A lobby group for the broker-dealer industry is warning New Jersey about the grave consequences of moving ahead with its proposed fiduciary rule -- but a consumer advocate group is urging the state not to be bullied by what are most likely empty threats.
The Insured Retirement Institute warns that broker-dealer firms operating in New Jersey would be forced to significantly scale back their operations — or shut down entirely — if the state’s proposed fiduciary rule becomes final.
“This would make it more difficult for IRI members and others in the financial services industry to continue doing business in New Jersey. We fear that the proposal will drive firms to significantly scale back their offerings in New Jersey or potentially even discontinue operating in New Jersey,” Jason Berkowitz, IRI chief legal and regulatory affairs officer, says in a written testimony submitted to New Jersey’s Bureau of Securities ahead of today’s public hearing on the fiduciary rule.
“To be clear, this would not be driven by a fear of stronger regulation, but rather by simple economics as the cost of doing business would eventually outweigh the potential rewards. If this comes to pass, the citizens of New Jersey will ultimately lose access to the wide variety of products and services available to other Americans to help them achieve their financial goals,” he adds.
IRI’s members include life insurers, asset managers and distributors of insured retirement strategies, such as broker-dealers, banks and marketing organizations.
“We count among our members several large financial institutions headquartered in and around New Jersey, as well as nearly 1,000 financial advisors across the state who are affiliated with more than 40 different broker-dealer firms,” Berkowitz says.
IRI says its members account for more than 95% of annuity assets in the U.S., including the top 10 distributors of annuities ranked by AUM.
In 2016, IRI members had $4.3 billion in total variable annuity sales in New Jersey, making it the seventh largest variable annuity market in the U.S., according to the group’s data.
The comment period for New Jersey’s proposed fiduciary rule — Fiduciary Duty of Broker-Dealers, Agents, Investment Advisers and Investment Adviser Representatives — was extended to July 18, one day after the public hearing on the proposal.
The New Jersey fiduciary rule proposal requires all investment professionals registered with its Bureau of Securities to act as fiduciaries to their customers when providing investment advice or recommending an investment strategy; when opening or transferring assets to any type of account; or the purchasing, selling or exchanging of any security.
IRI says it is rejecting New Jersey’s proposed fiduciary rule because it is “inconsistent and incompatible” with Reg BI. IRI also claims the proposed state rule would cause economic viability problems for broker-dealers and deprive the state’s residents of product choice.
Reg BI will achieve the New Jersey Bureau of Securities’ goal of investor protection without the need for further rulemaking while preserving investor choice and access to products and services, Berkowitz says.
“For the Bureau to create a separate regulatory structure that destroys the distinction between brokerage and advisory services is, at its best, misguided, and at worst, antithetical to the SEC’s policy decision to protect the distinction between broker-dealers and investment advisors in an effort to promote investor choice, contain cost and ensure investor access to financial advice," Berkowitz says.
IRI believes action on the proposed New Jersey fiduciary rule should be postponed until state officials can evaluate Reg BI.
"By rejecting the SEC’s approach, the Bureau threatens to create a regulatory labyrinth for BDs offering services in New Jersey,” Berkowitz says. “BDs will not only have to comply with Reg BI but also the Bureau’s more expansive and inconsistent rules, as well as any laws or rules that may be promulgated in other states where they may have clients.”
Berkowitz says the proposal fails to address how “this layered regulatory system” would impact investor access to financial advice.
The actions of New Jersey, Nevada and Massachusetts — with the latter two states also crafting their own fiduciary rules — are effectively reviving aspects of the Department of Labor fiduciary rule that was struck down last year by the U.S. Court of Appeals for the Fifth Circuit.
“This desire to bring back a rule that was thrown out in federal court fails to recognize the significant negative impacts the rule was already having in the marketplace, despite the fact that it never become fully effective,” Berkowitz says.
Meanwhile, investor protection groups have thrown their support behind the New Jersey proposal.
Several aspects of the proposal are “vastly more protective of investors” than Reg BI, according to a comment letter submitted by 17 investor protection groups, including the Alliance for Retired Americans, Americans for Financial Reform Education Fund, the Consumer Federation of America and New Jersey Citizen Action.
The groups say New Jersey’s proposal offers better investor protection because it applies a uniform fiduciary standard across an “appropriately broad range of advisory activities.”
In his written testimony submitted to the New Jersey Bureau of Securities ahead of this week’s hearing, Micah Hauptman, financial services counsel at CFA, asks the Bureau not to be “misled” by the “meritless claims” or be “bullied” by the “threats” of industry organizations that are asking the state to “stand down.”
Hauptman says Reg BI “will not meaningfully change harmful industry practices or improve protections for investors.” He identifies some of the CFA’s “many concerns” about Reg BI:
- Reg BI doesn’t define what best interest means, and the discussion it does provide of this topic suggests it largely reflects existing Finra policy.
- Reg BI doesn’t require brokers to recommend what they reasonably believe to be the best of the reasonably available options.
- While Reg BI says that brokers have to consider costs when making recommendations, the release [of the rule] makes clear that as long as a broker can come up with some other reason why they recommended an investment that costs more and just so happens to pay them more, they’re good. Despite the fact that Finra has the same requirement that brokers consider costs, the SEC provided no guidance on whether or how this consideration would be any different under the rule.
- Reg BI allows firms to continue to artificially create harmful incentives that encourage and reward brokers for making very specific recommendations that are very profitable to the firm but that are likely to taint the advice, to investors’ detriment. It requires only that they mitigate in some undefined way the harmful incentives they themselves created. And the release strongly suggests that policies and procedures that are required under existing Finra rules would be sufficient mitigation.
- The conflict of interest provisions, which were already weak in the proposal, actually got weaker in the final rule. They are more reliant on disclosure, despite the fact that we know conflict disclosure doesn’t work.
- Reg BI allows dual registrants to engage in hat-switching with impunity, addressing it through meaningless disclosure, which will perpetuate investor confusion and harm.
“You are also likely to hear threats from the brokerage industry that, if faced with a fiduciary standard that forces them to significantly change their practices, they will leave the state rather than comply, which will limit investor access and choice,” Hauptman says. “In other words, they’ll threaten to take their ball and go home if they don’t get their way on the playground.”
Hauptman says it’s “predictable” that the brokerage industry lobbyists and some firms will make these arguments, but “it’s highly doubtful that all, or even many, of them will follow through.”
“Broker-dealers who are most entrenched in their opposition to any obligation to genuinely do what’s best for their customers [may threaten] to curtail services,” he adds. “In our view, that would be an immediate black eye for any firm that decided to take that approach and would tell the public everything they need to know about that firm’s commitment to investors, not just within New Jersey, but nationally.”