States are reacting to uncertainty surrounding recent federal regulations on the standard of care financial planners use for their clients' accounts by passing state based rules. A fiduciary duty imparts the highest degree of legal responsibility on financial planners by requiring them to set aside personal or company interests in favor of their clients’ interests. While many investment firms require their investment advisers to operate under fiduciary duties rules, many broker-dealers who also manage accounts like retirement savings accounts are exempt. Instead, these broker-dealers operate based on a suitability standard
. In contrast to a fiduciary standard, a suitability standard only requires broker-dealers to make “suitable” recommendations to their clients, allowing them to avoid having to place their interests below their clients' interests.
Earlier this month, a U.S. Department of Labor (DOL) regulation (29 CFR 2510
) reforming fiduciary requirements went into effect. The rule, which was drafted during the Obama Administration and initially scheduled to go into effect at the beginning of the year, was delayed
by the incoming Trump Administration for further review. According to White House Press Secretary Sean Spicer, the regulation represented
“exactly the kind of government regulatory overreach the president was put in office to stop.” However, Trump-appointed Secretary of Labor Alexander Acosta allowed the rules to go into partial effect on June 9.
In their current form, the rules require financial planners and investment brokers who handle retirement savings accounts to operate using a fiduciary standard. The rationale is that this operating standard would prevent broker-dealers from steering client funds toward retirement securities with higher fees and lower returns, a practice that the Obama Administration estimated costs investor $17 billion dollars a year
However, a Goldman Sachs report estimates
that complying with the new rules will cost $13 billion initially and more than $7 billion annually. Industry players are also worried that the high cost associated with disclosure requirements will decrease the sale of annuities, an important investment tool in retirement accounts. Annuity carriers argue that the rule and resulting decrease in annuity sales will adversely impact investors who benefit from the guaranteed lifetime income that annuities offer. The National Association for Fixed Annuities
and U.S. Chamber of Commerce
have filed lawsuits on similar grounds. Some also argue
that it is impossible for fee-only advisers to give conflict-free advice, and that the required fees charged are enormous when compounding interest is factored in. For example, a fee of 1 percent over a period 40 years could result in the loss of hundreds of thousands dollars to the client.
Despite going into partial effect, the future of the rules is far from set in stone. Last year, Congress voted to overturn
these DOL regulations, but President Obama vetoed the legislation. This year, one day before the rules went into effect, the House of Representatives passed a bill
that would scrap them. It remains unclear whether President Trump would sign such legislation into law. Large financial industry players such as the Financial Services Institute are also opposed
to the DOL rules as they are currently written. The uncertainty about the rules' long-term survivability has caused some states to explore their own financial industry reform legislation.
Nevada has taken the most significant steps toward addressing the fiduciary issue. A new law (NV SB 383
), which Governor Brian Sandoval (R) signed earlier this month, not only extends the fiduciary standard to all financial planners, including broker-dealers, but it also requires financial planners to disclose any profits or commissions they might receive from a client's investments. The law also requires financial planners to periodically assess a client's financial goals to ensure the adviser is aware of them and reasonably trying to meet them. Some industry experts have speculated that the provision of the law requiring brokers to act as fiduciaries could be subject to a legal challenge.
“There could be a federal pre-emption issue." George Michael Gerstein, counsel at Stradley Ronon Stevens & Young, told the MultiState Insider
. "There's a little bit of a question as to whether a state could force broker-dealers to register [as a fiduciary] when they don't have to do so at the federal level.”
Connecticut, New York, and New Jersey are also considering legislation to address concerns over fiduciary duties, though their proposed reforms are far less sweeping than Nevada's. In these three states, bills focus on expanding disclosure requirements. Under bills in New York and New Jersey, “non-fiduciary investment advisors,” meaning “any individual or institution that advertises or uses in self identification any term that is suggestive of investment,” would be required to obtain a written acknowledgment from clients that the adviser is not a fiduciary (NJ AB 2729
A Connecticut bill (CT HB 6992
) operates under a similar principle, but with slightly different language. There is no written statement requirement and the disclosure only has to be made upon request. The bill defines financial planners in the state as “a person offering individualized financial planning or investment advice to a consumer for compensation.” The bill recently passed the state legislature, and Governor Dan Malloy (D) has five business days to sign or veto the bill.
The bipartisan action in Nevada demonstrates that state lawmakers are willing to address issues concerning conflicts of interest and fiduciary standards in retirement savings. In addition to passing their own laws, groups like the National Association of Insurance Commissioners are examining
the possibility of state regulators using key provisions of the DOL fiduciary rule to establish “uniformity and consistency
” for the sale of annuities. If Congress repeals the DOL fiduciary regulations in the upcoming debates over the Dodd–Frank Wall Street Reform and Consumer Protection Act, states may attempt to further fill the void. If this is the case, bills like those in Nevada and New Jersey could become models for legislators in other states.
Summary of State and Federal Fiduciary Legislation Department of Labor Fiduciary Rules (29 CFR 2510)
Nevada’s Enacted Fiduciary Law (NV SB 383)
- Implemented on June 9, 2017.
- Requires only advisers on retirement accounts to act in their clients’ best interest using a fiduciary standard.
- Exempts broker-dealers from fiduciary duties.
- Requires advisers to charge reasonable fees and prohibits them from implicitly or explicitly lying to clients.
- Faces stiff opposition and the threat of repeal as part of a Dodd-Frank overhaul bill approved by the House of Representatives on June 8, 2017.
New York (NY AB 2464) & New Jersey (NJ AB 2729) Proposed Fiduciary Bills
- Goes into effect July 1, 2017.
- Extends the fiduciary standard to all financial planners and advisers who receive compensation to advise other persons concerning the investment of money.
- Modifies the definition of “financial planner” by removing the exemption of broker-dealers and investment advisers and their representatives.
- Financial planners must “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.”
- Financial planners must also periodically “make diligent inquiry of each client” to assess the client’s financial present and future goals.
- Maintains exemptions from the definition of financial planner for attorneys, CPAs, and insurance producers.
- Authorizes the state's securities administrator to “adopt regulations defining or excluding acts, practice,s or courses of business as violations of that fiduciary duty."
Connecticut Proposed Fiduciary Bill (CT HB 6992)
- Do not include dealer-brokers in the definition of financial planners.
- Require non-fiduciary investment advisers to disclose to clients in writing that they do not have a fiduciary relationship with the client, and are not required to act in the client’s best interests.
- The written statement reads: “I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns for you.”
- Requires financial planners to disclose, upon request, “whether or not such financial planner has a fiduciary duty to such consumer.”
- Defines "financial planner" as a person offering individualized financial planning or investment advice to a consumer.
- Passed the legislature and sent to the governor on June 21, 2017.