Securities Regulation Daily Massachusetts adopts broker-dealer/agent fiduciary duty rule
Tuesday, February 25, 2020

Massachusetts adopts broker-dealer/agent fiduciary duty rule

By Jay Fishman, J.D.

Massachusetts becomes the first state to adopt a fiduciary standard for broker-dealers and agents following federal Regulation Best Interest.

The Massachusetts Securities Division has adopted, effective March 6, 2020 for enforcement starting September 1, 2020, a fiduciary duty for broker-dealers and agents when they provide investment advice; recommend an investment strategy; open or transfer assets to any account type; or buy, sell or exchange any security.

The final rule. Broker-dealers and agents are deemed to act unethically and dishonestly when they fail to act as fiduciaries for their customers during any period the broker-dealers or agents:

  • have or exercise discretion over a customer’s account (unless the discretion relates solely to the time and/or price of the order’s execution);
  • have a contractual fiduciary duty; or
  • have a contractual obligation to regularly or periodically monitor a customer’s account as determined by a customer agreement.

Two fiduciary duties: duty of care and duty of loyalty. Broker-dealers and agents have both a fiduciary duty of care and a fiduciary duty of loyalty. A broker-dealer or agent, to exercise the fiduciary duty of care, must reasonably inquire about: (1) the risks, costs and conflicts of interest pertaining to all recommendations made and investment advice given; (2) the customer’s investment objectives, risk tolerance, financial situation and needs; and (3) any other relevant information.

A broker-dealer or agent, to exercise the duty of loyalty, must: (1) disclose all material conflicts of interest; (2) make all reasonably practicable efforts to avoid conflicts of interest, eliminate reasonably unavoidable conflicts, and mitigate reasonably unavoidable or uneliminated conflicts; and (3) make recommendations and give investment advice by considering only their customers’ interests (without considering any other party’s financial or other interests).

Note that: (a) disclosing a conflict, by itself, does not meet or demonstrate the duty of loyalty; (b) the duty of loyalty is presumed breached if a broker-dealer or agent recommends any investment strategy, the opening of or transferring of assets to a specific account type, or the purchase, sale or exchange of any security if the recommendation is made for a sales contest; and (c) securities issued by U.S. federal, state and municipal governments are excluded from the duty of loyalty.

Customer exclusions. A "customer" includes current and prospective customers but does not include:

  1. financial institutions such as banks, savings and loan associations, insurance companies, trust companies, or registered investment companies;
  2. broker-dealers registered with a state securities commission (or agency or office performing like functions);
  3. investment advisers registered with the SEC or with a state securities commission (or agency or office performing like functions); or
  4. any other institutional buyers defined in the Massachusetts securities rules.

When not a fiduciary duty. The fiduciary duty does not apply to persons acting as Employment Retirement Income Security Act (ERISA)-defined fiduciaries for an employee benefit plan, its participants, or its beneficiaries. Also, the fiduciary duty does not create any capital, custody, margin, financial responsibility, recordkeeping, bonding, financial, or operational reporting for broker-dealers or agents that differs from, or is in addition to, 15 U.S.C. §78o(i) requirements.

Changes made to proposed rule to arrive at the above final rule. During the proposed rule’s comment period, from December 19, 2019 to January 7, 2020 (when the public hearing was held), the Securities Division reviewed approximately 682 written comments and heard oral testimony from 23 speakers at the hearing. The significant comments made that resulted in the Securities Division amending the proposed version of rule to arrive at the above final rule were as follows:

  1. The proposed rule applied the fiduciary duty to broker-dealers, agents, investment advisers and investment adviser representatives. Commenters suggested that the fiduciary duty apply to only broker-dealers and agents that provide investment advice and not also to federal covered investment advisers. The Securities Division went a step further by removing all investment advisers and investment adviser representatives from the final rule since advisers and their representatives already have a fiduciary duty.
  2. The proposed rule applied to purchases, sales and exchanges of securities, commodities and insurance products such as annuities. Commenters requested removing commodities and insurance products from fiduciary duty application since these instruments are excluded from the definition of "security." The Securities Division agreed and removed them from the final rule.
  3. The proposed rule imposed a fiduciary duty during any time a broker-dealer or agent receives ongoing compensation or provides investment advice to a customer in connection with non-brokerage financial advice. Many commenters wrote that this extended duty might run contrary to the "incidental" exemption from the 1940 Advisers Act (mentioned above in the final rule). The commenters specifically declared that:
    1. requiring broker-dealers and agents to conduct ongoing monitoring under these circumstances would be outside the scope of the "incidental" exemption (specified in the first part of the final rule); and
    2. this ongoing monitoring would impose additional costs onto broker-dealers and their agents that would ultimately be passed on to their customers. The Securities Division agreed and removed this provision from the final rule.

“Final rule dissenters.” George Michael Gerstein, co-chair of the Fiduciary Governance Group at Stradley Ronon in Washington made an assumption that there will be litigation brought against the Massachusetts rule on federal preemption and other grounds, and that other states will wait to see how the litigation plays out before moving ahead. Ken Bentsen, President and CEO of the Securities Industry and Financial Markets Association (SIFMA) said that SIFMA looks forward to reviewing the rule with particular attention to whether it is consistent with existing fiduciary and best interest standards, in other words whether it is consistent with the SEC’s 2019- adopted Regulation Best Interest rule.

Lastly, Barbara Roper, Investor Protection Director for the Consumer Federation of American expressed her disappointment with the Securities Division’s final rule, calling it a watered-down version of the proposal that other states should not use to craft their own fiduciary duty rules. Roper was particularly disappointed with the final rule’s not applying to commodities or annuities, along with the elimination of the ongoing duty to monitor during any time a broker-dealer or agent receives ongoing compensation or when an investor has a reasonable expectation that the investor’s broker will be providing ongoing services, based on how the broker holds out and markets the broker’s services.

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