On February 21, 2020, the Massachusetts Securities Division (the “Securities Division”) announced the finalization of its Fiduciary Rule.1
This Part I summarizes the evolution of the Massachusetts Fiduciary Rule and the modifications from the proposed rule released on December 3, 2019 (the “December Amended Proposal”).2
Part II will summarize the requirements of the Massachusetts Fiduciary Rule and compare the implementation requirements beyond what is required for compliance with the SEC’s Regulation Best Interest (“Reg BI”). (Spoiler: There are a few key differences between the final Massachusetts Fiduciary Rule (the “Final Regulation”) and Reg BI, but the Final Regulation is much, much closer to Reg BI than the prior two proposed versions of the Final Regulation.)
The Final Regulation codifies a fiduciary conduct standard for broker-dealers (“BDs”) and their agents (“RRs”) when conducting securities business into or out of Massachusetts, and makes the failure to adhere to this fiduciary standard a dishonest or unethical practice (which can result in fines, revocation of registration in the Commonwealth, and collateral consequences with other state and federal agencies).
A summary of the most notable modifications to the December Amended Proposal and guidance from the Securities Division on the Final Regulation is summarized below.3
Timing of Implementation
The Final Regulation will become effective on March 6, 2020 and enforcement will begin on September 1, 2020.
The Securities Division has an active, and often aggressive, Enforcement Division, that will certainly begin enforcing the Final Regulation 6 months, and 11 days from today.
What’s New Since December?
As compared to the December Amended Proposal, the Final Regulation:
- Removed references to investment advisers and investment adviser representatives because they are already held to a fiduciary standard under securities laws and including them within the scope of the regulations may have unintended consequences. Therefore, the Final Regulation only applies to BDs and RRs.
- Removed references to commodities and insurance products because these products are excluded from the definition of “securities” under the Massachusetts Uniform Securities Act and the Final Regulation is limited to securities business. Therefore, the Final Regulation does not apply to commodities or insurance products. (But, the sale of a security to purchase an insurance product would still be covered under the rule.)
- Did not change the definition of customer. Commenters asked that the definition of customer be limited to retail customers domiciled in Massachusetts, but the Final Regulation was not changed based on these comments. The Securities Division stated that “the Massachusetts Uniform Securities Act is clear on the scope and applicability of the Final Regulations and does not need further clarification.”
- This means branch offices in Massachusetts must comply with the Final Regulation with respect to all business conducted from Massachusetts with retail clients even if the customer is a non-Massachusetts customer. Also, RRs anywhere in the country must comply when transacting with a retail customer located in Massachusetts.
- Unlike Reg BI, a “customer” under the Final Regulation is not limited to natural persons investing for personal, family or household purposes. However, institutional investors (including sophisticated companies with more than $5 million in assets) are among those excluded from the definition of “customer” under the Final Regulation.
Clarification on Application of Fiduciary Duty
Many commenters were concerned that the December Amended Proposal would impose an ongoing duty on a BD or RR when the duty would not otherwise exist. The Adopting Release clarifies when the fiduciary standard is imposed and when it is imposed as an ongoing duty.
- The fiduciary duty runs during the “period in which incidental advice is made in connection with the recommendation of a security to the customer” (i.e., when the recommendation or advice is given).
- The fiduciary duty will extend beyond the recommendation period when the BD or RR has:
- Discretionary authority over a customer’s account;
- A contractual obligation that imposes a fiduciary duty; or
- A contractual obligation to monitor the customer’s account on a regular or periodic basis (e.g., a duty to monitor once per quarter means the fiduciary duty applies during the course of the quarterly review).
- The Final Regulation removed the sections requiring BDs and RRs to comply with a fiduciary standard of conduct during the time the BDs and RRs: (i) receive ongoing compensation or provide investment advice in connection with other non-brokerage accounts; and (ii) engage in any act that would result in a customer having a reasonable expectation that the BD or RR would monitor the customer’s account on a regular basis.
- These sections were removed in part because commenters worried that ongoing monitoring of brokerage accounts would be outside the “incidental” exemption of the Investment Advisers Act of 1940. Commenters also raised the concern that ongoing monitoring would impose additional costs that would then be passed to the customers and may result in less choice and limited services for customers.
Use of Certain Titles
The Final Regulation removed the presumption that use of certain titles, purported credentials, or professional designations imposed an ongoing fiduciary duty. The Securities Division believes that the other protections under the Final Regulation, which protect customers when receiving recommendations from financial professionals, are sufficient and that attention to titles, as opposed to conduct, is not necessary to achieve customer protection.
Guidance on Disclosure, Avoidance, Elimination, and Mitigation of Conflicts
The Final Regulation adds a reasonableness standard to the duty of loyalty and provides additional guidance on the obligations of BDs and RRs to disclose, avoid, eliminate, and mitigate conflicts of interest.
- The addition of the reasonableness standard clarifies that not all conflicts must be avoided or eliminated. Examples of conflicts that cannot reasonably be avoided or eliminated are: (i) receiving compensation in connection with making a recommendation, (ii) recommending and selling proprietary products, and (iii) making a sale or recommendation of a principal transaction. The Adopting Release explains that BDs and RRs can mitigate the conflict by ensuring the corresponding fee charged is reasonable and by otherwise complying with the remainder of the fiduciary duty.
- The Final Regulation removed the presumption that a recommendation made in connection with a quota requirement, express or implied, or other special incentive program is a breach of the duty of loyalty.
- Commenters expressed concern that if the presumption included quota requirements or other special incentive programs that firms would be prohibited from using certain compensation systems or having the ability to determine health and welfare benefits for its employees. The Securities Division removed the quota requirement and other special incentive programs because the other protections of the Final Regulation are sufficient to protect customers.
- The Final Regulation creates a presumption that a recommendation made in connection with any sales contest is a breach of the BD’s or RR’s duty of loyalty. (Reg BI prohibits sales contests relative to specific securities or specific types of securities within a limited period of time. The Massachusetts prohibition is not similarly limited.)
- The Final Regulation specifically excludes government securities – securities issued by U.S. federal, state and municipal governments – from the duty of loyalty provisions.
If you have any questions about the Massachusetts Fiduciary Rule, the regulation of broker-dealers, or state or federally registered investment advisers, please feel to contact us.
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