Home » state securities laws

Category: state securities laws

Massachusetts Adopts Fiduciary Standard for Brokers


Massachusetts has adopted a fiduciary rule for broker-dealers and their agents.  The rule applies broadly to any investment advice or recommendation to any customer other than an institutional buyer.  A broker has a continuing fiduciary obligation when the broker has investment discretion or has assumed a contractual obligation to monitor a client’s account.  A broker must make reasonable inquiry into a client’s investment objectives, risk tolerance, and financial situation and disclose, avoid, eliminate and mitigate all conflicts of interest.  The rule becomes effective on March 6, and enforcement commences on September 1.

Until courts resolve the potential conflict between the Massachusetts fiduciary standard and Regulation Best Interest, we recommend that brokers observe the (arguably) higher Massachusetts standard if they have customers there. 

VC Manager Failed to Register as Investment Adviser


The SEC has commenced proceedings against the principal of a venture capital fund manager for failing to properly register as an investment adviser under state law.  The Connecticut securities regulator entered a final order alleging failure to register the fund manager as an investment adviser under Connecticut law and making false representations about the success of the funds.  The action led to criminal proceedings to which the respondent entered guilty pleas.  Now, the SEC has begun proceedings to implement federal civil penalties under the Advisers Act.

Avoiding required registration will not long go unnoticed.  Eventually, the state securities regulators or the feds will find you.  Your risk goes up exponentially if an aggrieved client has lost money or a competitor raises eyebrows. 

New York State Expands Securities Enforcement Statute

 New York Governor Andrew Cuomo signed a law that reinstates the 6-year statute of limitations for the Martin Act, a statute that prohibits deceptive practices in securities transactions.  A recent court case, seemingly counter to prior precedent, had limited the statute to three years.  The New York State Attorney General Letitia James stressed the importance of the Martin Act because “the federal government continues to abdicate its role of protecting investors and consumers.”  Governor Cuomo explained that NYS is “enhancing one of the state’s most powerful tools to prosecute financial fraud so we can hold more bad actors accountable, protect investors and achieve a fairer New York for all.”

We would have preferred that the New York State Legislature re-write the Martin Act to make it less ambiguous and subject to prosecutorial discretion.  This wrangling over securities enforcement and statutes of limitations make it difficult on the industry to fully understand and follow a clear standard of care.

SEC Bars and Fines State-Registered Adviser for Options Cherry-Picking Scheme


The SEC barred a state-registered adviser from the industry and assessed over $400,000 in fines, disgorgement and interest for allocating options trades that benefited himself and his wife to the detriment of clients.  The adviser utilized an omnibus trading account at a third party broker-dealer to allocate profitable trades to his personal accounts and unprofitable trades to clients.  According to the SEC, during the relevant 7-month period, the personal accounts had a net positive 45.2% one-day return, but the client accounts had a net negative 45.0% one-day return, a statistically significant difference that could not be explained by random chance.  The SEC accused the adviser of securities fraud under the Securities Act (Rule 10b-5) and the Advisers Act (Section 206).

OUR TAKE: If you operate a state-registered (or unregistered) adviser, don’t assume the SEC doesn’t have the regulatory means to uncover and prosecute wrongdoing.  The feds still have jurisdiction over the securities markets and any person providing investment advice.

Massachusetts Proposes Its Own Fiduciary Rule

The Massachusetts Securities Division has proposed a fiduciary rule for all brokers and advisers for the provision of recommendations, advice and selection of account type. The proposed rule would require that all recommendations and advice be made in the best interest of customers and clients without regard to the broker/adviser’s interests. The MSD asserts that the suitability standard has not sufficiently protected customers against sales contests, churning, risky products and bad brokers. The MSD also criticizes the SEC’s recently adopted Regulation Best Interest because it (i) does not fully protect investors; (ii) relies too much on disclosure; and (iii) does not resolve customer confusion about the applicable standard of care. The MSD is accepting comments until July 26.

The expansive MSD proposal includes any type of financial adviser, any type of customer, and any type of advice. If adopted, the MSD’s rule would set up a court case about whether Regulation Best Interest preempts state fiduciary rules.

