A calm surface on the waters of investment advice reform is about to be broken by what could be the beginning of a fiduciary blue wave at the state level.
Next Monday, the New Jersey Bureau of Securities is expected to release for public comment a proposed rule that would require all financial advisers in the state to put their clients' interests ahead of their own when making investment recommendations.
This statewide fiduciary duty could very well conflict with the final advice rule the Securities and Exchange Commission is expected to promulgate later this year or in early 2019. With the SEC reviewing thousands of comments about its proposal, the advice reform issue has been relatively quiet for a few weeks. That is set to change.
Other states could join New Jersey in drafting their own standard. In Nevada, there is already a fiduciary law on the books. But the state's securities regulator has not yet proposed the regulations that would implement it.
With New Jersey in the state fiduciary lead, here's what to watch for.
NEW JERSEY RULE REGULATES BEHAVIOR
Unlike investment advice legislation introduced in the New Jersey and New York legislatures, the New Jersey regulation — as well as the Nevada law — targets the behavior of financial advisers. Requiring them to act in the best interests of their clients instead of just disclosing whether they are fiduciaries would make the regulation much tougher than the bills.
RULEMAKING MOVES FASTER THAN LEGISLATION
The other aspect of rulemaking that can make it more potent than legislation is that it can move much faster. The securities bureau in New Jersey ultimately reports to Governor Phil Murphy. Generally, an executive branch is nimbler than a legislature, where bills almost always face political crosswinds, even when one party dominates both chambers.
RULEMAKING COULD FACE COURT CHALLENGES
The speed advantage of regulation comes with a vulnerability: Rules are more likely than laws to be overturned in court.
"If this rule ends up being restrictive on broker-dealers, I would imagine they'll challenge the validity of the rulemaking in court," said Jamie Hopkins, professor of retirement planning at The American College. "It's always easier to get something out the door through rulemaking. The drawback is that it would have less deference [in court] than a state statute."
There already are warnings that the New Jersey proposal would violate federal preemption laws. The American Retirement Association asserts that federal retirement law, the Employee Retirement Income Security Act, would trump a New Jersey rule.
"There is a strong argument to be made that any regulation of fiduciary advisory services to employer-sponsored retirement plans and their participants and beneficiaries would be preempted by ERISA — a case that has been outlined in an opinion letter commissioned by us and authored by [law firm] Trucker Huss, and which we intend to share with the New Jersey regulators as they consider this new initiative," Joseph Caruso, ARA government affairs counsel, said in a statement.
WILL NEW JERSEY START A BLUE WAVE?
When Mr. Murphy announced the New Jersey rulemaking, it removed any doubt about where he stands on investment advice reform. The former Goldman Sachs executive, a Democrat, is firmly on the side of investor advocates who have denounced the killing of the Labor Department's fiduciary rule in a federal appeals court and have asserted that the SEC proposal is too weak.
Other states, especially those that are blue — with Democratic majorities in the state legislature or a Democrat in the governor's office — may follow New Jersey's lead and propose their own advice standards.
On an issue that is becoming increasingly partisan, it's not hard to imagine more resistance to what Democratic governors may perceive as the Trump administration's lack of support for investor protection.
"I expect some states will jump into that [fiduciary] arena," Mr. Hopkins said.
The fiduciary waters will start churning again in a few days.