The far reach of state law – Nevada proposes fiduciary duty regulations for broker-dealers and investment advisers

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Under Nevada law, financial planners owe a fiduciary duty to their clients.1 In accordance with this duty, a financial planner must disclose, at the time advice is given, any gain the financial planner may receive if the advice is followed.2 In addition, financial planners must stay “informed concerning, [each] client’s financial circumstances and obligations and [each] client’s present and anticipated obligations to and goals for his or her family.”3 Historically, Nevada’s definition of a financial planner excluded broker-dealers, sales representatives and investment advisers. However, effective July 1, 2017, the definition was revised, with the result being that broker-dealers, sales representatives and investment advisers (and their representatives) are no longer excluded from the definition of financial planner.4

To effectuate these changes in statutory law, the Nevada Securities Division (the Securities Division) has now proposed regulations (“Proposed Regulations”) for public comment, which, if adopted, would fundamentally change the legal obligations of broker-dealers and investment advisers doing business in Nevada.5 The comment period for the Proposed Regulations closes on March 1, 2019. Following the close of this comment period, the Securities Division will hold a workshop (its second) to discuss the Proposed Regulations. Below, we provide a summary of the Proposed Regulations and some implications.

Broker-Dealers and Investment Advisers

The Proposed Regulations impose a fiduciary duty on broker-dealers, sales representatives, investment advisers and representatives of investment advisers during the time period for which they: (1) provide investment advice; (2) perform discretionary trading;6 (3) maintain assets under management; (4) act in a fiduciary capacity towards the client; (5) disclose fees or gains; (6) through the completion of any contract; and (7) through the term of engagement of services.7 Broker-dealers and sales representatives will be presumed to owe a fiduciary duty to their clients.8

Investment Advice Defined

The Proposed Regulations define the term “Investment Advice.” “Investment advice” includes, but is not limited to: (1) providing advice or a recommendation regarding the buy, hold, or sale of a security to a client; (2) providing advice or a recommendation regarding the value of a security to a client; (3) providing analyses or reports regarding a security to a client; (4) providing account monitoring for the purpose of potentially recommending a buy, hold, or sale of a security; (5) providing advice or a recommendation regarding the type of account a client should open; (6) providing advice or a recommendation regarding the fee options available for the services provided by the investment adviser, representative of the investment adviser, broker-dealer, or sales representative; (7) providing information on a personalized investment strategy; (8) providing a financial plan that includes consideration of buying, holding, or selling a security; (9) providing a limited list of securities for consideration by a client or by a limited group of clients that is tailored to the client or group of clients; (10) providing information about a security that is not provided in the offering documents or is an opinion regarding the security or its potential performance; (11) recommending a broker-dealer, sales representative, investment adviser, representative of an investment adviser, or financial planner; and (12) providing advice or a recommendation regarding an insurance product or an investment by comparison to a security, or that includes the buy, sale or hold of a security.9

Under the Proposed Regulations, providing information about a security that is specifically contained in the security’s offering documents is presumed not to be investment advice. However, this presumption is lost if, as part of the discussion, the broker-dealer, investment adviser or their representatives recommends one product over another, recommends a buy, hold or sale, or advises on the purchase, hold, sale or value of a security to a client or limited group of clients.10  

In addition, broker-dealers, sales representatives, investment advisers and representatives of an investment adviser may provide the following to the general public without it being considered investment advice under the Proposed Regulations: (1) a general investment strategy that applies to the general public; or (2) an investment company ranking or bond mutual fund volatility rating ranking, if consistent with FINRA rules.11

Broker-Dealers and Sales Representatives

The Proposed Regulations state that a broker-dealer and a sales representative owe a fiduciary duty to their clients in five instances: when they: (1) provide investment advice to clients; (2) manage assets; (3) perform discretionary trading; (4) utilize Fiduciary Titles (discussed below); or (5) otherwise establish a fiduciary relationship with clients.12

However, the Proposed Regulations provide certain exemptions to the fiduciary duty for broker-dealers and sales representatives who provide isolated investment advice to clients – this is referred to in the Proposed Regulations as the “Episodic Fiduciary Duty Exemption”.13 Instead of an ongoing fiduciary duty, the fiduciary duty owed to a client under this exemption ends once the advice is received by the client, the transaction is complete, if applicable, and the required Fee and Gain Disclosures have been made.14 Under this exemption, the broker-dealer and sales representative would not have an ongoing obligation to provide investment advice to a client regarding the security unless otherwise required by law. Furthermore, the broker-dealer or sales representative is not required to stay informed regarding the client’s current financial circumstances and obligations.15 Note, however, that the Episodic Fiduciary Duty Exemption is only available if: (1) the broker-dealer or sales representative does not manage the client's assets; (2) the broker-dealer or sales representative does not create periodic financial plans for the client, provide ongoing investment advice or enter into a contract to provide investment advice; (3) the broker-dealer or sales representative does not perform discretionary trading for the client; (4) the broker-dealer or sales representative has not otherwise developed a fiduciary relationship with the client from previous or concurrent services undertaken on behalf of the client; (5) the broker-dealer and sales representative do not utilize Fiduciary Titles; (6) the facts and circumstances surrounding the transaction do not indicate that additional or ongoing investment advice is reasonably expected by the client relative to that transaction, type of product or advice; and (7) the client solicited the investment advice.16

