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News January 24, 2011 Issue

SEC Recommends Uniform Fiduciary Standard Of Care For The Protection Of Retail Investors

Score one for Aunt Millie, Commissioner Elise Walter’s fictional "everyman" investor.

In the SEC‘s highly anticipated report, "Study on Investment Advisers and Broker-Dealers," the SEC staff agreed with Walter that retail investors need more protection and certainty than currently provided in the securities laws.

Finding that broker-dealers advising retail clients should be subject to a fiduciary duty equal to the current standard applicable to advisers, the staff recommended that the SEC move forward to develop harmonized rules that would level the playing field for retail investors when receiving "personalized investment advice about securities."

The standard of conduct for all brokers, dealers, and investment advisers under those circumstances, said the recommendation, "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."

Harmonized rules should 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)."

Investor advocates cheered the findings. Barbara Roper, Director of Investor Protection at the Consumer Federation of America, said the recommendation is a first step in the right direction. "For years, the SEC has stood by and allowed broker-dealers to market themselves to investors as trusted advisers without requiring them to meet the most basic standard appropriate to that role – a fiduciary duty to act in their customers’ best interests," she said. Charles Moran, chairman of the Certified Financial Planner Board of Standards, said "the extension of a fiduciary standard of care to all broker-dealers will build much-needed confidence among the average American consumer whose faith in the financial markets is still shaken."

Industry representatives on both sides of the aisle were supportive, but cautious. Care must be taken to ensure the "well-established fiduciary duty under the Advisers Act" is not watered down, said Investment Adviser Association executive director David Tittsworth. He also cautioned against establishing different standards of care for different clients.

Calling the study’s approach "workable," Securities Industry and Financial Markets Association (SIFMA) general counsel Ira Hammerman expressed the need to "ensure that the broker-dealer role is not hindered."

Brokers have long expressed concern that commission-based fees structures are jeopardized under a fiduciary standard. However, Section 913 explicitly provides that the receipt of commission-based compensation, or other standard compensation, for the sale of securities does not, in and of itself, violate the uniform fiduciary standard of conduct. The SEC study specifically noted that the staff’s recommendation is intended to "assure that retail investors continue to have access to various investment products and choice among compensation schemes to pay for advice."

Hammerman also called for the SEC to ensure comparable oversight, examination and enforcement of retail registered investment advisers, as the study recommends. "Only if a uniform fiduciary standard of care is combined with [an] effective oversight, examination and enforcement program can investor protection truly be achieved," he said.

The Commission voted to submit the study to Congress, but just barely. Commissioners Kathleen Casey and Troy Paredes disagreed that the study had fulfilled its Congressional mandate. The study’s "pervasive shortcoming," they said, is the failure of the staff to justify its recommendation for "fundamental" regulatory regime change. More research, empirical data, and analysis are required. The study doesn’t adequately articulate or substantiate the problems that would be addressed by rulemaking. Nor does it adequately address the risks of adverse impact to investors presented by the rulemaking itself.

Acknowledging the tight timing required to produce the study, the two commissioners urged that further economic analysis was needed to inform any SEC actions. "[W]e do not intend to suggest that we could not ultimately, after further research and analysis, support the recommendations contained in the Study."

The 208-page study was delivered to Congress late Friday evening and released to the public early Saturday. The study responds to the mandate in Section 913 of the Dodd-Frank Act to study 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. Section 913 also required the SEC to explore 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.

Pursuant to section 913(g), the SEC is authorized to move forward with the rulemakings recommended in the report.

Here are the section-by-section highlights:

Current state of the adviser and broker-dealer industries.

Over 11,000 SEC-registered advisers manage more than $38 trillion for more than 14 million clients. Approximately five percent of those advisers are also registered as broker-dealers. Twenty-two percent of SEC registered advisers have a related person that is a broker-dealer. Eighty-eight percent of adviser representatives are also registered representatives of a broker-dealer. Eighteen percent of FINRA-registered broker-dealers are also advisers registered with the SEC or a state. Most advisers charge their clients fees based on a percentage of assets under management. Most broker-dealers receive transaction-based compensation.

