On April 17, 2019 the New Jersey Bureau of Securities issued a proposal to require that retail broker dealers use the “fiduciary rule” in their dealings with customers. The rule proposal will also codify the fact that investment advisors already operate under the fiduciary rule. This will mean that in New Jersey brokers will have to put the interests of their clients first and not their commissions.
Imposition of the fiduciary standard on retail broker dealers has been a controversial topic nationwide for the past several years. The SEC staff has recommended to the Commission that the fiduciary rule be incorporated in federal securities laws. They have not been successful. Several years ago the Department of Labor passed regulations requiring that the fiduciary standard be applied to individual IRAs and 401(k) plans. However, a federal appeals court overturned those regulations in September 2018.
The SEC staff has now proposed to issue Regulation Best Interest in an effort to further enhance customer protection. However, in announcing its rule proposal, the Bureau of Securities stated that Regulation Best Interest does not go far enough in protecting investors.
Currently, retail broker dealers, almost all of who are members of the Financial Industry Regulation Authority (“FINRA”), are governed by FINRA’s suitability standards (brokers must have a reasonable basis to believe a recommended investment is suitable for the client). The fiduciary rule puts a greater duty on brokers. Under the fiduciary rule, broker dealers and their registered representatives owe duties of loyalty and care to their customers. They must serve the best interests of their clients and any conflict with their customers’ best interests must be eliminated or fully disclosed.
In the view of the state regulator, the proposed rule amendment (N.J.A.C. 13:47A-6.3) and new rule (N.J.A.C. 13:47A-6.4) will establish a uniform standard for investment professionals and rectify perceived investor confusion because of the lack of uniformity of the standards of care required of retail broker dealers and investment advisors.
Under the rule, the failure of a broker dealer and/or its representative to act as a fiduciary will be viewed as “a dishonest or unethical business practice.” This standard will be imposed on brokers when providing investment advice, recommending a strategy, opening or transferring assets to a new account or the purchase, sale or exchange of any security.
These rule proposals are directed at retail customers. The State apparently believes that the suitability standard employed by FINRA in its oversight of the securities industry is insufficient. One obvious target of New Jersey regulators ire – sales contests. Broker dealers will have to reconsider the use of sales contests in their New Jersey branch offices. In its comments to the rule proposal, the Bureau specifically referenced sales contests that financially reward brokers for selling a specific product or opening certain types of customer accounts. Such contests will be presumed by state regulators to be a breach of the duty of loyalty owed to clients. Furthermore, even disclosing the existence of the sales contest to the investor will not, in and of itself, satisfy the standard of loyalty owed the client.
Interested parties have until June 14th to send comments to the Bureau. Lubiner, Schmidt & Palumbo has over thee decades experience in securities litigation and regulatory law. If you are in a legal or compliance department of a BD with offices in New Jersey, you can contact the firm to discuss the implications of the fiduciary rule proposal for your firm.