State and Federal Regulators can look to their system of limitations and shared jurisdiction in Blue Sky Laws to ease confusion in the Fiduciary Rule.
The Department of Labor’s fiduciary rule feels like the
train that will never come on a Friday afternoon. Unfortunately, while more passengers gather
on the platform, they aren’t all merely waiting for the 5:02 express to the
suburbs; instead, more regulators on different levels are itching to weigh in
with their own policies. While some
lawmakers, like Senator Jon Tester,
a democrat from Montana, urged the Securities Exchange Commission (“SEC”) to
consider working with the Department of Labor (“DOL”) so that investment
advisors “don’t get ping-ponged back and forth between two rules,” its possible
that a third rail of regulation could exist in the form of states changing
their definitions of fiduciaries.
the Department of Labor’s rule, portions of which have gone into effect,
addresses what information financial advisors can discuss and recommend to
their clients, with a goal of keeping those advisors from recommending products
the FA has an interest in but is not appropriate for the investor. In other
words, it makes the FA put the client’s interests ahead of their own. Several
months ago, we published an article on this blog on the different kinds of
fiduciaries and how they relate to portions of ERISA. As we said in that blog
post: a fiduciary is someone who is authorized by an agreement to act on behalf
of another. The term fiduciary is more than a label; it carries a certain
set of obligations with it, including high duty of care to the investor. Thus,
if one regulator calls only FAs discussing retirement accounts a fiduciary
(along the lines of the DOL) and another regulator calls anyone discussing
investments a fiduciary (along the lines of the SEC), then there could be two
different but related sets of rules.
And while the SEC Commissioner may have testified recently
that he is working to harmonize a rule with the DOL as a top priority for him,
the SEC has been soliciting public comment on standards of conduct for
financial advisors and broker-dealers.
Other SEC Commissioners have stated that they think the DOL’s rule is
disruptive of the broker-client relationship.
When states get involved in expanding these definitions, the
situation gets the curious and curiouser. In the Spring of 2017, Nevada’s
legislature passed a law authorizing its regulators to expand the reach of the
definition of fiduciaries. Now, Nevada,
California, Missouri, South Carolina and South Dakota all impose fiduciary
duties on broker-dealers. As of
September of 2017, 14 states do not impose fiduciary
standards on broker-dealers and 32 others have limited fiduciary standards.
Given that, there could be a real need for the SEC to step in and create its
own law, one that might trump state laws through the doctrine of preemption.
Its possible that this ping-ponging
between different rules could be rectified in a similar manner to how state and
federal securities laws work. While every state has its own securities
regulations (called “Blue Sky Laws”) that are designed to protect state
residents from fraudulent sales of securities, those laws give way to the
federal ones concerning registration requirements. It’s actually not as
confusing as it sounds: fraud has always been a concept that is defined by
state law. And, there are other federal systems and codes that specifically
incorporate or defer to state law on various issues; one example is the
Bankruptcy Code’s provisions o the
definition of property rights.
Essentially, federal and state regulators carve out their own
areas. So to with regard to
registration, the federal law sets out that “no
state law, rule, regulation, order or other administrative action requiring or
regarding the registration or qualification of securities or securities
transaction may apply directly or indirectly to a covered security.” Other
provisions prohibit states from interfering with communications (prospectus,
proxy, reports). For
securities not traded on national exchanges, the prohibition against regulating
registration does not apply.
states do retain jurisdiction to investigate and bring enforcement actions
based on unlawful conduct or deceit in connection with securities transactions,
in other words, fraud. States also license brokers and FAs. To be clear, both
states and the SEC have jurisdiction to investigate fraud, this kind of
jurisdiction is called concomitant jurisdiction, meaning at the same time.
Similarly, certain civil rights issues may raise concomitant jurisdiction
between a state attorney general and the US Attorney General. This
system of preemption, limitation and concomitant jurisdiction could harmonize
the fiduciary rule.
Its possible for states to be limited in their roles in how they extend fiduciary duties and whom they wish to bring into that definition. State regulators and federal regulators aren’t waiting on the same train when it comes to sale of securities. They either all get on the same train concerning fraud in how the securities are sold, or they get on totally different trains when it comes to registration. This too could happen with state and federal laws with regard to fiduciaries, based on state licensing laws. Hopefully, all of the players can work out a clear system before investors and advisors get left behind on the platform.
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