Regulators Struggle to Raise the Standard of Care for Financial Advice

On March 15, 2018, the U.S. Court of Appeals for the Fifth Circuit (“Fifth Circuit”) in a 2-1 decision vacated the Obama-era U.S. Department of Labor’s (“DOL”) Fiduciary Rule (“Fiduciary Rule”), which responded to a historical shift from traditional pension plans to individually managed accounts, such as individual retirement accounts (“IRAs”) and 401(k)s. The Fiduciary Rule would have applied a fiduciary standard to advisors who provide investment advice in the distribution phase of individual retirement plan assets or rollovers, thus imposing trust law standards of care and undivided loyalty. The DOL—now under the Trump administration—did not ask the Fifth Circuit to review its decision and has until June 13 to request the U.S. Supreme Court to hear its appeal.

At the same time, a best interest standard of conduct for advisors remains under active consideration by the Securities and Exchange Commission (“SEC”) and New York Department of Financial Services (“NYDFS”). Although in apparent agreement that individual investors deserve additional protection, it remains to be seen whether these regulators can develop a harmonized standard of care. At a public hearing on April 18, the SEC Commissioners voted 4-1 to propose rulemaking and interpretations imposing a best interest standard on broker-dealers and clarifying the standard of conduct for investment advisors. In December 2017, the NYDFS proposed a best interest standard for the sale of life insurance and annuity products in an amendment to its suitability regulation. On April 27, in response to industry comments, the NYDFS updated its proposal, which will go into effect following a 30-day notice and comment period.

Last year, in response to the DOL’s Fiduciary Rule, the National Association of Insurance Commissioners (“NAIC”) also proposed a best interest standard for the sale of annuity products to be added to its Suitability in Annuity Transactions Model Regulation. Following the Fifth Circuit’s decision, the NAIC announced it is reconsidering a best interest standard and will focus on strengthening the current suitability standard. In fact, Vice Chairman of the Annuity Suitability Working Group, Iowa Insurance Commissioner Doug Ommen recently said that the current suitability model regulation is protecting investors. He went on to state, “I’m very uncomfortable with the idea that we’re going to push aside what is now a history and tradition of suitability, create something new and then wait for a number of years of SEC deliberation on what that means.”


As the dissent in the Fifth Circuit noted: “Over the last forty years, the retirement-investment market has experienced a dramatic shift toward individually controlled retirement plans and accounts. Whereas retirement assets were previously held primarily in pension plans controlled by large employers and professional money managers, today, IRAs and participant-directed plans, such as 401(k)s, have supplemented pensions as the retirement vehicles of choice, resulting in individual investors having greater responsibility for their own retirement savings. This sea change within the retirement-investment market also created monetary incentives for investment advisors to offer conflicted advice, a potentiality the controlling regulatory framework was not enacted to address.”

Despite this “sea change,” the majority opinion struck down the Fiduciary Rule. Conducting a Chevron analysis, the majority determined that Congress had clearly defined the scope of an investment advice fiduciary to be limited to employer – or union – sponsored retirement and welfare benefit plans. As a result, it held that the DOL lacked the statutory authority to revise the term to include IRAs and participant-directed plans during the distribution phase.

The majority’s decision aligned with the position of financial service providers and insurance companies, which strengthened their challenge of the Fiduciary Rule by claiming it could deprive individual investors of professional investment advice. According to the plaintiffs, the cost of compliance with additional regulations would force investment professionals to raise their fees or stop offering services. Indeed, the majority noted that Metlife, AIG and Merrill Lynch had already reduced their presence in the brokerage and retirement-investment market. Despite the complexity of the Fiduciary Rule and the changes in conduct it requires, it is fair to ask whether these companies cannot in fact absorb these additional costs. From the consumer’s point of view, it seems incongruous that an employee could build up substantial retirement savings in the accumulation phase of a 401(k) plan with fiduciary protections only to be faced with a conflicted investment professional during the distribution phase or that an individual with an IRA never had the protection of non-conflicted advice.


Notwithstanding the Fifth Circuit’s decision, increased regulation of financial service providers and insurance producers may impose a best interest standard of care. As we noted, the SEC Commissioners voted 4-1 to propose a best interest standard for broker-dealers and interpretations designed to “enhance the quality and transparency of investors’ relationships with investment advisors and broker-dealers while preserving access to a variety of advice relationships and investment products.” Commissioner Kara Stein, who cast the dissenting vote, stated, however, that the proposals essentially preserved the existing suitability standard.  Even the Commissioners who voted in favor of the proposals made it clear that they were relying on the industry to help shape the final rule. According to a press release from the SEC, the proposals:

  • Require broker-dealers to act in the best interest of their retail customers when making a recommendation, without putting their own interest ahead of their customers;
  • Reaffirm and clarify the standard of conduct investment advisors owe to their customers; and
  • Mandate broker-dealers and investment advisors provide retail customers with a relationship summary on a standardized form to disclose the services they offer, the standard of conduct by which they are bound, the fees they charge and potential conflicts of interest.

