On February 15, the Commonwealth Securities Division (Massachusetts’ securities regulator), filed an administrative enforcement action against Scottrade for violating an internal company policy. The complaint alleges that Scottrade’s failure to comply with its own internal policy violated a Massachusetts Uniform Securities Act provision prohibiting broker-dealers from engaging in unethical or dishonest conduct in the securities business. The complaint repeatedly refers to the US Department of Labor’s (DOL) fiduciary rule, and the press release accompanying the complaint suggests Massachusetts is “enforcing” that rule. However, a careful reading of the complaint makes clear the only law being enforced is the Massachusetts Uniform Securities Act.
The internal policy referred to in the complaint was drafted and implemented in anticipation of the DOL fiduciary rule and the perceived need to comply with certain conditions of the related Best Interest Contract (BIC) Exemption and Principal Transaction Exemption before the conditions were delayed. Although the fiduciary rule and related exemptions all became applicable on June 9, 2017, most of the costly and burdensome conditions of the BIC Exemption and the Principal Transaction Exemption have been delayed until July 1, 2019. However, the “impartial conduct standards” of those exemptions are now in effect. Those standards generally require a financial institution and its advisers to give prudent advice that is in a retirement investor’s best interest, charge no more than reasonable compensation, and refrain from making materially misleading statements.
The DOL is re-examining the fiduciary rule and related exemptions as directed by President Trump and considering possible changes and alternatives, which will have to be proposed for public comment before taking effect. Commonwealth Secretary William Galvin, who heads the Commonwealth Securities Division, has been an outspoken proponent of the DOL’s fiduciary rule and publicly criticized attempts to modify or rescind the rule and related exemptions.
According to the Securities Division’s administrative complaint, Scottrade responded to the fiduciary rule by adding the following section to its broker and adviser compliance manuals: “The firm does not use or rely upon quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or reasonably expected to cause associates to make recommendations that are not in the best interest of Retirement Account clients or prospective Retirement Account clients.” The requirement that advisors be subject to no incentives that are either intended or would reasonably be expected to cause them to make inappropriate recommendations is in Section II(d)(3) of the BIC Exemption and Section II(d)(3) of the Principal Transaction Exemption, neither of which is currently applicable.
The administrative complaint alleges Scottrade violated this internal policy by running two sales contests that did not segregate retirement assets, “while failing to inform [customers] of the conflicts arising from the sales contests.” The complaint fails to mention that not all contests are prohibited by the quoted policy language, but only those that are intended or are reasonably expected to cause inappropriate advice. The contests awarded cash prizes to advisors bringing in new assets, including through rollovers. The complaint does not indicate whether Scottrade may have had policies in place to ensure rollovers were not inappropriately or imprudently recommended. Assuming such rollover policies were in force and complied with, the contests would not have been intended or reasonably expected to cause a violation of the impartial conduct standards, and there would be no need to segregate retirement assets from the contests.
Rather than address whether appropriate rollover policies had been adopted, the complaint goes on to criticize the failure of Scottrade’s representatives to affirmatively disclose to clients the existence of the contests and related prizes. However, nothing in either the quoted internal policy or the impartial conduct standards applicable during the transition period would have mandated any such affirmative disclosure.
The complaint repeatedly references the DOL’s fiduciary rule and emphasizes that the DOL’s temporary enforcement policy during the transition period applies only to “fiduciaries working diligently and in good faith to comply with the Fiduciary Rule.” However, the claim does not purport to enforce the DOL’s fiduciary rule or the applicable conditions of the BIC exemption. Instead, the complaint alleges only that Scottrade’s failure to comply with its own internal policy violated Section 204 of the Massachusetts Uniform Securities Act, which prohibits broker-dealers and others from “engag[ing] in any unethical or dishonest conduct or practices in the securities . . . business[.]”
It is unclear whether the Securities Division would have had a basis for its enforcement action absent Scottrade’s internal policy language, and there is at least a question whether a claim so closely intertwined with the DOL’s fiduciary rule would be preempted by ERISA. Nonetheless, Massachusetts’ enforcement action against Scottrade raises the troublesome prospect that other states’ financial regulators and attorneys general could look for opportunities to pursue similar actions against financial institutions during the transition period if they have put into effect policies to comply with provisions of the fiduciary package that are not yet in effect and may never be implemented. The DOL’s consideration of possible changes and alternatives to the fiduciary rule and related exemptions has prompted some states – including New York, New Jersey, Connecticut, and Nevada – to enact or propose their own versions of the fiduciary rule. Like William Galvin, New York Attorney General Eric Schneiderman and a host of other state attorneys general have vocally opposed efforts to modify or rescind the fiduciary rule and related exemptions.