Breach of the Fiduciary Duty

The Proposed Regulations provide a non-exhaustive list of conduct which breaches the fiduciary duty.17 This list includes instances in which the broker-dealer or the investment adviser: (1) fails to perform adequate and reasonable due diligence on a product or investment strategy prior to a sale or prior to providing investment advice; (2) recommends a security or an investment strategy that is not in the client's best interest, or the recommendation or sale deviates from firm policies, offering limitations or other law; (3) provides investment advice on a product or investment strategy without understanding or conveying all risks or features of the product or investment strategy; (4) puts their own interest, other client’s interests or the firm’s interest ahead of the client; (5) fails to provide current offering documents on the product prior to execution of the transaction; (6) fails to disclose that a recommended product was a proprietary product or that the advice was based upon a limited pool of products or fails to convey all material risks or features of the product; (7) fails to adequately disclose all information regarding a potential conflict of interest; (8) fails to comply with best execution rules; (9) recommends or sells a security without disclosure of a bad actor disqualification as defined in Regulation D, Rule 506; (10) recommends or charges a fee that is unreasonable; (11) violates an applicable FINRA rule or other applicable self-regulatory organization (SRO) rule that relates to client communications or disclosure; (12) engages in conduct prohibited by FINRA’s conduct rules or Nevada’s rules on unethical and dishonest practices or fraudulent practices; or (13) limits the availability of securities to certain clients unless based upon a client’s investment goals, a client’s investment strategy, a firm’s limitation of quantity or type of investment that can be sold to a client, or the security’s own sales limitations.18

Permitted Activities

The Proposed Regulations identify three types of conduct that are not “per se” violations of the fiduciary duty, so long as the activity does not otherwise violate applicable law.19 First, broker-dealers and sales representatives may sell proprietary products so long as they also advise the client that the product is proprietary; inform the client of all risks associated with the product; and comply with applicable SRO rules.20 Second, broker-dealers and sales representatives may receive transaction-based commissions for sales so long as the transaction-based commissions are in the client’s best interest as opposed to other types of fees, and the commission is reasonable.21 Finally, broker-dealers, sales representatives, investment advisers and representatives of investment advisers are permitted to hold or manage cash positions for a client so long as they inform the client of all risks associated with the cash position and comply with applicable law, including SRO rules.22

Dual Registration

The Proposed Regulations include a presumption for investment advisers who also act as broker-dealers and representatives of investment advisers who also act as sales representatives, whether through the same entity or a related entity.23 Under the Proposed Regulations, “any investment adviser who also acts as a broker-dealer, whether through the same entity or a related entity, and any representative of an investment adviser who also acts as a sales representative, is presumed to be acting in their capacity as an investment adviser or representative of an investment adviser.”24 Such investment advisers may not use the Episodic Fiduciary Duty Exemption.25

Exemptions to the Fiduciary Duty

The Proposed Regulations provide three exemptions from the fiduciary duty for broker-dealers and sales representatives who comply with other applicable laws and firm policies governing their conduct.26 First, a broker-dealer or sales representative who executes an unsolicited transaction for a client whose assets are not managed by the broker-dealer or sales representative is exempt from the fiduciary duty for that transaction so long as the client does not receive investment advice (implicitly or explicitly), discretionary trading services, ongoing contractual services or a financial plan from the broker-dealer or sales representative.27 Second, a broker-dealer who executes a trade in good faith that was recommended to a client by an investment adviser or representative of an investment adviser is exempt from the fiduciary duty for that transaction so long as the broker-dealer does not provide investment advice to the client, asset management, discretionary trading services or a financial plan.28 Finally, a clearing firm that receives a direct instruction for the execution of a transaction from a broker-dealer is exempt from the fiduciary duty for that transaction so long as the clearing firm acts in good faith and complies with all other applicable law.29 None of these exemptions are available to a broker-dealer or sales representative who uses certain titles, discussed below.

