On April 18, 2018, the SEC proposed an interpretation of the “federal fiduciary standard” applicable to investment advisers under Section 206(1) and (2) of the Investment Advisers Act of 1940 (Advisers Act) in connection with the proposal that same day of new Regulation Best Interest, which would establish a standard of conduct applicable to broker-dealers.14 The proposed interpretation is intended to provide additional guidance regarding the duties of loyalty and care applicable to investment advisers and to set forth a single description of the existing components of the fiduciary requirements under the Advisers Act.
Duty of Care
Under the proposed interpretation, an investment adviser’s duty of care would be clarified to include duties to (1) act and provide advice in a client’s best interest, (2) seek best execution of client transactions in circumstances in which the investment adviser may select broker-dealers and execute trades and (3) provide ongoing advice and monitoring over the course of the investment adviser’s relationship with the client. As set forth in the proposal, the duty to act in a client’s best interest includes the duty to make a reasonable inquiry to determine the client’s investment profile, including the client’s financial circumstances, level of sophistication, investment experience and objectives, and to provide personalized advice suitable to and in the best interest of the client based upon the client’s investment profile. The investment adviser must also update the client’s investment profile to reflect any changed circumstances. In determining whether investment advice is in the best interest of the client, the proposal indicates that an investment adviser should consider the cost, including fees and compensation, associated with the advice, as well as the investment product’s or strategy’s objectives, characteristics, liquidity, risks, potential benefits, volatility and expected performance under different market and economic conditions. With respect to an investment adviser’s duty to seek best execution, the proposal clarifies that “the determinative factor is not the lowest possible commission cost but whether the transaction represents that best qualitative execution.”
Duty of Loyalty
As stated in the proposed interpretation, an investment adviser’s duty of loyalty requires that the adviser put its client’s interest first and neither favor its own interests over those of a client nor unfairly favor one client over another. “An adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure to its clients of all material conflicts of interest that could affect the advisory relationship.” The proposed interpretation cautions, however, that disclosure alone “is not always sufficient to satisfy the adviser’s duty of loyalty and section 206 of the Advisers Act.” Disclosure must be sufficiently clear and detailed to enable a client to understand the adviser’s conflicts and business practices and make a reasonably informed decision whether to consent to them. The proposal states that consent to a conflict of interest (whether affirmative or implied) would not be appropriate in circumstances in which a client does not understand the nature of the conflict or in which the material facts regarding the conflict are not fully and fairly disclosed.
Proposed Enhanced Regulation
In addition, pursuant to the proposal, the SEC is seeking comment on whether rules should be proposed to establish for investment advisers (1) federal licensing and continuing education requirements applicable to adviser representatives, (2) requirements to deliver periodic account statements and (3) certain financial responsibility requirements, which may include requirements to maintain minimum net capital levels, obtain fidelity bond coverage and/or segregate assets.
The public comment period will be open until August 7, 2018.
The proposed interpretation and request for comment described above, Advisers Act Release No. 4889, is available at: https://www.sec.gov/rules/proposed/2018/ia-4889.pdf