By John M. Jascob, J.D., LL.M.
NASAA has urged the Illinois Supreme Court to reverse a lower court’s ruling and hold that heightened fiduciary duties applied to an investment adviser’s conduct in switching clients between indexed annuities. NASAA contends that the antifraud provisions of the Illinois Securities Law apply to the entire scope of an adviser’s relationship with his clients. Carving out an exception to those fiduciary obligations and holding advisers to a lower suitability standard when selling indexed annuities would erode important investor protections, according to NASAA (Van Dyke v. White, October 25, 2017).
Annuity switches. The appellee, Richard Van Dyke, had effected 33 indexed annuity transactions for 21 advisory clients, for which he earned approximately $183,000 in commissions. The transactions, which Van Dyke had solicited, involved the liquidation of the clients’ previous indexed annuity contracts and the purchase of new annuities with higher fees.
The Illinois Secretary of State then commenced an administrative enforcement action against Van Dyke, finding that his conduct in “switching” the annuity contracts breached his fiduciary duty to his clients under provisions of the Illinois Securities Law. The Secretary of State revoked Van Dyke’s adviser registration, permanently prohibited Van Dyke from offering or selling securities in Illinois, and imposed a fine of approximately $330,000. The Illinois Court of Appeals, however, reversed the administrative order, concluding that the annuities at issue were not "securities" under Illinois law and that the adviser’s conduct was not fraudulent.
Avoiding regulatory arbitrage and perverse incentives. NASAA urged the Illinois Supreme Court to look to federal precedent for guidance when interpreting Section 12(J) of the Illinois Securities Law, which makes it a violation for investment advisers to engage in fraudulent conduct. NASAA urged the state high court to join other state supreme courts in following the U.S. Supreme Court’s decision in SEC v. Capital Gains Research Bureau (U.S. 1963). These state court decisions have held that advisers (whether registered or not) owe their clients fiduciary duties under state securities laws.
NASAA acknowledged that the law is unclear concerning the applicable standard of care when a conflict exists between a dually-registered adviser’s competing duties under Illinois’ insurance and securities laws. NASAA believes, however, that the court should apply the higher standard—in this case the fiduciary duty standard. The investment adviser designation holds special meaning to investors apart from any other license the adviser may hold, NASAA stated. Accordingly, this special meaning requires that those who have earned the right to call themselves investment advisers are held to a higher standard in dealing with their clients.
A regulatory regime that holds advisers to the higher fiduciary duty standard when selling securities, but a lower suitability standard when selling annuities incentivizes investment advisers to skew their recommendations towards insurance products such as annuities, thereby facilitating a system of regulatory arbitrage, NASAA argued. If the lower court’s decision were allowed to stand, NASAA believes that investment advisers in Illinois will play off of the bifurcated system created by the ruling in an attempt to avoid breach of fiduciary claims when those claims are related to the purchase or sale of an insurance product.
The case is No. 121452.