The staff of the SEC has delivered to Congress a long-awaited study pursuant to Section 913 of the Dodd-Frank Act. That provision of the Dodd-Frank Act requires the SEC to conduct a study to evaluate:

  • The effectiveness of existing legal or regulatory standards of care (imposed by the SEC, a national securities association, and other federal or state authorities) for providing personalized investment advice and recommendations about securities to retail customers; and
  • Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute.

The 208 page study, delivered on January 21, 2011, noted that the regulatory schemes for investment advisers and broker-dealers are designed to protect investors through different approaches.

Investment Advisers. Investment advisers are fiduciaries to their clients, and the regulation under the Investment Advisers Act of 1940 generally is principles-based. An investment adviser is a fiduciary whose duty is to serve the best interests of its clients, including an obligation not to subordinate clients’ interests to its own. Included in the fiduciary standard are the duties of loyalty and care. An investment adviser that has a material conflict of interest must either eliminate that conflict or fully disclose to its clients all material facts relating to the conflict.

Broker-Dealers: Broker-dealers that do business with the public generally must become members of FINRA. Under the antifraud provisions of the federal securities laws and self regulatory organization, or SRO, rules, including SRO rules relating to just and equitable principles of trade and high standards of commercial honor, broker-dealers are required to deal fairly with their customers. While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts have found broker-dealers to have a fiduciary duty under certain circumstances. Moreover, broker-dealers are subject to statutory, SEC and SRO requirements that are designed to promote business conduct that protects customers from abusive practices, including practices that may be unethical but may not necessarily be fraudulent. The federal securities laws and rules and SRO rules address broker-dealer conflicts in one of three ways: express prohibition; mitigation; or disclosure.

An important aspect of a broker-dealer’s duty of fair dealing is the suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the interests of its customer. Broker-dealers also are required under certain circumstances, such as when making a recommendation, to disclose material conflicts of interest to their customers, in some cases at the time of the completion of the transaction. The federal securities laws and FINRA rules restrict broker-dealers from participating in certain transactions that may present particularly acute potential conflicts of interest. At the state level, broker-dealers and their agents must register with or be licensed by the states in which they conduct their business.

Recommendations. Consistent with Congress’s grant of authority in Section 913, the staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2). In particular, the staff recommends that the SEC exercise its rulemaking authority under Dodd-Frank Act Section 913(g), which permits the SEC to promulgate rules to provide that:

“[T]he 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.’

The standard outlined above is referred to in the study as the “uniform fiduciary standard.”

SEC Commissioners Casey and Paredes. Commissioners Casey and Paredes issued a statement outlining certain reservations about the study. That statement said in part:

“In our view, the Study’s pervasive shortcoming is that it fails to adequately justify its recommendation that the [SEC] embark on fundamentally changing the regulatory regime for broker-dealers and investment advisers providing personalized investment advice to retail investors. The Study recommends the adoption of a new uniform fiduciary duty standard and harmonization of two disparate regulatory regimes. But it does so without adequate articulation or substantiation of the problems that would purportedly be addressed via that regulation. The Study also does not adequately recognize the risk that its recommendations could adversely impact investors . . .

Because of our concerns, we oppose the Study’s release to Congress as drafted. We do not believe the Study fulfills the statutory mandate of Section 913 of the Dodd-Frank Act to evaluate the “effectiveness of existing legal or regulatory standards of care” applicable to broker-dealers and investment advisers.”

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