On January 21, 2011, the Securities and Exchange Commission (“SEC”) released the study (the “Fiduciary Study”) of its staff mandated by Section 913 of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).1 This provision requires the SEC to conduct a study to evaluate: (i) the effectiveness of existing legal or regulatory standards of care for providing personalized investment advice and recommendations about securities to retail customers; and (ii) whether there are legal or regulatory gaps in these standards that should be addressed by rule or statute.
While recognizing that there are extensive regulatory frameworks that govern the conduct of investment advisers and broker-dealers, and that there are different basic business models for investment advisers and broker-dealers, the Fiduciary Study finds that many retail investors do not understand and are confused by the roles played by investment advisers and broker-dealers. The Fiduciary Study finds that "many investors are also confused by the different standards of care that apply to investment advisers and broker-dealers" when providing personalized investment advice about securities. The Fiduciary Study further states that retail investors "should not have to parse through legal distinctions to determine" the type of advice they are entitled to receive. Instead, retail customers should "be protected uniformly when receiving personalized investment advice or recommendations about securities regardless of whether they choose to work with an investment adviser or a broker-dealer." At the same time, the Fiduciary Study notes that retail investors should "continue to have access to the various fee structures, account options, and types of advice that investment advisers and broker-dealers provide."
Based on these findings, the SEC issued the following recommendations.
Standard of Conduct:
The SEC should exercise its rulemaking authority to implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers. Specifically, the SEC Staff recommends that the uniform fiduciary standard of conduct established by the SEC should provide that: the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the SEC may, by rule, provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.
Duty of Loyalty:
A uniform standard of conduct will obligate both investment advisers and broker-dealers to eliminate or disclose conflicts of interest. The SEC should prohibit certain conflicts and facilitate the provision of uniform, simple, and clear disclosures to retail investors about the terms of their relationships with broker-dealers and investment advisers, including any material conflicts of interest.
Implementing the Uniform Fiduciary Standard:
The SEC should engage in rulemaking and/or issue interpretive guidance addressing the components of the uniform fiduciary standard: the duties of loyalty and care. In doing so, the SEC should identify specific examples of potentially relevant and common material conflicts of interest, in order to facilitate a smooth transition to the new standard by broker-dealers and consistent interpretations by broker-dealers and investment advisers. The Staff is of the view that the existing guidance and precedent under the Investment Advisers Act of 1940 (the "Advisers Act") regarding fiduciary duty, as developed primarily through SEC interpretive pronouncements under the antifraud provisions of the Advisers Act, and through case law and numerous enforcement actions, will continue to apply.
The SEC should address through interpretive guidance and/or rulemaking how broker-dealers should fulfill the uniform fiduciary standard when engaging in principal trading.
Duty of Care:
The SEC should consider specifying uniform standards for the duty of care owed to retail investors, through rulemaking and/or interpretive guidance. Minimum baseline professionalism standards could include, for example, specifying what basis a broker-dealer or investment adviser should have in making a recommendation to an investor.
Personalized Investment Advice About Securities:
The SEC should engage in rulemaking and/or issue interpretive guidance to explain what it means to provide “personalized investment advice about securities.”
The SEC should consider additional investor education outreach as an important complement to the uniform fiduciary standard.
The SEC also recognized that harmonization of certain aspects of current investment adviser and broker-dealer regulation should be considered where it could add to investor protection in a meaningful way. Specifically, it recommended considering harmonizing rules in the following areas:
- Advertising and Other Communications: The SEC should consider articulating consistent substantive advertising and customer communication rules and/or guidance for broker-dealers and investment advisers regarding the content of advertisements and other customer communications for similar services. In addition, the SEC should consider, at a minimum, harmonizing internal pre-use review requirements for investment adviser and broker-dealer advertisements or requiring investment advisers to designate employees to review and approve advertisements.
- Use of Finders and Solicitors: The SEC should review the use of finders and solicitors by investment advisers and broker-dealers, and consider whether to provide additional guidance or harmonize existing regulatory requirements to address the status of finders and solicitors and their respective relevant disclosure requirements, to assure that retail customers better understand the conflicts associated with the solicitor’s and finder’s receipt of compensation for sending a retail customer to an investment adviser or broker-dealer.
- Supervision: The SEC should review supervisory requirements for investment advisers and broker-dealers, with a focus on whether any harmonization would facilitate the examination and oversight of these entities (e.g., whether detailed supervisory structures would not be appropriate for a firm with a small number of employees), and consider whether to provide any additional guidance or engage in rulemaking.
- Licensing and Registration of Firms: The SEC should consider whether the disclosure requirements in Form ADV and Form BD should be harmonized where they address similar issues, so that regulators and retail investors have access to comparable information. The SEC also should consider whether investment advisers should be subject to a substantive review prior to registration.
- Licensing and Continuing Education Requirements for Persons Associated with Broker-Dealers and Investment Advisers: The SEC could consider requiring investment adviser representatives to be subject to federal continuing education and licensing requirements.
- Books and Records: The SEC should consider whether to modify the Advisers Act books and records requirements, including by adding a general requirement to retain all communications and agreements (including electronic information and communications and agreements) related to an adviser’s “business as such,” consistent with the standard applicable to broker-dealers.
Study on Enhancement of Investment Adviser Examinations
The Fiduciary Study is related to the separate study (the “Investment Adviser Examination Study”) mandated by Section 914 of the Dodd-Frank Act as to the need to enhance the examination of investment advisers.2 In that study, the SEC recommended to Congress that it consider three alternatives to augment examinations of investment advisers: (i) impose user fees on investment advisers to fund examinations; (ii) utilize one or more self-regulatory organizations ("SROs") to oversee and examine investment advisers; or (iii) grant FINRA the authority to examine dual registrant broker-dealer/investment advisers under the Advisers Act.
The release of the studies was not without controversy. Commissioners Kathleen Casey and Troy Paredes issued a joint statement opposing the Fiduciary Study in which they said that the report “does not adequately recognize the risk that its recommendations could adversely impact investors.” Commissioner Elisse Walter issued a statement in connection with the Investment Adviser Examination Study in which she expressed disappointment that the SRO option was not given more prominence.