Current regulatory scheme.

Advisers are fiduciaries under a principles-based regulatory regime and broker-dealers have an obligation of fair dealing. Advisers are subject to duties of loyalty and care. Broker-dealer regulation focuses on business operations from an anti-fraud perspective, said the report. Broker-dealers are subject to requirements "designed to promote business conduct that protects customers from abusive practices, including practices that may be unethical but may not necessarily be fraudulent."

Retail investor perceptions.

This, essentially, is the foundation for the report’s recommendations. Comments from "many retail investors and investor advocates" detailed confusion and uncertainty about the titles of adviser and broker-dealer. Many expected action in their best interests, regardless of the type of investment professional involved. Retail investors rely on their financial professional for some of their most important life decisions, said the report. "Investors have a reasonable expectation that the advice they are receiving is in their best interest. They should not have to parse through legal distinctions to determine whether the advice they receive was provided in accordance with their expectations."


Uniform fiduciary standard.

The staff recommended that the SEC engage in rulemakings to expressly apply a uniform fiduciary standard to both advisers and broker-dealers when providing "personalized investment advice about securities to retail customers."

Rulemaking and/or interpretive guidance should address the components of the fiduciary standard, loyalty and care. "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," said the report.

Duty of loyalty.

Both advisers and broker-dealers will be obligated to eliminate conflicts of interest or disclose them. The SEC should prohibit certain conflicts and assist in the development of "uniform, simple and clear" disclosures to retail investors about the terms of their relationship with these investment professionals and any material conflicts of interest that may be present.

The staff said consideration should be given to the "utility and feasibility" of a summary relationship disclosure document that would contain key information about a firm’s services, fees and conflicts, including "whether its advice and related duties are limited in time or are ongoing."

Principal trading.

The staff should, through rulemaking or interpretive guidance, address how broker-dealers should fulfill fiduciary duties when engaged in principal trading, said the report. Principal trading raises the concerns of price manipulation and securities dumping. Because the Dodd-Frank Act requires the broker-dealer standard of conduct to be "no less stringent than" an adviser’s required conduct, a broker-dealer should be required to disclose its conflicts of interest related to principal transactions. The staff added, however, that a broker-dealer would not necessarily be required to follow the specific notice and consent procedures. "Of course," said the report, "broker-dealers would remain subject to obligations relating to suitability, best execution, and fair and reasonable pricing and compensation."

The staff acknowledged concerns from the broker-dealer industry regarding principal trading in fixed-income securities, including municipal bonds. However, the staff believes a uniform fiduciary standard would require that "sufficiently specific facts" be disclosed so that retail investors understand the conflicts involved. The staff noted that "requests for consent embedded in voluminous advisory agreements or other account opening agreements would impede provision of such consent."

Duty of Care.

Adviser commenters stated they operate under care principles that are "clear and well-established," with the flexibility to accommodate the variety of advisory business models. Broker-dealer commenters argued their care standard is "far more developed" and the advisory duty of care is ambiguous. The staff said it believes it should specify minimum professional obligations under the duty of care in a harmonized regulatory regime. Any resulting rules or guidance could take into account long-held Advisers Act fiduciary principles. Flexibility would exist because the standards would be minimum expectations, and would not establish a safe harbor "or otherwise prevent the Commission from applying a higher standard of conduct based on specific facts and circumstances."


Personalized investment advice about securities. It is a facts-and-circumstances analysis said the staff, and the Dodd-Frank Act does not offer a definition. "Advice" has been interpreted under the Advisers Act numerous times by the staff, as has the term "impersonal investment advice." The broker-dealer regulatory regime focuses on whether a "recommendation" has been made. Recommendations generally take the form of a "call to action" or are communications that "reasonably could influence" entering into a particular transaction or engaging in a particular trading strategy, said the study.

