Yesterday the New Jersey Bureau of Securities (“NJBOS”) issued its Rule Proposal titled “Fiduciary Duty of Broker-Dealers, Agents, Investment Advisers, and Investment Adviser Representatives”.  Below is a link to the Press Release, which in turn includes a link to the Rule Proposal itself.  The Rule Proposal would amend existing section N.J.A.C. 13:47A-6.3 and then add new section N.J.A.C. 13:47A-6.4.

We have reviewed the Rule Proposal and identify the below highlights.  The public comment period on the Rule Proposal ends June 14, 2019.  The Rule would take effect 90 days after a Notice of Adoption is published.  Let us know if we can be of any help, even if it is just to talk through the new proposed requirements.

  • The Rule Proposal would (i) codify the existing common law fiduciary duty for investment advisers and investment adviser representatives, and (ii) apply a new fiduciary duty requirement to broker-dealers and their agents.  Under the proposed Rule, it would be a “[d]ishonest and unethical business practice” not to comply with the fiduciary duty.  While the Rule does not create a private cause of action, for investment professionals doing business in New Jersey or with New Jersey customers, the Rule Proposal imposes a regulatory standard and may, in practice, set the standard of care expected of investment professionals in other contexts, including defending civil claims.
    • Of note, the fiduciary duty is owed only to a “customer”, and the Rule Proposal seeks to limit that definition to retail customers by excepting from that definition a number of entities such as banks, S & L associations, insurance and registered investment companies, broker-dealers, investment advisers, and any person or entity with assets of at least $50 million.
    • The fiduciary duty would not only apply to investment recommendations or investment advice, such as the purchase, sale or exchange of a security, but would also apply to “the opening of, or transfer of assets to, any type of account”.  So the type of account recommended (e.g. brokerage vs. advisory) will be subject to review under the fiduciary duty standard.
    • The fiduciary duty requirement does not apply to those persons already acting in a fiduciary capacity to an ERISA plan or the accounts used by that plan.  But keep in mind that IRAs are not ERISA accounts, and would be subject to the Rule Proposal.
  • The fiduciary duty has two components – the duty of care and the duty of loyalty.
    • The duty of care requires the investment professional (i) to use the same “care, skill, prudence and diligence” that a prudent investment professional would, and (ii) to make reasonable inquiry into information related to the recommendation or investment advice and to the customer profile.
    • The duty of loyalty requires that a recommendation, or investment advice, is made without regard to the financial or any other interest of the investment professional.
      • There is a presumption of a breach of the duty of loyalty insomuch as there is direct or indirect compensation involved (in the providing of a recommendation or investment advice) that is “not the best of the reasonably available [compensation] options”.  This concept seeks to address sales contests, improper incentives, and unreasonable compensation.  However, under the Rule a broker-dealer and its agent are still permitted to receive a “transaction-based fee” (e.g. commission) to the extent it is reasonable and represents the best of the reasonably available fee options.
      • There shall not be a presumption that the duty of loyalty is satisfied simply because a conflict of interest is disclosed.
    • Except as discussed below, the fiduciary duty would not change the episodic relationship in the brokerage context – the Rule Proposal would not create an ongoing duty upon the broker-dealer to monitor the customer’s account following execution of the specific investment recommendations.
  • Probably one of the more controversial parts of the Rule Proposal will be section 13:47A-6.4(a)1(ii), which covers the scenario in which a “dual registrant” maintains both brokerage and advisory accounts for the same customer.  In that case, the episodic relationship that normally exists in the brokerage context would be changed such that the dual registrant would have the ongoing duty to monitor the entire relationship with the customer, regardless of account type.