Which Laws Apply to Broker-Dealers? Federal Laws? State Laws? Both? General Principles Leading to an Answer

Posted in: Business Law

The laws of the United States draw on many legal and legitimate sources. After all, the United States is a conglomeration of states and governing bodies. In addition, each state may have different cultural, social, and financial issues, and may need to establish its own laws to deal with them. However, the states’ freedom to establish their laws must be limited in order to avoid or restrict and regulate possible conflicts among the various laws with which all citizens should comply. Therefore, the United States has imposed limits by rules, which determine which of the laws that regulate the same, or a similar regulatory area, govern. These rules are called “rules of preemption.”

Although preemption is driven by one purpose—to determine which rule applies—there are many different preemption rules because they deal with different laws and situations. Thus, the first layer of preemption rules deals with the classification of preemption rules and their source. These include the U.S. Constitution; congressional laws, rules issued by various commissions and institutions, which were established by federal laws, such as the Securities and Exchange Commission; various state laws; and rules enacted by state regulators. This note describes the laws and preemption rules that govern the relationship among different or conflicting United States laws.

1. The United States Constitution. The Supremacy Clause in the U.S. Constitution provides that federal United States law is the “Supreme law of the land,” state law notwithstanding. Thus, U.S. federal law can preempt state law, either expressly or by implication, imposing rules that differ from state rules and then are supreme to the state rules. Thus, Congress can explicitly or implicitly preempt state laws. State laws can be preempted by two types of federal laws: “conflict preemption” or “field preemption.”

2. The Federal and State Laws. Federal law issued by Congress or under congressional mandate, can preempt State law explicitly, stating that its rules govern, regardless of any other rules. Furthermore, federal law could preempt state law by occupying and regulating a particular field of activities. If Congress has regulated such an area and spoken about a subject, state laws may not conflict with congressional rules. Thus, under “field preemption,” that is, the area preemption, “state law is preempted when it regulates conduct in a field that Congress intended the Federal Government to occupy exclusively. Such an intent may be inferred from a ‘scheme of federal regulation . . . so pervasive as to make reasonable the inference that Congress left no room for the States to supplement it,’ or where an Act of Congress ‘touches a field in which the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject.’”

In addition, “state law is pre-empted by federal law to the extent that it actually conflicts with federal law,” i.e., “where it is impossible for a private party to comply with both state and federal requirements,” “or where state law ‘stands as an obstacle to the accomplishment and execution of the full purposes and objectives of Congress.’” In short, when it is not possible to fully comply with both state and federal law without violating a provision of either laws or both laws.

3. Preemption – State Laws Regulating the Fiduciary Duties of Brokers. Brokers’ fiduciary duties under state common law are not preempted by the federal securities laws, although the Investment Advisers Act includes a limited preemption of state law. Generally, states may not “require[e] the registration, licensing, or qualification” of a federally-registered adviser,” except that the federal Act specifically does not prohibit a State from “investigating and bringing enforcement actions with respect to fraud or deceit against an investment adviser.”

4. The Current Potential Conflicts: In June 2017, the State of Nevada imposed a state fiduciary duty on investment advisers and broker-dealers. The duty of investment advisers may differ from that imposed by federal law. In addition, after the recent SEC broker fiduciary duty proposals, the president of the Investment Company Institute noted “the potential for inconsistent and confusing standards of conduct,” noting specifically that recent state legislative activity (including the Nevada act) “has raised the specter of multiple and differing standards of conduct (or related disclosure requirements).” Consequently, he urged the SEC, in any final rule on broker fiduciary duty, “to explicitly affirm . . . that SEC standards of conduct would preempt any standards under state law that are inconsistent with SEC regulation.”

In sum, the issue of preemption will continue, but there may be some signals to predict where it will be going. Here are unsupported predictions. One signal will highlight the different interests of the parties involved, that is, the conflicted interest of brokers’ characterization advice as “sales talk.” It is not difficult to imagine that state laws that will tighten brokers’ duties in this function will meet with continued brokers’ objections. That is, unless the market, i.e., public investors, rather than law enforcement, will demand brokers to be trustworthy as fiduciaries are. The public can be educated at least by asking the relevant questions and demanding the answers in writing. The law can then be copied into clients’ demand for trustworthy behavior. It may well be that brokers may attract investors when the brokers announce their voluntary acceptance of fiduciary duties in writing. In addition, there are some brokers’ duties that are related to market manipulations. Those might fall within the Securities and Exchange Commission’s current rule. Finally, there is history. When the securities market crashed years ago Congress rolled up its sleeves and imposed strict rules that helped revive it. Hopefully such bitter medicine would not be necessary these days.

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