The staff believes that a rule or guidance defining and/or interpreting "personal investment advice about securities" is warranted. At a minimum, said the report, any rule or guidance should include the concept of a recommendation, and exclude impersonal investment advice.

Retail customer. The staff recommended that the SEC specify that retail customers include both the individual retail customer given advice on a one-on-one basis, and groups of retail customers where circumstances would cause members of the group reasonably to believe that the advice is intended for them.

Benefits of a uniform fiduciary standard.

The staff believes a uniform fiduciary standard "may offer several benefits," including:

  • Most importantly – Disregard of "regulatory labels" (adviser or broker-dealer) to ensure investors receive advice given in their best interest under a uniform standard;
  • Heightened investor protection;
  • Heightened investor awareness;
  • Flexibility to accommodate different existing business models and fee structures;
  • Preservation of investor choice; and
  • Continuing application of currently existing duties under law.

The staff also stated its belief that, to fully protect the interests of retail investors, the SEC should couple the fiduciary duty with effective oversight.

Harmonization of regulation.

The staff believes that where harmonization of regulation would add meaningful investor protections, it would level the playing field for investors, offering them the same or substantially similar protections when obtaining the same or substantially similar services.

The report said that in reviewing potential areas of the regulations for harmonization, the SEC should consider:

  • Whether Form ADV and Form BD should be harmonized in areas that relay comparable information, so investors may make more ready comparisons;
  • Whether advisers should be subject to substantive review prior to registration;
  • Articulating consistent advertising and customer communication regulations and/or guidance, or in the alternative, harmonizing internal pre-use review requirements for approving advertisements;
  • Harmonizing regulations regarding the status of finders and solicitors, so retail investors better understand the conflicts presented by these compensated roles;
  • Whether harmonization of supervisory requirements would facilitate examination and oversight "(e.g., whether detailed supervisory structures would not be appropriate for a firm with a small number of employees)"; and
  • Whether the adviser books and records requirements should be broadened to include general retention requirements consistent with broker-dealer recordkeeping standards. Current differences, said the staff, limit the effectiveness of internal supervision and compliance structures and the ability of regulators to access information and verify the entity’s compliance with applicable requirements.

The report also indicated the SEC could consider requiring adviser representatives to be subject to continuing education and licensing requirements.

The lack of a continuing education requirement and uniform federal licensing requirement for investment adviser representatives may be a gap, said the staff. Establishing such requirements given the SEC’s current lack of infrastructure "may raise certain challenges," however. Should these requirements be imposed, the staff suggested that "a private organization could develop the program."

Items of note from the study:

Broker-dealers may be required to develop a brochure. Consideration of developing a uniform approach to initial disclosures for retail customers, said the staff, "presumably would include extending to broker-dealers a requirement of a general relationship disclosure document analogous to form ADV Part 2 at or prior to account opening."

No arbitration recommendations at this time. The staff did not recommend that any action be taken with respect to harmonizing arbitration remedies, which differ significantly between advisers and broker-dealers. The staff noted that Section 921 of the Dodd-Frank Act provides the SEC with an opportunity to review this issue in greater detail.

Lesser alternatives to a uniform fiduciary standard have significant drawbacks. The study rejected the alternatives of removing the broker-dealer exclusion under the Advisers Act or imposing a standard of care alone on broker-dealers. Section 913 required the staff to explore these alternatives to imposing a uniform standard of care. The drawbacks of both alternatives include preventing regulatory reform from taking the best from each regulatory regime, a possible reduction in investor choices, impose duplicative regulation, and be more costly.


In the study, the staff quoted Supreme Court Justice Benjamin Cardozo as saying "to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry." Much the same can be said of the SEC’s study. It reports and recommends, but represents only the beginning of further inquiry, recommendations and rulemaking. In an interview, SIFMA’s Hammerman likened the situation to a baseball game. The industry, he observed, is in the third inning of a game likely to see extra innings.