The Dodd-Frank Act implemented a number of investor protection provisions that affect broker-dealers. Of course, most readers are familiar with Section 913 of the Dodd-Frank Act, which mandated that the SEC conduct a study concerning the effectiveness of current legal and regulatory standards of care for broker-dealers, investment advisers and their associated persons when providing personalized investment advice to retail investors. Brokerdealers are generally not subject to a fiduciary standard of care. By contrast, investment advisers are considered “fiduciaries” who must act in the best interest of their customers. Broker-dealers are currently excluded from the definition of “investment adviser” unless, for example, they charge separately for their investment advice. Although broker-dealers generally are not considered “fiduciaries,” they do owe various duties to their customers, such as the duty to recommend “suitable” investments, obtain “best execution” when effecting trades and charge fair commissions or mark-ups for their services. These duties fall short of a fiduciary’s requirement to act in the best interests of the client and to avoid placing the interests of the fiduciary ahead of those of the client.

On January 21, 2011, the SEC released the study, which was prepared by the SEC staff. The study does not necessarily reflect the views of the five SEC commissioners who must ultimately decide which, if any, rules should be adopted. Two commissioners dissented from the decision to release the study based on their concern that the study failed to adequately support its position with empirical data. Due to, among other things, this 5-to-2 majority, the study should be viewed as another step towards the likely imposition of a fiduciary standard for broker-dealers.

The study’s principal conclusion is that the SEC should establish a uniform fiduciary standard for broker-dealers and investment advisers when providing personalized investment advice to retail customers. Under this standard, both broker-dealers and investment advisers must act in the best interest of their customers; in doing so, they must act without regard for their own financial interest; broker-dealers would be held to a fiduciary standard no less stringent than the existing fiduciary standard for investment advisers under Sections 206(1) and 206(2) of the Investment Advisers Act of 1940 (the “Advisers Act”). The study contemplates that the uniform fiduciary standard would involve both a duty of loyalty and a duty of care. Under the duty of loyalty, a broker or adviser would be prohibited from putting its interests ahead of the customer and would be required to disclose any conflicts of interest. Under the duty of care, a broker or adviser would be held to minimum standards of review and analysis when making investment recommendations or otherwise providing personalized investment advice to retail customers. It is not clear how, if at all, the proposed duty of care would differ from the suitability requirements already imposed on broker-dealers. The study discusses a number of issues that would need to be addressed if the uniform fiduciary standard were adopted, and recommends that the SEC clarify how the standard would be applied through rulemaking and/or interpretive guidance. The study also considers and rejects alternative approaches that would have resulted in broker-dealers being subjected to all or most of the provisions of the Investment Advisers Act. The study is short on specifics as to how the fiduciary standard would be implemented and how key terms should be defined. In addition to recommending a uniform fiduciary standard, the study recommends that the SEC consider harmonizing the regulation of broker-dealers and investment advisers in other areas.

As broker-dealers await additional SEC guidance, they must begin to address changes arising in connection with FINRA’s adoption of revisions to its rules relating to brokers’ “know your customer” and suitability obligations. See our prior issues for updates on these changes here: In addition, broker-dealers also should consider their relationships with employee benefit plans in light of proposed changes to an ERISA regulation, which could cause them to be considered fiduciaries for ERISA purposes. On October 21, 2010, the Department of Labor issued a proposed regulation that may expand significantly the categories of persons considered fiduciaries as a result of their providing investment advice to plans subject to ERISA or to participants or beneficiaries of such plans. ERISA which subjects fiduciaries to standards of prudence and loyalty to the plans for which they are fiduciaries, as well as to conflict of interest rules, referred to as the “prohibited transaction rules.” See our prior report on these proposed changes