SEC Investor as Purchaser Subcommittee Issues Recommendations Related to Broker-Dealer Fiduciary Duty

by Goodwin

The Investor as Purchaser Subcommittee (the “Subcommittee”) of the SEC’s Investor Advisory Committee (the “Committee”) issued two principal recommendations (the “Recommendations”) regarding SEC adoption of a uniform standard of duty for investment advisers and broker-dealers engaged in the delivery of personalized investment advice to retail investors.

Findings.  The Subcommittee preceded the discussion of its Recommendations with a series of findings, including the following:

  1. both broker-dealers and investment advisers play an important role in helping Americans organize their financial lives, accumulate and manage retirement savings, and invest toward other important long-term goals, such as buying a house or funding a child’s college education;
  2. when the federal securities laws were enacted, Congress drew a distinction between broker-dealers, who were regulated as salespeople under the Securities Exchange Act of 1934 (the “Exchange Act”), and investment advisers, who were regulated as advisers under the Investment Advisers Act of 1940 (the “Advisers Act”);
  3. the roles of some broker-dealers and investment advisers have converged, with many broker-dealers offering advisory services, such as investment planning and retirement planning, that are similar to the services offered by investment advisers and marketing themselves in ways that highlight the advisory aspect of their services;
  4. broker-dealers and investment advisers are subject to different legal standards when they offer advisory services – a suitability standard for broker-dealers and a fiduciary duty for investment advisers, which afford different levels of protection to the investors that rely on their services;
  5. investors typically make no distinction between broker-dealers and investment advisers, and most are unaware of the different legal standards that apply to their advice and recommendations; and
  6. investors may be harmed if they choose a financial adviser under a mistaken belief that the financial adviser is required to act in their best interest when that is not the case, receive recommendations that comply with a suitability standard but carry additional costs or risks without affording additional benefits, or fail to receive the ongoing account supervision that they expect based on the manner in which brokers’ advisory services are sometimes marketed.

The Subcommittee stated in its findings that the key difference between the suitability standard currently in place for broker-dealers and the fiduciary duty standard currently in place for investment advisers is the requirement that investment advisers, as fiduciaries, act in the best interests of their clients and appropriately manage and fully disclose conflicts of interest that could bias their recommendations.  The Subcommittee noted that although many investors don’t understand the meaning of “fiduciary duty,” or know whether it or suitability represents the higher standard, investors generally treat their relationships with both broker-dealers and investment advisers as relationships of trust and expect that the recommendations they receive will be in their best interests. Accordingly, in making the recommendations, the Subcommittee stated its belief that personalized investment advice to retail customers should be governed by a fiduciary duty which includes an enforceable, principles-based obligation to act in the best interest of the customer, regardless of whether that advice is provided by an investment adviser or a broker-dealer.

Recommendation Number 1.  The Subcommittee recommended that the SEC conduct a rulemaking to impose a fiduciary duty on broker-dealers when they provide personalized investment advice to retail investors.  In making this recommendation, the Subcommittee stated that it favors accomplishing this rulemaking by amending the Advisers Act to narrow the broker-dealer exclusion from the Advisers Act while also providing a safe harbor for brokers who do not engage in broader investment advisory services or hold themselves out as providing such services.  Additionally, the Subcommittee recognized that the SEC is considering rulemaking under Section 913(g) of the Dodd-Frank Act (“Section 913”), noting that adoption of a uniform fiduciary standard for investment advisers and broker-dealers was recommended by the staff of the SEC in the Study on Investment Advisers and Broker-Dealers completed in January of 2011 as required by Section 913 (the “Section 913 Study”).  The Section 913 Study was covered in the January 25, 2011 Financial Services Alert. The Subcommittee recommended that, if the SEC chooses to adopt rules imposing a uniform fiduciary duty on investment advisers and broker-dealers under Section 913, such rules should:

  1. ensure that the uniform fiduciary duty standard is no weaker than the existing Advisers Act standard by incorporating an enforceable, principles-based obligation to act in the best interests of the customer;  
  2. ensure the continued availability of transaction-based recommendations, by being sufficiently flexible to permit the existence of certain sales-related conflicts of interest, subject to a requirement that any such conflicts be fully disclosed and appropriately managed; and
  3. prohibit or restrict certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the SEC deems contrary to the public interest and the protection of investors, while recognizing that some forms of transaction-based payments would be acceptable under a fiduciary standard.

The Subcommittee provided supporting rationales for each aspect of the recommendation, including a discussion of reports by various industry groups supporting the adoption of a uniform standard.

Recommendation Number 2.  The Subcommittee recommended that in connection with any rulemaking adopting a uniform fiduciary duty standard for investment advisers and broker-dealers, the SEC should also adopt a uniform, plain English disclosure document to be provided to customers and potential customers of broker-dealers and investment advisers that covers basic information about the nature of services offered, fees and compensation, conflicts of interest, and disciplinary record.

The Subcommittee noted that relevant topics included in such a disclosure document might include a description of: the services provided; the fees and expenses related to such services; the compensation structure paid to the broker-dealer or investment adviser; related conflicts of interest; any limitations on the services; the professional background of the representatives of the broker-dealer or investment adviser; and any disciplinary history.

The Subcommittee stated that Form ADV, which investment advisers use to disclose to their clients, provides a reasonable starting point for designing such a document; however, the Subcommittee noted limitations in Form ADV and recommended that the SEC work to develop an effective document conveying the relevant information to investors in a way that enables them to act on that information.

Consideration of the Recommendations.  The Committee was scheduled to consider the Recommendations on October 10, 2013; however, consideration was postponed and no action has been taken with respect to the Recommendations by the Committee or the SEC.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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