January 28, 2011-- Last Friday, the SEC delivered to Congress a 166-page study (available here) mandated by the Dodd-Frank reform legislation (the "Study") concerning the regulatory requirements that apply to investment advisers and broker-dealers when they provide personalized investment advice about securities to retail customers.

The Study recommends that the SEC exercise its rulemaking and administrative authority so that broker-dealers who give such personalized investment advice would be subject to a fiduciary duty to act in the best interest of customers, comparable to the standard that currently applies to investment advisers (see part I. below). The Study also recommends that the Commission give further consideration to various other changes or actions to "harmonize" or otherwise improve the regulation of investment advisers and broker-dealers (see part II. below).

A cross-divisional SEC staff task force authored the study, which states that it does not necessarily reflect the views of the SEC or any individual Commissioners. Indeed, two of the SEC's five Commissioners believed that the Study was so deficient in certain respects that it should not have been provided to Congress in its current form (see part III. below).

Pursuant to Dodd-Frank, the SEC has the requisite authority to implement the Study's recommendations without further action from Congress. The SEC, however, is not required to take any action and could, subject to certain limitations, also take action that is at variance with the Study's recommendations. The SEC is not subject to any statutory deadlines by which it must take any further action.

I. Recommended Uniform Fiduciary Standard

The Study recommends that the SEC, by rule, adopt the following uniform fiduciary standard of conduct for broker-dealers and investment advisers:

[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 Study emphasizes that the uniform fiduciary standard would not necessarily impose on broker-dealers a continuing duty of care or loyalty to a retail customer after providing personalized investment advice. Such a continuing duty could arise in particular circumstances or from other sources, however.

The Study recommends that the SEC implement the uniform fiduciary standard by providing additional guidance (by rule or by interpretation) concerning the components of that standard: i.e., a duty of loyalty and a duty of care. In this regard, the Staff believes that the existing guidance and precedent under the Investment Advisers Act regarding fiduciary duty, as developed primarily through SEC interpretive pronouncements under the antifraud provisions of that act, and through case law and numerous enforcement actions, will continue to apply to broker-dealers and investment advisers.

Speaking generally, the Study's recommendation is that, under the recommended uniform fiduciary standard, broker-dealers making investment recommendations to retail customers be subject to the same fiduciary duty to which investment advisers currently are subject. The Staff's recommendation, moreover, is that the uniform fiduciary standard would not replace, but would be in addition to, any other standards, duties or requirements that otherwise would apply.

A. Conflicts of Interest

The Study makes clear that, although the uniform fiduciary standard would require a firm to eliminate or disclose material conflicts of interest, it would not mandate the absolute elimination of any particular conflicts, absent another requirement to do so. In particular, the Study notes that the receipt of commission-based compensation, or other standard compensation, for the sale of securities would not, in and of itself, violate the uniform fiduciary standard. Similarly, the Study notes that a broker-dealer would not be prohibited from offering only proprietary products, but may be subject to disclosure and consent requirements in connection with that practice.

Nevertheless, the Study recommends that the SEC consider whether rulemaking would be appropriate to prohibit some conflicts, to require firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements. The Study, however, provides little indication of what conclusions the SEC would reach with respect to most types of conflict.

In the Staff's view, the uniform fiduciary standard would not in itself impose requirements on principal transactions by broker-dealers that are the same as the requirements that the Investment Advisers Act imposes on principal transactions by investment advisers. Nevertheless, the Study recommends that the SEC address through rulemaking and/or interpretive guidance how broker-dealers should fulfill the uniform fiduciary standard when engaging in principal trading. The Study states that, at a minimum, a broker-dealer should be required to disclose its conflicts of interest with respect to principal transactions (as well as to comply with otherwise applicable suitability, best execution, and fair and reasonable pricing/compensation requirements). The Staff believes that the disclosure provided by the broker-dealer would need to provide sufficient facts so that investors are able to understand the conflicts of interest in connection with principal transactions. Also, to the extent that a firm seeks to rely on customer consent with respect to principal transactions, the Staff believes that "requests for consent embedded in voluminous advisory agreements or other account opening agreements would impede the provision of such consent."

B. Other Recommendations Concerning the Uniform Fiduciary Standard

Some of the Study's other significant recommendations in connection with the uniform fiduciary standard are as follows:

  • Duty of Care -- The SEC should consider rulemaking or interpretive guidance to specify uniform standards for the duty of care owed by broker-dealers and investment advisers to retail customers. The Study explains that the SEC, for example, could specify the minimum basis a broker-dealer or investment adviser should have for making a recommendation to a retail customer.  
  • Disclosure -- The SEC should take action to facilitate uniform, simple, and clear disclosure to retail investors regarding the terms of their relationships with broker-dealers and investment advisers (including concerning conflicts of interest). Such disclosures might include, for example, (a) a general relationship guide (akin to the new Form ADV part 2A that investment advisers are now required to deliver at the time of entering a new customer relationship) and (b) more specific disclosure at the time of providing particular types of advice that may relate to transactions that the SEC believes raise particular customer protection concerns.  
  • Key Definition -- The SEC should engage in rulemaking and/or issue interpretive guidance to explain what it means to "provide personal investment advice about securities," as that term is used in the proposed uniform fiduciary standard.  
  • Investor Education -- The SEC should consider additional investor education outreach as an important complement to the uniform fiduciary standard.  
  • Enforcement -- The SEC should engage in effective enforcement and oversight with respect to the uniform fiduciary standard. In this connection, Dodd-Frank contains a specific provision that would obligate the SEC to enforce violations of the standard consistently against both investment advisers and broker-dealers.  

II. Other "Harmonization" of Regulation

Some of the Study's significant recommendations that do not specifically relate to the uniform fiduciary standard are as follows:

  • 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. Such guidance or harmonization could be advisable to address the status of finders and solicitors, and their respective disclosure requirements, to assure that retail customers better understand the conflicts associated with the solicitors' and finders' receipt of compensation for directing 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. This could include, for example, an evaluation of whether detailed supervisory structures would be inappropriate for a firm with a small number of employees.  
  • 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 Investment Advisers Act books and records requirements, including by adding a general requirement to retain all communications and agreements (including those in electronic form) related to an adviser's "business as such," consistent with the standard applicable to brokerdealers.  

III. Separate Statement by Commissioners Casey and Paredes

The SEC's two Republican Commissioners (Kathleen L. Casey and Troy A. Paredes) published a separate joint statement (available here). The Casey/Paredes statement expresses the view that the Study does not adequately address whether the regulatory disparities that the Study identifies are actually systematically harming or disadvantaging retail customers of broker-dealers on the one hand or customers of investment advisers on the other. Accordingly, Commissioners Casey and Paredes believe that the Study lacks a basis to reasonably conclude that a uniform fiduciary standard, or other regulatory harmonization, would enhance investor protection.

Because of their concerns, these Commissioners state that they do not believe that the Study fulfills Dodd-Frank's mandate to evaluate the "effectiveness of existing legal or regulatory standards of care" applicable to broker-dealers and investment advisers. Accordingly, Commissioners Casey and Paredes state that they oppose the Study's release to Congress as drafted.

Commissioners Casey and Paredes also fault the Study for failing to adequately consider the potential overall cost that its recommended reforms would have for broker-dealers, investment advisers, and retail investors.

In their statement, these Commissioners emphasize that, if further research and analysis is performed, they might support the recommendations contained in the Study. They also provide some suggestions as to the specifics of what such additional research and analysis could include.