State Securities Regulators Report Significant Increases in Criminal Penalties

 The North American Securities Administrators Association (NASAA) reports that in 2017 the 51 state securities regulators brought cases resulting in 1,985 years of prison time and probation, a 47% increase over the prior year.  The state regulators also commenced 4,790 investigations in 2017, a 10% increase over the prior year, and initiated 2,105 enforcement actions, a nearly 6% increase.  State securities regulators continued their increased focus on registered investment advisers, taking 377 enforcement actions against RIAs as compared to 270 against BDs.  NASAA reports that cases against unregistered firms and individuals exceeded those against registered firms and individuals.   “Securities fraud is a constant, ongoing, ever-evolving threat to investors. But as this year’s enforcement survey demonstrates, NASAA members are well-prepared, well-organized, and uniquely qualified to continue to aggressively protect investors,” said NASAA’s Enforcement Chair.

OUR TAKE: Unlike the SEC, the state securities regulators have the power to pursue criminal penalties including prison time.  Regardless of what happens at the federal level, the states appear ready to flex their enforcement muscles.

CFTC and States Sign Information Sharing Agreement for Enforcement

The Commodity Futures Trading Commission (CFTC) and the North American Securities Administrators Association (NASAA), the organization of state securities regulators, have signed an information sharing agreement intended to facilitate state regulators to investigate and enforce the Commodity Exchange Act.  The Agreement also allows the CFTC to share information about state securities laws violations.  The NASAA President described the unique role of state securities regulators because “they can bring enforcement actions for both securities law and commodities law violations” which is “particularly relevant given the recent epidemic of schemes involving cryptocurrencies and other modern types of commodities.

OUR TAKE:  The MOU deputizes the state regulators to enforce the commodities laws, which helps the budget-strapped CFTC.  It also continues the trend of more active state securities authorities.


State-Registered Adviser Barred and Fined for Cherry-Picking

The SEC fined and barred the principal of a state registered adviser for cherry-picking trades to favor his personal accounts over client accounts.  The adviser used an omnibus account at two different brokerage firms over a 3-year period to engage in day trading.  The SEC asserts that the adviser allocated trades after the relevant security’s intraday price changed.  The SEC maintains that the trading outcomes indicate a statistically significant allocation to personal accounts.  Over the period, the respondent’s first day allocations resulted in 81.9% profitable trades to his personal account but only 16% to client accounts.  The brokerage firms closed his omnibus accounts because they suspected cherry-picking, although they did not inform the respondent why they terminated.  A third brokerage firm did not allow omnibus accounts.

OUR TAKE: State-registered advisers are not subject to SEC exam or the compliance rule (206(4)-7), which requires a compliance program that includes annual testing and reporting.  As a consequence, an adviser that is not SEC registered can go several years engaging in clearly illegal conduct without detection.



Massachusetts Sues to Enforce Compliance with Fiduciary Rule

The Massachusetts Securities Division has commenced administrative proceedings against a large broker-dealer because it ran sales contests that violated its own policies adopted to comply with the Department of Labor’s fiduciary rule.  The DoL rule, which became effective in June 2017, requires firms to follow an “impartial conduct standard” including acting in the best interest of customers, charging reasonable compensation, and ensuring full disclosure.  In response to the rule, the BD adopted compliance policies prohibiting conflicts of interest when dealing with retirement accounts.  Following adoption of the new policies, the firm launched sales contests, which the MSD alleges involved misrepresentations and conflicts of interest.  The MSD alleges that the firm violated Massachusetts ethical conduct standards by failing to abide by its own policies and the DoL rule.

OUR TAKE: Even though he DoL won’t enforce the fiduciary rule, the impartial conduct standard applies to firms that recommend products to retirement accounts.  Nevada has already passed its own fiduciary legislation.  Now, Massachusetts uses its enforcement powers to compel fiduciary compliance.  Expect other states to follow.


Massachusetts Alleges that Adviser Shouldn’t Have Charged Performance Fee

The Massachusetts Securities Division instituted administrative proceedings against an unregistered fund manager for unlawfully charging a performance fee in addition to misleading investors.   The MSD asserts that the respondent unlawfully “householded” an elderly client’s assets with a nephew with power of attorney in order to meet net worth thresholds required to charge a performance fee.  Massachusetts law prohibits charging performance fees in violation of Rule 205-3 of the Advisers Act, which limits performance fees.  In addition to other sanctions, the MSD seeks to prohibit the respondent from registering as an exempt reporting adviser.

OUR TAKE: Expect more cases like this where the state regulators take the enforcement lead.  This is a rare case specifically alleging violations of the performance fee rule.  Also, securities lawyers and compli-pros should take notice that (i) the Massachusetts statute makes it unlawful to violate an SEC rule that would otherwise apply only to SEC-registered advisers and (ii) the MSD seeks to prohibit federal exempt reporting adviser registration as a remedy.