Earlier today, on February 21, 2020, the Massachusetts Securities Division (“MASD”) adopted amendments to its regulations in an effort to hold broker-dealers and agents to a fiduciary standard when dealing with their customers (the “Massachusetts Rule”).
While I personally believe that the rule will ultimately be overturned based on federal preemption, in an effort to avoid that from happening, MASD drafted the regulation so that the failure to adhere to the fiduciary standard would be deemed a dishonest or unethical practice. Also in an effort to avoid preemption arguments under the National Securities Markets Improvements Act, the rule states that it does not require any making or keeping of additional records, but at a minimum, it would seem to require revisions to policies and procedures.
Regardless of my predictions and the ultimate staying power of the Massachusetts Rule, legal and compliance departments will need to start preparing for its effective date of September 1, 2020. In an effort to help easily digest the rule, below is a chart outlining the aspects of the rule in comparison to Regulation Best Interest (the “SEC Rule”).
| The Massachusetts Rule | The SEC Rule | Notes | |
| Who it applies to? | Broker-dealers and agents | A broker, dealer, or a natural person who is an associated person of a broker or dealer… | The scope of coverage is identical. |
| For what category of investors does the standard apply? | The term “customer” shall include current and prospective customers, but shall not include: (a) A bank, savings and loan association, insurance company, trust company, or registered investment company; (b) A broker-dealer registered with a state securities commission (or agency or office performing like functions); (c) An investment adviser registered with the SEC under Section 203 of the Investment Advisers Act of 1940 or with a state securities commission (or agency or office performing like functions); or (d) Any other institutional buyer, as defined in 950 CMR 12.205(1)(a)6. and 950 CMR 14.401. Does not apply to a fiduciary to an employee benefit plan, its participants, or its beneficiaries, as those terms are defined in the Employee Retirement Income Security Act (ERISA) | Retail customers: a natural person, or the legal representative of such natural person, who: (i) Receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer, or a natural person who is an associated person of a broker or dealer; and (ii) Uses the recommendation primarily for personal, family, or household purposes. | The Massachusetts Rule is arguably broader in scope than the SEC Rule. The Massachusetts Rule applies to all customers, but provides 4 specific carve outs which encompass most institutional investors. However, the Massachusetts Rule would seem to apply to most organizations with assets of less than $5 million and 501(c)(3) charities with portfolios less than or equal to $25 million |
| When it applies? | When providing investment advice or recommending an investment strategy, the opening of or transferring of assets to any type of account, or the purchase, sale, or exchange of any security. During any period in which the broker-dealer or agent: 1. Has or exercises discretion in a customer’s account, unless the discretion relates solely to the time and/or price for the execution of the order; 2. Has a contractual fiduciary duty; or 3. Has a contractual obligation to monitor a customer’s account on a regular or periodic basis, as such regular or periodic basis is determined by agreement with the customer | When making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer… at the time the recommendation is made | |
| Standard of Care | Fiduciary duty- To meet the fiduciary duty, each broker-dealer or agent shall adhere to duties of utmost care and loyalty to the customer. | Shall act in the best interest of the retail customer | The Massachusetts Rule appears to be more amorphous and potentially more restrictive. The SEC Rule is met if a broker-dealer or agent meets the specific component obligations (i.e., Disclosure Obligation, Care Obligation, Conflict of Interest Obligation, and the Compliance Obligation) |
| Duty of Care/Care Obligation | (a) The duty of care requires a broker-dealer or agent to use the care, skill, prudence, and diligence that a person acting in a like capacity and familiar with such matters would use, taking into consideration all of the relevant facts and circumstances. For purposes of this paragraph, a broker-dealer or agent shall make reasonable inquiry, including: 1. The risks, costs, and conflicts of interest related to all recommendations made and investment advice given; 2. The customer’s investment objectives, risk tolerance, financial situation, and needs; and 3. Any other relevant information. | The broker, dealer, or natural person who is an associated person of a broker or dealer, in making the recommendation, exercises reasonable diligence, care, and skill to: (A) Understand the potential risks, rewards, and costs associated with the recommendation, and have a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers; (B) Have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation and does not place the financial or other interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; (C) Have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile and does not place the financial or other interest of the broker, dealer, or such natural person making the series of recommendations ahead of the interest of the retail customer. | |
| Duty of Loyalty | The duty of loyalty requires a broker-dealer or agent to: 1. Disclose all material conflicts of interest; 2. Make all reasonably practicable efforts to avoid conflicts of interest, eliminate conflicts that cannot reasonably be avoided, and mitigate conflicts that cannot reasonably be avoided or eliminated; and 3. Make recommendations and provide investment advice without regard to the financial or any other interest of any party other than the customer. | Disclosure Obligation: The broker, dealer, or natural person who is an associated person of a broker or dealer, prior to or at the time of the recommendation, provides the retail customer, in writing, full and fair disclosure of: (A) All material facts relating to the scope and terms of the relationship with the retail customer, including: (1) That the broker, dealer, or such natural person is acting as a broker, dealer, or an associated person of a broker or dealer with respect to the recommendation; (2) The material fees and costs that apply to the retail customer’s transactions, holdings, and accounts; and (3) The type and scope of services provided to the retail customer, including any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer; and (B) All material facts relating to conflicts of interest that are associated with the recommendation Conflict of Interest Obligation: The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to: (A) Identify and at a minimum disclose, or eliminate, all conflicts of interest associated with such recommendations; (B) Identify and mitigate any conflicts of interest associated with such recommendations that create an incentive for a natural person who is an associated person of a broker or dealer to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer; (C)(1) Identify and disclose any material limitations placed on the securities or investment strategies involving securities that may be recommended to a retail customer and any conflicts of interest associated with such limitations, , and (2) Prevent such limitations and associated conflicts of interest from causing the broker, dealer, or a natural person who is an associated person of the broker or dealer to make recommendations that place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer…. | The Massachusetts Rule imposes an obligation to avoid conflicts of interest to the extent reasonably practical, and eliminate those that cannot be reasonably avoided. This is a more difficult standard to implement than the SEC Rule’s standard to identify and disclose or eliminate. |
| Duty of Loyalty and Sales Contests | It shall be presumed to constitute a breach of the duty of loyalty for a broker-dealer or agent to recommend any investment strategy, the opening of or transferring of assets to a specific type of account, or the purchase, sale, or exchange of any security, if the recommendation is made in connection with any sales contest. | The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to: … (D) Identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific securities or specific types of securities within a limited period of time. | The Massachusetts Rule appears to prohibit additional types of sales contests. The SEC Rule is limited is limited to security-specific or product specific contests and are tied to a limited duration. The Massachusetts Rule extends to strategies, account types and conversions, and exchanges. |