In late January, the Securities and Exchange Commission submitted to Congress a study recommending the adoption of a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice to retail customers. This proposed standard would be "no less stringent" than the standard currently applicable to investment advisers, and would include the duty to "act in the best interest of the customer." The recommended change is intended to bring greater consistency to the standards of conduct that apply when retail customers receive personalized investment advice about securities.
Traditionally, investment advisers and broker-dealers have been subject to differing standards of care. Federal law defines "investment advisers" as those who "engage in the business of advising others. . .as to the value of securities or as to the advisability of investing in, purchasing, or selling securities. . ." 15 U.S.C. § 80b-2. Advisers are regulated under the Investment Advisers Act of 1940 and owe a fiduciary duty to their clients. An adviser must serve the best interests of the client, and owes the client the duties of loyalty and care.
Broker-dealers engage in "the business of offering, buying, selling, or otherwise dealing or trading in securities. . ." 15 U.S.C. § 78b(12). They may provide a variety of other services, including providing research and advice; selling proprietary products (e.g., private equity and other alternative investments); and referring investors to affiliates for non-securities financial offerings, such as mortgages, insurance, or bank deposits. Broker-dealers are excluded from the definition of "investment adviser" under the Advisers Act where, inter alia, investment advice is incidental to the conduct of one's business as a broker or dealer. Broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, but they do have a duty of fair dealing. This duty includes a "suitability" obligation -- broker-dealers must make recommendations that are consistent with the interests of their customers.
In 2010, Congress determined that the SEC should evaluate these differing standards of conduct. Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to conduct a study regarding the obligations of brokers, dealers and investment advisers. Specifically, the Act required the SEC to evaluate the effectiveness of existing legal or regulatory standards of care. The SEC was also tasked with determining whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers.
Pursuant to the Dodd-Frank mandate, the Commission established a cross-Divisional staff task force to conduct the study. During a month-long comment period in August 2010, the SEC received more than 3,500 comment letters from a range of sources, including investors, financial professionals, industry groups, academics, and other financial regulators. Importantly, the Securities Industry and Financial Markets Association (SIFMA) -- a securities industry trade group representing the interests of hundreds of securities firms, banks and asset managers -- supported the development of a uniform federal fiduciary standard of care. SIFMA argued that retail customers "should receive the same standard of care when receiving the same services," notwithstanding advisers' and broker-dealers' different regulatory status. SIFMA, thus, recommended that the SEC adopt a uniform standard of care that is "easy to understand" and offers clear and consistent protections to individual investors.
Taking into account the information gathered during the month-long comment period, the SEC's task force found that many retail investors "do not understand the differences between investment advisers and broker-dealers or the standards of care applicable" to these different groups. Thus, according to the task force, many people "find the standards of care confusing, and are uncertain about the meaning of various titles and designations used by investment advisers and broker-dealers."
In order to remedy these problems, the study recommends that the SEC engage in rulemaking to implement a uniform standard of conduct that addresses investor confusion and provides a more consistent regulatory regime. The uniform standard, which the staff describes as "no less stringent" than the fiduciary standard currently applied to investment advisers, would essentially be an extension of that standard to broker-dealers. According to the study, "the standard of conduct for all brokers, dealers and investment advisers, when providing personalized investment advice about securities to retail customers. . .shall be to act in the best interests of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice."
Commissioners Kathleen Casey and Troy Paredes issued a separate statement opposing the study's release to Congress. They argue that the study fails to adequately justify its recommendations. "The study recommends the adoption of a new uniform fiduciary standard," they write, "[b]ut it does so without adequate articulation or substantiation of the problems that would purportedly be addressed via that regulation." In short, Commissioners Casey and Paredes argue that the staff has presented a solution in search of a problem: the study articulates a uniform fiduciary standard for investment advisers and broker-dealers, but it fails to explain why such uniformity is necessary.
Casey and Paredes also emphasize the need to evaluate the costs associated with a uniform standard. They argue that the study embarks on "fundamentally changing the regulatory regime for broker-dealers and investment advisers" without adequately accounting for the possibility that a uniform fiduciary standard may actually harm investors. According to Casey and Paredes, "investors may have fewer broker-dealers and investment advisers to choose from, may have access to fewer products and services, and may have to pay more for the services and advice they do receive." Casey and Paredes ultimately conclude that the study is a "starting point for further research," but that they cannot determine whether rulemaking is appropriate without the benefit of further analysis.
Notwithstanding these objections, it is likely that the SEC will engage in rulemaking to adopt a uniform fiduciary standard. Dood-Frank authorizes this rulemaking, and as noted above, securities industry representatives such as SIFMA support the staff's recommendation. The development of a uniform fiduciary standard may lead to significant changes in the legal and regulatory landscape. Individuals and companies should work closely with outside counsel to determine how they may be affected by SEC rulemaking in this area.