Questions to ask to stay compliant as rules change

The regulatory landscape for investment advice fractured in 2017.

States enacted new rules. The Securities and Exchange Commission began to focus on a definition of “fiduciary.” And the National Association of Insurance Commissioners began considering and issuing rules governing investment advice that parallel, supplement or might even conflict with the Labor Department’s evolving fiduciary investment advice guidance.

There are four key questions for advisers evaluating how rules could affect their businesses.

If the new rule is product-specific, what products does it cover?

Advisers need to know what types of investments and advice a new rule covers to determine its impact. An adviser could easily find that one part of his or her service offering (such as advice on annuities for individuals) is affected, while another (such as 401(k) plan advice) is not.

Not all state rules cover the same products. For example, during the past year, states including New York and Montana have been overhauling their “suitability” rules for the distribution of insurance products. However, New York’s new rule differs from Montana’s in that New York’s would apply to life insurance products in addition to annuities.

Some states are less focused on products and are instead regulating all “investment advice.” Connecticut, for example, enacted a law last year that imposes requirements on all persons offering individualized financial planning or investment advice.

Does the state law impose a new “standard of care” the adviser will need to meet?

In general, the new state-based laws and regulations have done one of two things: imposed a new standard of care or required new disclosures.

For example, Connecticut requires advisers to disclose upon request whether the adviser has a fiduciary duty to a consumer for each recommendation being made. Nevada, on the other hand, subjects investment advisers to a general fiduciary duty when making recommendations.

If a statute or regulation requires disclosures, an adviser may face awkward discussions with clients who may ask, “Why isn’t the adviser obligated to act in my best interests?”

On the other hand, where states are imposing a whole new standard of care, an adviser may need to overhaul his or her practice — and in different ways in different states.

What is the new standard of care an adviser will need to meet?

For laws and regulations that impose a new standard of care, this is the most important of the questions for advisers.

Traditionally, the fiduciary standard has been the highest standard under the law.

Arguably, the Department of Labor’s “best-interest standard” is an even higher standard of care. At the moment, there are four main standards of care being considered.

The fiduciary standard is the standard owed by trustees to trusts, and it imposes on advisers the duties of prudence and loyalty. Last year, Nevada enacted a statute imposing a fiduciary duty on broker-dealers, sales representatives and investment advisers.

Recently, a challenger to the fiduciary standard’s “highest standard” title has emerged.

The standard the DOL articulated in its “best-interest-contract exemption,” and being considered by New York, tracks the fiduciary standard of care but adds that the fiduciary must act “without regard to the financial or other interest” of the adviser or any other party.

Consumer rights groups have argued this is merely a restatement of the traditional fiduciary standard of care, but others have argued the new language could be interpreted by courts as imposing a new standard.

Below these is the standard that the NAIC has proposed. It would require annuity distributors to act with reasonable diligence, care, skill and prudence in a manner that puts the interest of the consumer first and foremost.

Finally, there is the suitability standard. It requires an adviser to have reasonable grounds for believing that a recommendation is suitable for a consumer on the basis of facts disclosed by that consumer.

For each standard of care, there is a trade-off between consumer protection and ease of compliance, as well as trade-offs in terms of amount of available advice, cost of advice and litigation risk. Although there is widespread agreement that a best-interest standard makes sense, there is no one definition of what “best interest” means. Given the regulatory uncertainty, we now live in a world where “best interest” can have a wide range of meanings.

How will the state laws interact with federal standards?

The last factor to consider is whether the new rule is a permanent move toward a more fractured regulatory system. Does it contribute to a 50-state patchwork approach, or does it acknowledge the benefit of a nationwide standard?

If states choose to make their laws apply only in the absence of federal rules, advisers will have a strong incentive to work with the DOL and the SEC to develop workable national rules. If they do not, an adviser may be forced to develop dozens of different compliance overlays to provide advice nationally or simply choose to operate in a handful of key states.(See other stories from the latest Retirement Plan Adviser here)

David N. Levine and Kevin L. Walsh are attorneys at Groom Law Group.

Related Topics: Securities and Exchange Commission