Patchwork State Fiduciary Rules Won’t Have a Happy Ending

An article from the Wall Street Journalthis past weekend describes how several states are front-running the U.S. Securities Exchange Commission’s Regulation Best Interest rule, passing their own versions of a fiduciary standard without waiting to see what the country’s top securities regulator thinks is best for individual investors.

As I told the Wall Street Journal for this article, “It’s hard to argue with the fact that multiple inconsistent duplicative and conflicting standards will increase costs and make the system less efficient.”

These state fiduciary initiatives are the wealth management equivalent of blue-sky laws, the patchwork quilt of state-by-state requirements that duplicated federal requirements for registering new issues of stocks and bonds offered to the public. Blue-sky laws increased the costs of raising capital and caused some issuers to skip certain states entirely, leaving investors in those states with no chance to invest in those new securities offerings. 

Like the current generation of state fiduciary proposals, Blue Sky laws are grounded in the constitutional principle of states’rights. Both Congress and the courts are loathe to pre-empt states’rights – except where there is a compelling public interest in doing so.

When it comes to regulation of national securities markets, it’s pretty clear that the public’s interest is best served by having one set of rules that applies across all 50 states.

Congress recognized this when it passed the National Securities Markets Improvement Act (known by the unfortunate acronym NSMIA) in 1996, which – among other things – preempted states from imposing different or additional recordkeeping requirements on broker dealers. That’s exactly what these state fiduciary rules would do. And it’s why they are unlikely to survive inevitable legal challenges.

In the meantime, they seem likely to be premature and unnecessary nuisances.