary's submission date of November 29, 2019.
The Massachusetts Proposal is an updated version of a pre-proposal originally circulated on June 14, 2019. The pre-proposal was issued in the wake of the SEC's Regulation Best Interest ("Reg BI") rule set June 5, 2019 adoption. As a result, the pre-proposal immediately became part of the ongoing debate surrounding Reg BI's sufficiency. The Massachusetts Proposal also now joins two other state fiduciary regulatory proposals: Nevada (proposal issued on January 22, 2019) and New Jersey (proposal issued on April 15, 2019). All three proposals lead to questions about federal preemption.
Summary of Changes:
For your reference, we are including a redline comparing the June pre-proposal and the December proposal.
Changes from the pre-proposal to the proposal include:
- Expanding the scope of the fiduciary duty well beyond securities to also include commodity and insurance products.
- Expanding the scope of clients and customers to include both existing and prospective clients.
- Removing the concept of best reasonably available options for the customer or the client.
- Adding a requirement in connection with titling, whereby use of certain titles including adviser, manager, consultant or planner in conjunction with terms such as financial, investment, portfolio, or retirement, among others, would trigger regular or periodic account monitoring.
- Explicitly prohibiting sales contests, quotas, or related incentive programs.
- More explicitly applying a uniform standard to investment advisers, investment adviser representatives, broker-dealers, and broker-dealers agents/representatives (without mention of the term "federal covered adviser").
- Separating the requirement to disclose material conflicts of interest on the one hand, from the obligation to avoid, eliminate, and mitigate conflicts of interest.
- Specifically enumerating contractual obligations that can trigger a fiduciary duty requirement, such as contractual obligation to monitor an account or ongoing compensation.
- Emphasizing that account monitoring triggers fiduciary duty, even if this is based on reasonable customer/client expectation.
We anticipate that the Massachusetts Proposal will proceed on an accelerated basis. The rule proposal notes that dates for the hearing and comment deadline will be provided at a later date. We expect publication of the rule to occur in the next Register on December 13, 2019, and for a hearing to be announced fairly close in time with this publication
Hearings have a 21 day advance public notice requirement, which would mean the hearing could occur as early as January 2020. There is no administrative rule governing how much time needs to elapse after hearing or close of public comment and the effective date of the regulation. After close of the hearing/comment period, the rule need only be advertised in the Register to take effect, though enforcement can be delayed as part of setting the effective date.
The Massachusetts Proposal and Reg BI
Secretary Galvin has been critical that Reg BI does not go far enough, and asserts the Massachusetts Proposal would provide protections that Reg BI does not provide. For example, in a November 29, 2019 statement issued in conjunction with filing the Massachusetts Proposal for publication, Secretary Galvin stated "I am proposing this standard because the SEC has failed to provide investors with the protections they need against conflicts of interest in the financial industry with its 'Regulation Best Interest' rule". Earlier public statements during the Reg BI comment period echo much of the same sentiments. These public statements lend further credence to our expectation that the Massachusetts Proposal may be adopted fairly expeditiously.
As much as the Massachusetts Proposal is a standalone regulatory initiative, its interrelationship with the Reg BI rule set will remain apparent in the upcoming months for three reasons. First, firms are in the process of implementing applicable Reg BI rule set components (Reg BI and Form CRS for broker-dealers and broker-dealer representatives, Form CRS for investment adviser representatives of SEC-registered investment advisers) alongside the expected rulemaking process for the Massachusetts Proposal. Second, aspects of the Massachusetts Proposal, particularly the discussion on conflicts, interact with Reg BI obligations. And third, we also expect that the existence of the Reg BI rule set will be a core argument in any federal preemption debate.
As firms in the midst of Reg BI and Form CRS implementation evaluate the potential impact of the Massachusetts Proposal on their businesses, firms will have to consider the scope and geographic reach of their businesses, as well as the additional uncertainty resulting from any potential litigation challenge to the Massachusetts Proposal.
We note that federal covered investment advisers should particularly focus on investment adviser representatives registered in Massachusetts, as well as investment adviser representatives with clients in Massachusetts, while broker-dealers should also be examining their Massachusetts operations to assess regulatory risk. We are available to discuss the specifics of each situation, whether you have business operations in Massachusetts, clients in Massachusetts, or registered personnel in Massachusetts.