Securities Law Prof Blog

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

Wednesday, August 31, 2011

The Uniform Fiduciary Standard for Securities Professionals -- Part I

It is well documented that retail customers are confused about the different titles, services and duties of the securities professionals who offer them investment advice.  Through history and evolution, two different regulatory systems that turn on an increasingly incoherent distinction between investment advisers and broker-dealers are in place to regulate investment advice providers.  If we were designing a regulatory system from scratch, it is hard to imagine that the current version would get many votes.  Accordingly, Dodd-Frank § 913 required the SEC to 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 SEC staff completed the required study in January 2011.

While the statute does not mandate that the SEC take any action, SEC Chair Mary Schapiro recently stated that she hopes that the agency will release for public comment this fall a proposal for a uniform fiduciary standard for all securities professionals that provide retail investment advice. This rulemaking will be a long and controversial process as it involves the future regulation of two industries that take pride in their different traditions and compete head-on for the retail investors’ business.  Moreover, if final rules are adopted and challenged in court, the D.C. Circuit has made it abundantly clear that it will critically review the SEC’s assessment of the costs and benefits of rules implementing Dodd-Frank; see Business Roundtable v. SEC (D.C. Cir. July 22, 2011).

Because of its importance to retail investors, I plan to devote a number of posts to this topic in the weeks ahead.  This post describes the January 11, 2011 SEC staff study’s recommendations.  (Parentheticals refer to the report’s page numbers.)  Future posts will describe responses to the report and other recent developments relating to the regulation of investment advisers and broker-dealers under Dodd-Frank.

The Bottom Line

The SEC staff study recommends that the SEC promulgate rules 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)” (v-vi).  In particular, the SEC should adopt the “uniform fiduciary standard,” which the study describes as follows:

“the 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 Commission 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” (vi). 

The staff considered, but ultimately rejected recommending, alternatives to the uniform fiduciary standard, such as repealing the broker-dealer exclusion in the Investment Advisers Act and imposing the standard of conduct and other requirements of the Investment Advisers Act on broker-dealers.

The study sets forth a number of recommendations to implement through rulemaking or interpretive guidance the uniform fiduciary standard and its component duties of loyalty and care.  These recommendations are phrased generally and thus postpone the difficult task of working out the standard’s specific contours, e.g.:

• The SEC “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” (vi).

It is worth noting that “ [t]he 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” (vi-vii). This suggests that the existing law is well-developed.  To the contrary, since the Investment Advisers Act does not provide customers with a private right of action for faulty investment advice, there is a paucity of case law addressing investors’ remedies outside of Rule 10b-5, which requires scienter.

Duty of Loyalty

Conflicts of Interest.   “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” (vii).  More specifically, the study provides:

 Elimination of Conflicts:
The SEC 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” (vii)


The SEC should consider the most effective means of disclosure, i.e., “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)” (vii)

The SEC 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)” (vii)

Principal Trading.  The SEC “should address through interpretive guidance and/or rulemaking how broker-dealers should fulfill the uniform fiduciary standard when engaging in principal trading” (vii)
Duty of Care

The SEC “should consider specifying uniform standards for the duty of care owed to retail investors …. 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” (vii)

Personalized Investment Advice About Securities

The SEC “should engage in rulemaking and/or issue interpretive guidance to explain what it means to provide ‘personalized investment advice about securities’” (vii)

Harmonization of Regulation

  The staff also identified other areas where regulation of investment advisers and broker-dealers differs and recommended that the SEC consider whether regulation in those areas “should be harmonized for the benefit of retail investors”(viii)

• Advertising and Other Communications
• Use of Finders and Solicitors
• Supervision
• Licensing and Registration of Firms
• Licensing and Continuing Education Requirements for Persons Associated with Broker-Dealers and Investment Advisers
• Books and Records


With respect to benefits, the study states that “the Staff believes that the uniform fiduciary standard and related disclosure requirements may offer several benefits, including the following:

• Heightened investor protection;
• Heightened investor awareness;
• It is flexible and can accommodate different existing business models and fee structures;
• It would preserve investor choice;
• It should not decrease investors’ access to existing products or services or service providers;
• Both investment advisers and broker-dealers would continue to be subject to all of their existing duties under applicable law; and
• Most importantly, it would require that investors receive investment advice that is given in their best interest, under a uniform standard, regardless of the regulatory label (broker-dealer or investment adviser) of the professional providing the advice” (viii)


The study notes that it is “sensitive to the costs that could be incurred by investors, broker-dealers, investment advisers, and their associated persons due to any change in legal or regulatory standards related to providing personalized investment advice to retail investors” (143).   It also observes that “costs associated with possible regulatory outcomes are difficult to quantify” and that the rulemaking process would provide commenters the opportunity to provide information on costs (144).  The study then goes on to discuss costs associated with three options: eliminating the broker-dealer exclusion (which it identifies as the most expensive and which it does not recommend), adopting a uniform fiduciary standard, and additional harmonization of the regulatory regime.

 With respect to adopting a uniform fiduciary standard, the study reviews various options broker-dealers might take in response to new regulation and sums up by stating the obvious:

[T]o the extent that broker-dealers respond to a new standard by choosing from among a range of business models, such as converting brokerage accounts to advisory accounts, or converting them from commission-based to fee-based accounts, certain costs might be incurred, and ultimately passed on to retail investors in the form of higher fees or lost access to services and products. Any increase in costs to retail investors detracts from the profitability of their investments (162).

Similarly, with respect to additional harmonization, the study states:

Ultimately, the costs associated with additional harmonized standards would depend on various factors, including which and how many standards are harmonized, whether the harmonization had an overall greater impact on broker-dealers or on investment advisers, how broker-dealers and investment advisers decide to respond to such harmonization (e.g., by pursuing any of the potential outcomes described above, or others not contemplated in this Study), and the extent to which any increased costs on intermediaries (i.e., broker-dealers and investment advisers) were passed on to retail customers (163).

Future posts will review and assess responses to the SEC staff study on Section 913.


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