Use of Titles

Similar to the US Securities and Exchange Commission’s (SEC) proposed standard of care, the Proposed Regulations would restrict the use of certain titles by persons who are not acting as fiduciaries. Under the Proposed Regulations, a broker-dealer or sales representative who includes any of the following in their title, name or biographical description, or holds themselves out as any of the following, cannot limit the fiduciary duty owed to a client, and may not use the Episodic Fiduciary Duty Exemption or any other exemptions: (1) advisor/adviser; (2) financial planner/financial consultant; (3) retirement consultant/retirement planner; (4) wealth manager; or (5) counselor (the Fiduciary Titles).30  The Proposed Regulations also provide that the Securities Division reserves the right to restrict additional titles from use by persons who are not acting as a fiduciary.31

Required Disclosures

The Proposed Regulations require broker-dealers, sales representatives, investment advisers and representatives of investment advisers who receive “gains” as a result of a client following their advice to make certain disclosures to their clients at the time the advice is given, unless the disclosure is permitted to be disclosed at a later time.32 These disclosures must include: (1) percentage of managed assets fee; (2 ) commission on the sale of a security; (3) mark-up or mark-down commission; (4) market maker commission (Electronic Communication Network rebates or credits); (5) discounts based upon the number of transactions or clients; (6) management fees; (7) deferred or trailed fees or commission; (8) front-end load or back-end load fees; (9) service fees; and (10) payment for order flow (the Fee and Gain Disclosures).33 If the actual amount of the compensation is not known at the time of the advice, then the broker-dealer, sales representative, investment adviser or representative of an investment adviser must disclose that the gain may be paid; the manner of ascertaining the gain; and the actual amount received within a reasonable time period, which may be established by other rule or law.34 In addition, a broker-dealer, sales representative, investment adviser or representative of an investment adviser does not need to comply with Fee and Gain Disclosure requirements if they charge a fee based upon a specific percentage of assets under management pursuant to an agreement with the client, and regularly provide the correct actual calculations and charges consistent with applicable law.35 Finally, the amount of any finder’s fees, referral fees or other benefits for recommending broker-dealers, sales representatives, investment advisers and representatives of investment advisers must be disclosed, along with any related agreements, at the time of a referral.36

Key Takeaways

If adopted, many aspects of the Proposed Regulations are likely to have a significant impact on broker-dealers and investment advisers and their client relationships.The following are a few key takeaways from the Proposed Regulations that broker-dealers and investment advisers should note:

  • Broker-dealers and sales representatives will be presumed to owe an ongoing fiduciary duty to their clients, unless the broker-dealer or sales representative proves that he/she qualifies for an exemption from the fiduciary duty.
  • Any investment adviser who also acts as a broker-dealer, whether through the same legal entity or a related entity, will be presumed to be acting in his/her capacity as an investment adviser. This presumption also applies to representatives of an investment adviser who also act as sales representatives.
  • Broker-dealers and sales representatives will not be able to qualify for an exemption if they use titles such as advisor, adviser, financial planner, financial consultant or wealth manager. 
  • Broker-dealers and sales representatives are permitted to sell proprietary products and receive transaction-based compensation, with appropriate risk disclosures and considering the client’s best interest, but it must be in the client’s best interest to be charged on a transactional basis, and the commission must be reasonable.
  • Finally, the Proposed Regulations reserve the right of the Securities Division to adopt any rule, exemption, form or prohibition related to a fiduciary duty that is adopted by the SEC, so long as such adoption does not diminish Nevada’s fiduciary duty standard.

View the Proposed Regulations.

Read Eversheds-Sutherland’s summary of the SEC’s proposed standard of conduct.
________

1 Nev. Rev. Stat. § 628A.020.
  
2 Nev. Rev. Stat. § 628A.020.
  
3 Nev. Rev. Stat. § 628A.020.
  
4 Nev. Rev. Stat. § 628A.010(3).
  
5 The Proposed Regulations can be found here: https://www.nvsos.gov/sos/home/showdocument?id=6156
  
6 Under the Proposed Regulations, “discretionary trading does not include a broker-dealer’s or sales representative’s limited conduct of exercising discretion as to the time and price of buying or selling a security that is based upon a client's direction, or transactions executed to satisfy customer margin obligations.” Proposed Regulations, Section 4.4.
  
7 Sections 1.2, 3.1 
  
8 Section 9. 
  
9 Section 4.1.
  
10 Section 4.2.
  
11 Section 4.3.
  
12 Section 1.1.
  
13 Section 2.
  
14 Section 2.1.
  
15 Section 2.3.
  
16 Section 2.2.
  
17 Section 8.
  
18 Section 8.1.
  
19 Section 6.
  
20 Section 6.1.
  
21 Section 6.3.
  
22 Section 6.2.
  
23 Section 3.2.
  
24 Section 3.2.
  
25 Section 3.2.
  
26 Section 5.
  
27 Section 5.1.
  
28 Section 5.2.
  
29 Section 5.3.
  
30 Section 5.4.
  
31 Section 5.4(f).
  
32 Section 7.
  
33 Section 7.1. The Proposed Regulations notes that it is not intended to require a broker-dealer, sales representative, investment adviser or representative of an investment adviser to disclose the profit or gain that may accrue as a result of all business activities. Section 7.4.
  
34 Section 7.2.
  
35 Section 7.3.
  
36 Section 7.5.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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