Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Saturday, January 22, 2011

SEC Staff Study Recommends Uniform Fiduciary Standard for Investment Advisers and Broker-Dealers

Today the SEC released the Study on Investment Advisers and Broker-Dealers required by Section 913 of the Dodd-Frank Act.  As virtually everyone expected, the Study recommends adoption of a uniform fiduciary standard for investment advisers and broker-dealers who provided individualized advice to retail investors.  As is ever the case, however, the "devil is in the details," and the Study is short on specifics. 

 The Report is a staff report and expressly states it does not set forth the views of the Commission.  The two Republican Commissioners (Casey and Paredes) opposed the release of the Study in its present form because, in their view, "a stronger analytical and empirical foundation than provided by the Study is required before regulatory steps are taken that would revamp how broker-dealers and investment advisers are regulated." 

First, it is important to remember what section 913 required the SEC to do.  Section 913 requires the agencyto conduct a study to evaluate:
• The effectiveness of existing legal or regulatory standards of care (imposed by the Commission, 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 Study recommends establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers under Advisers Act Sections 206(1) and (2), subject to two important limitations set forth in the statute.  Section 913 explicitly provides that the receipt of commission-based compensation, or other standard compensation, for the sale of securities does not violate the uniform fiduciary standard of conduct applied to a broker-dealer and  that the uniform fiduciary standard does not require broker-dealers to have a continuing duty of care or loyalty to a retail customer after providing personalized investment advice.

The Study sets forth the following recommendations for implementing a uniform fiduciary standard:

"Implementing the Uniform Fiduciary Standard: The Commission 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 Commission 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 Advisers Act regarding fiduciary duty, as developed primarily through Commission interpretive pronouncements under the antifraud provisions of the Advisers Act, and through case law and numerous enforcement actions, will continue to apply.

"Duty of Loyalty: A uniform standard of conduct will obligate both investment advisers and broker-dealers to eliminate or disclose conflicts of interest. The Commission 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.

"The Commission should consider which disclosures might be provided most effectively (a) in a general relationship guide akin to the new Form ADV Part 2A that advisers deliver at the time of entry into the retail customer relationship, and (b) in more specific disclosures at the time of providing investment advice (e.g., about certain transactions that the Commission believes raise particular customer protection concerns).

"The Commission also should consider the utility and feasibility of a summary relationship disclosure document containing key information on a firm’s services, fees, and conflicts and the scope of its services (e.g., whether its advice and related duties are limited in time or are ongoing).

"The Commission should consider whether rulemaking would be appropriate to prohibit certain conflicts, to require firms to mitigate conflicts through specific action, or to impose specific disclosure and consent requirements.

"Principal Trading: The Commission 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 Commission 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 Commission should engage in rulemaking and/or issue interpretive guidance to explain what it means to provide “personalized investment advice about securities.”

"Investor Education: The Commission should consider additional investor education outreach as an important complement to the uniform fiduciary standard."

The Study then addresses the related issue of harmonizing the regulation of investment advisers and broker-dealers:

"Harmonization of Regulation: The Staff believes that a harmonization of regulation—where such harmonization adds meaningful investor protection—would offer several advantages, including that it would provide retail investors the same or substantially similar protections when obtaining the same or substantially similar services from investment advisers and broker-dealers. The following recommendations address certain other areas where investment adviser and broker-dealer laws and regulations differ, and where the Commission should consider whether laws and regulations that apply to these functions should be harmonized for the benefit of retail investors:

"Advertising and Other Communications: The Commission 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 Commission 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 Commission 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 adviser or broker-dealer.

"Supervision: The Commission 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 Commission 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 Commission 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 Commission could consider requiring investment adviser representatives to be subject to federal continuing education and licensing requirements.

"Books and Records: The Commission 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."

Finally, while Congress mandated a study of this issue, it did not mandate that the SEC engage in rulemaking.  It remains very much to be seen whether and when the SEC will take up rulemaking.  Certainly Commissioners Casey and Paredes have made clear their view that additional empirical research is needed before adoption of any rules.

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