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Melanie Waddell

Industry Spotlight > Broker Dealers

Fiduciary Fight Set to Move to More States After Massachusetts Ruling

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What You Need to Know

  • A court decision to uphold the Massachusetts fiduciary rule could open doors to similar regulations on brokers in other states, lawyers say.
  • OMB could release Labor’s new fiduciary plan as early as this month.
  • The Massachusetts ruling is somewhat of a recognition that Reg BI, for all its benefits, has a lot of flaws, says a former SEC attorney.

The fiduciary duty debate is raging once again with two recent developments: the Massachusetts fiduciary rule being upheld by the state’s highest court and the Labor Department’s new fiduciary rule being reviewed by the Office of Management and Budget.

With the ruling by the Massachusetts Supreme Judicial Court in late August, broker-dealers in Massachusetts providing investment recommendations or advice to retail customers now face a new compliance challenge: They must comply with the Securities and Exchange Commission’s Regulation Best Interest and with the state’s fiduciary rule.

A new fiduciary rule in Massachusetts brings with it a renewed impetus for other states to move forward with their own fiduciary rules — creating a patchwork of regulations, some observers complain — and is also an indication that Reg BI is flawed.

Labor filed its new fiduciary rule at OMB in early September.

While OMB reviews typically take 90 days, the word on the street is that OMB could release Labor’s fiduciary plan as early as this month.

“It makes sense for the proposal to be released by the OMB and published in the Federal Register before the next possible government shutdown in mid-November,” said Fred Reish, partner at Faegre Drinker.

Massachusetts Ruling

The Massachusetts Supreme Judicial Court ruled to uphold the Massachusetts fiduciary rule and allow Secretary of State William Galvin’s administrative case against Robinhood to move forward.

The case against Robinhood involves Galvin accusing the brokerage in December 2020 of violating state law by using overly “aggressive tactics to attract new, often inexperienced, investors” and “gamification to encourage and entice continuous and repetitive use” of its mobile application.

In April, Galvin, Massachusetts’ top securities regulator, appealed a Superior Court judge’s decision issued last March that struck down the state’s fiduciary rule.

With the Massachusetts Superior Court ruling, “broker-dealers operating in Massachusetts will be subject to a higher standard of care than that imposed by federal regulation and by almost any other state,” attorneys at K&L Gates opined in a recent alert.

The court’s determination that Reg BI “establishes a floor and that states are permitted to establish higher standards could embolden other states to adopt similar laws and will cause broker-dealers to have to monitor the standard of care in each jurisdiction where they operate, as opposed to adhering to a single standard,” the K&L Gates attorneys wrote.

James Tierney, who researches securities law at the Chicago-Kent College of Law, said on a recent webcast held by the Institute for the Fiduciary Standard that the ruling in Massachusetts “is an important recognition by a state Supreme Court that state regulators have an important role to play in a federal system to level up regulatory obligations and duties when it seems like the federal government is not doing enough.”

The ruling, according to Tierney, a former SEC attorney, is also “somewhat of a recognition that Reg BI, for all its benefits, has a lot of warts both in its design and implementation.”

The court’s decision “is instrumentally useful for advocates of stronger fiduciary protections in investment advice to make that case,” Tierney said.

Indeed, Ron Rhoades, associate professor of finance at Western Kentucky University and director of its personal financial planning program, said in a recent email that Reg BI “does not impose a fiduciary duty of loyalty” but “a new ‘best interest’ obligation that is still in the process of being defined and applied.”

With a new DOL fiduciary rule on the horizon, he said, “the fiduciary battlegrounds will continue to be active spheres where pro-fiduciary advocates will be pitted against firms whose economic models are threatened by the fiduciary standard.”

Fiduciary Battleground

The Massachusetts Supreme Judicial Court decision “adds additional traction to the ongoing movement in the marketplace, aided by fiduciary advocates and federal and state securities regulators, to move toward a bona fide fiduciary standard,“ according to Rhoades.

The most important aspect of the Massachusetts decision, according to Rhoades, “is that states are not preempted from adopting fiduciary standard by federal securities laws,“ nor by the SEC’s adoption of Reg BI.

While the Massachusetts decision “is not binding upon other state courts, nor on the federal courts, its precedent may well give impetus to at least a few other states to adopt fiduciary standards for broker-dealers when providing investment advice to retail clients.“

An alert from the law firm Ropes & Gray concurred that the Massachusetts ruling “leaves the door open for other state regulators to set more demanding standards applicable to broker-dealers operating in their states,“ and “raises a substantial threat of the very ‘patchwork of inconsistent state-level standards’“ of which former SEC Chairman Jay Clayton warned.

Further litigation in other state or federal jurisdictions may seek to challenge this reasoning.

Internet Advice

The Ropes & Gray alert also warns that the Massachusetts ruling also applies to investment recommendations or advice provided from outside the state via the internet.

For national broker-dealers, including those operating internet platforms, the decision “further complicates compliance and increases associated costs in states that impose obligations, like the Massachusetts Fiduciary Rule, that extend beyond Regulation BI’s obligations,” the alert said.

“Particular attention will be required to assess what sorts of communications by broker-dealers regarding investment opportunities to retail investors can be construed as investment recommendations or advice subject to heightened state-level standards,” the firm wrote.

For example, in Robinhood’s case, Galvin “claimed Robinhood had encouraged frequent, risky, and unsuitable trading by retail investors, published investment categories like ‘100 Most Popular’ or ‘Top Movers,’ implemented strategies to incentivize customer engagement with its trading platform, and that each of these practices was tantamount to making investment recommendations to customers,” the alert said.

Robinhood’s defenses to these arguments, the firm wrote, “have yet to be addressed by the trial court or in the Secretary’s administrative proceedings — as the litigation to date has focused on the legality of the Massachusetts Fiduciary Rule itself, not its application to Robinhood’s business.”

A spokesperson for Galvin’s office told me that regarding the administrative case against Robinhood, “the parties have asked to schedule a status conference, and that decision is still pending before the hearing officer.”


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