Jay Clayton has stated his goal is for a best interest standard that would ultimately harmonize regulation for the industry. The NAIC also hopes to build consensus, especially with the SEC. Regulatory harmonization would appease financial service providers and insurance companies burdened by overlapping regulators and regulations. This regulatory overlap in part arises from the SEC regulating variable annuities and registered fixed-indexed annuities. At the same time, state insurance commissioners supervise unregistered annuities and life insurance products.


Both the NAIC and NYDFS have considered raising the standard of conduct for how investment professionals market insurance products. In November 2017, the NAIC proposed the Suitability and Best Interest Standard of Conduct in Annuity Transactions Model Regulation, which would require that investment professionals ensure an annuity is not only suitable for the investor—as the rule currently requires—but also that the annuity is in the investor’s best interest. Under the proposed rule, “best interest” is defined as, “at the time the annuity is issued, acting with reasonable diligence, care, skill, and prudence in a manner that puts the interest of the consumer first and foremost.” The proposed model rule would also require investment professionals to make certain disclosures to their clients, including whether they have any material conflicts of interest. However, the NAIC appears to have retreated from this proposal. In response to the Fifth Circuit’s decision, the NAIC’s Annuity Suitability Working Group Chairman, Idaho Insurance Commissioner Dean Cameron, called for a round of comments to strengthen the current suitability model rule, which 39 jurisdictions have already adopted. This decision to restart the process was reportedly welcomed by many state insurance regulators.


Typically, the NAIC approves model rules which state regulators adopt. As is often the case, however, the NYDFS proposed its own rule. In December 2017, the NYDFS introduced a best interest standard in an amendment to Insurance Regulation 187, entitled Suitability in Life Insurance and Annuity Transactions. In April, following a 60-day comment period, the NYDFS issued an updated regulation. The NYDFS would raise the current suitability standard to a best interest standard. Their definition differs from that of the NAIC’s proposed best interest standard in several important ways. The NYDFS clearly states that investment professionals must make recommendations without regard to their own interests, while the NAIC appears to allow investment professionals to consider their own interests as long as they prioritize those of their client. More significantly, the NYDFS applies the best interest standard to sales of both annuities and life insurance as well as policy modifications, replacements, and recommendations to investors, even when they do not enter into a transaction.

As it was with cybersecurity regulations, the NYDFS is positioned to be a first-mover standard-setter. In the initial press release announcing the proposed rule, Governor Andrew Cuomo emphasized that New York embraces its role as a defender of consumer rights. Moreover, in a recent interview, NYDFS Superintendent Maria Vullo stated that the NYDFS hopes the best interest standard becomes “a national standard for life and annuity products.”


Although the NYDFS has spearheaded the effort to raise the standard of conduct for the insurance industry, state legislatures have also enacted laws or introduced bills that offer individual investors protection. In January, New Jersey lawmakers reintroduced legislation that would require investment professionals to disclose to their clients if they are not bound by a fiduciary standard. In June 2017, Connecticut Governor Dannell Malloy passed an act that requires investment professionals managing non-ERISA plans to disclose to their clients any conflicts of interest. No state has gone further than Nevada, which in June 2017 required broker-dealers and investment advisors to act as fiduciaries for their clients.

It is uncertain whether the Fifth Circuit’s decision will preempt the Nevada law or otherwise discourage states from moving forward with pro-consumer legislation. Maryland lawmakers have already scaled back a bill that would have imposed a fiduciary duty on broker-dealers, insurance agents, and investment advisors. However, Massachusetts Secretary of the Commonwealth William Galvin stated that in the absence of federal legislation, states bear a responsibility to protect consumers. In February, Secretary Galvin charged Scottrade Inc. with violation of both the Fiduciary Rule and the company’s internal policies, alleging that Scottrade Inc. arranged contests among brokers in order to boost sales of retirement products.

Professional organizations have also proposed a best interest standard of care. In June 2015, the Securities Industry and Financial Markets Association proposed a rule that would establish a best interest standard for broker-dealers serving individual clients, and advocated for the SEC to do the same. In March, the Certified Financial Planner Board of Standards Inc. unanimously approved a rule that requires Certified Financial Planners to act in the best interests of their clients at all times when providing financial advice.


Regardless of which regulations or regulators prevail, the transition to a new standard of conduct will not be seamless. The implementation of the Fiduciary Rule had already resulted in multiple claims brought against brokerages. As previously noted, Massachusetts brought a claim against Scottrade Inc. for an alleged violation of the Fiduciary Rule. In April, plaintiffs in a class action suit alleged that Edward Jones moved clients from commission-based to fee-based accounts, even when it was not in their best interests. The plaintiffs claim that Edward Jones engaged in reverse churning, using the Fiduciary Rule to justify a change in compensation method.

The decision to strike down the Fiduciary Rule may only create additional challenges, as investment professionals must weigh modifying their practice to reflect the regulatory landscape pre-Fiduciary Rule against waiting for further action by federal or state regulators, such as adoption by the SEC of some form of its proposed best interest regulation.  The NAIC is reconsidering its suitability model regulation in the wake of the Fifth Circuit’s decision and the SEC’s most recent proposals.  The NYDFS remains steadfast in its decision to move forward with its own best interest rule for life and annuity sales.