Bates Research - 01-09-20
Massachusetts State Fiduciary Rule and NAIC Annuity Standards Proposals Continue to Move Forward
Photo by Ken Lund under CC BY-SA 2.0
Bates Group continues to track a host of issues affected by the adoption of Regulation Best Interest (“Reg BI”), the 2019 package of rules and interpretations from the SEC setting standards of conduct for broker-dealers and independent advisers. These include a variety of state responses to the federal regulation, as well as Reg BI impacts on issuers of other complex financial products sold through brokers and advisers, specifically, recommendations to consumers on transactions involving annuity products. Here are some of the latest developments.
Massachusetts Introduces Revised Fiduciary Regulation Proposal
In prior posts, Bates Group reviewed legal challenges to the new federal regulation from state attorneys general, state legislative and regulatory initiatives (see here and here) designed to provide an alternative regulatory framework to protect in-state investors, and the North American Securities Administrator Association (“NASAA”) cautious position toward both these state approaches.
Just before the new year, the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth formally proposed a revised uniform fiduciary conduct standard for broker-dealers, agents, investment advisers and investment adviser representatives that provide financial advice to clients and client prospects in the state. In general, the regulation establishes a fiduciary duty and makes a violation of that duty a sanctionable "unethical or dishonest conduct or practice."
The revised proposal differs in several respects from the preliminary proposal issued last June. One legal analysis notes that, among other things, this new version adds “language expanding a potential breach of fiduciary duties to commodity and insurance products;” establishes the presumption that a fiduciary duty exists simply by the title used by an advisor; and requires an advisor to go beyond disclosure or mitigation of a conflict of interest by requiring efforts to actually avoid such conflicts. The proposed regulation also requires ongoing monitoring of accounts by registrants; bans sales contests, sales quotas, and other incentive programs; further clarifies duty of loyalty and care obligations, as well as existing suitability standards.
The breadth of the proposal has elicited strong reaction. Massachusetts Secretary William Galvin argues directly that Reg BI fails to provide investors the protection they need from harmful conflicts of interest and that his state proposal is the only way to truly strengthen investor protections. In response to the proposal, Kenneth Bentsen Jr., president and chief executive of the Securities Industry and Financial Markets Association (“SIFMA”) in a public statement said, “We are very concerned that the proposal exceeds the state’s authority, will diminish investor access to advice, products and services and will increase investor costs. We respectfully suggest that you delay any decision making until after Reg BI is fully implemented and the SEC, FINRA, and the Division and other state regulators have the chance to examine firms for compliance.” SIFMA recommended that the Division delay action for at least 18 months and then assess whether any further steps are necessary.
Secretary Galvin’s move to introduce the revised state regulation sets in motion the formal process by which Massachusetts’s fiduciary rule may be finalized and adopted. In so doing, Massachusetts becomes the next state to reach this juncture, (New Jersey’s rule proposal was first,) setting the stage for an inevitable legal battle over whether state or a national standards will prevail.
NAIC Committee Approves Revisions to Annuity Standards
Bates has also been following the efforts of the National Association of Insurance Commissioners (“NAIC”) to revise standards and procedures for providing recommendations to consumers on transactions involving annuity products. As we previously covered, an NAIC Working Group has been attempting to develop a framework that would revise its “Suitability in Annuity Transactions Model Regulation” with the federal Reg BI standards and accommodate 2019 New York regulations (Regulation 187) which require insurers to establish policies and procedures so that broker-dealers put the “best interest” of consumers ahead of their own.
On December 30, 2019, NAIC’s Life Insurance and Annuities Committee took an important step by approving revisions to the model regulation. In general, the revisions specify that the producer must satisfy obligations of care, disclosure, conflict of interest and documentation.
The regulators specifically pointed out that the model regulation does not require a fiduciary relationship between the producer and the customer and that it provides a safe harbor for producers that comply with the SEC’s Regulation Best Interest. (Notably, New York voted against it at Committee.) That said, the model regulation requires an agent to be able to demonstrate that a recommendation is in the consumer's best interest (the basis of which must be included in a written record), and must identify, manage and disclose material conflicts of interest. The model regulation now heads to the NAIC Executive Committee and Plenary for a final vote before the states may consider its adoption.
The Massachusetts and NAIC processes demonstrate the difficulty in reaching consensus around investor and consumer protection standards. The Massachusetts proposal will serve to build momentum for states to adopt fiduciary standards on broker-dealer recommendations to their clients. These state fiduciary rules, however, will face their test in court. No doubt the NAIC’s Reg BI-friendly model regulation for annuity products may possibly face similar state-by-state reactions and similar legal tests. Meanwhile, firms are left with heavy compliance burdens and lingering uncertainty.
Bates Group's Compliance team can help your firm through the implementation phase of Reg BI and navigating compliance concerning investor and consumer protection standards. To learn more about Reg BI compliance consulting support for your firm, please visit our Reg BI service page or contact Robert Lavigne, Managing Director, Bates Compliance, at firstname.lastname@example.org.