United States: SEC Adopts Interpretive Guidance On Investment Adviser Fiduciary Duty

On June 5, 2019, the Securities and Exchange Commission (the “SEC”) released a long-anticipated interpretation of investment adviser fiduciary duty under Section 206 of the US Investment Advisers Act of 1940 (“the Advisers Act”), a provision applicable to both SEC and state-registered investment advisers, as well as other investment advisers that are subject to the territorial jurisdiction of the Advisers Act but are not required to be registered under it.  The Release is intended to benefit market participants by “reaffirming and clarifying” the nature and scope of the duty in one place.  As a restatement of an existing body of law, the SEC says its interpretation should create no new duties.  

The Release is a companion to three other releases announced by the SEC on the same day, one establishing a “best interest” conduct standard for broker-dealers when acting for retail customers, another establishing Form CRS as an additional mandatory disclosure document for use by broker-dealers with retail customers and registered investment advisers with retail clients, and the third providing interpretive guidance on the conditions under which a broker-dealer may rely on the Adviser Act’s exclusion from the definition of the term “investment adviser” for investment advisory services that are “solely incidental” to the conduct of a broker-dealer business. Read our previous alert on these three releases.

Investment advisers with retail clients or who are dually registered or have affiliated broker-dealers will need to review this package of releases as a whole.  The two interpretive releases (one addressing an investment adviser’s fiduciary duty and the subject of this alert, and the other addressing the “solely incidental” definition) are effective upon their publication in the Federal Register.  The two rulemaking releases (establishing Regulation Best Interest and Form CRS, respectively) are effective 60 days after publication in the Federal Register and have delayed compliance dates of June 30, 2020.

Components of the federal fiduciary duty under the Advisers Act

The Advisers Act is often described as establishing a federal fiduciary duty for investment advisers, made enforceable by the Act’s antifraud provisions.  Perhaps surprisingly, however, that duty does not explicitly appear in the language of the statute and has never been defined by rule.  It thuseven after publication of this Release exists only in a series of court and SEC cases and statements.

As laid out in the Release, an investment adviser’s fiduciary duty is broad, applies to the entire adviser-client relationship, and reflects a Congressional intent to “eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser—consciously  or unconsciously—to render advice which was not disinterested.”1  The duty comprises both a duty of care and a duty of loyalty.

Duty of Care

The duty of care includes, among other things: (i) the duty to provide advice that is in the best interest of the client, (ii) the duty to seek best execution of a client’s transactions where the adviser is responsible for selecting broker-dealers to execute client trades, and (iii) the duty to provide advice and monitoring throughout the relationship.  The duty of care requires an adviser to make a reasonable inquiry into its clients’ objectives and to have a reasonable belief that the advice it provides is in the best interest of the client based on those objectives.

Duty of Loyalty

The duty of loyalty requires that an adviser not subordinate its clients’ interests to its own.  To fulfill its duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship, including the capacity in which the firm is acting with respect to the advice provided.  Additionally, an adviser must eliminate or expose through disclosure all conflicts of interest that might incline the adviser to render advice that is not disinterested.

Disclosures must be considered in light of all the facts

Whether disclosure is full and fair depends on, among other things, the nature of the client, the scope of the services, and the client’s ability to understand any material fact or conflict.  The Release emphasizes that full and fair disclosure for an institutional client can differ significantly from full and fair disclosure for a retail client because the former generally have a greater capacity and more resources than retail clients to analyze and understand complex conflicts and their ramifications.  Nevertheless, disclosures must be clear and detailed enough for every client, regardless of its nature, to make an informed decision to consent to the conflict or reject it.  For retail clients in particular, the Release acknowledges that it may be difficult to provide disclosure regarding complex or extensive conflicts that is both sufficiently specific and understandable.  In these cases where an investment adviser cannot fully and fairly disclose a conflict to a client such that the client can provide informed consent, advisers are instructed to eliminate the conflict or adequately mitigate the conflict such that full and fair disclosure and informed consent are possible.

“Putting the client first” versus “not subordinating the client interest”

The Release comes more than a year after the SEC’s initial draft interpretation, which proposed to interpret that the law “requires an investment adviser to put its client’s interests first.”2  The Final Interpretation uses somewhat different language: an investment adviser must “not subordinate its clients’ interest to its own.”

Commissioner Jackson, in the sole dissenting vote among the Commissioners, took issue with this subtle revision, noting that, according to a study conducted by his office, firms representing 89 percent of total assets under management told investors in their disclosures that they put investors first.3

Fiduciary duty varies depending on the client

What constitutes a reasonable understanding of a client’s investment profile varies depending on the client

The duty of care includes not only a duty to provide investment advice that is in the best interest of the client, but also a duty to provide investment advice that is suitable for the client.  To provide such advice, an adviser must have a reasonable understanding of the client’s investment objectives and the Release acknowledges that how an adviser develops such a reasonable understanding differs between retail investors and institutional investors.  The basis for such a reasonable understanding generally would include, for retail clients, an understanding of the investment profile, or for institutional clients, an understanding of the investment mandate.   For retail clients, the Release suggests an adviser should, at a minimum, make a reasonable inquiry into the client’s financial situation, level of financial sophistication, investment experience and financial goals – what is commonly called, in sum, the client’s investment profile.  Additionally, it generally will be necessary for an adviser to a retail client to update the client’s investment profile in order to maintain a reasonable understanding of the client’s investment objectives and adjust the advice to any changed circumstances.

By contrast, the nature and extent of the reasonable inquiry into an institutional client’s objectives generally is shaped by the specific investment mandates from those clients.  The Release provides that an adviser engaged to advise on a particular portfolio of an institutional client would need to gain a reasonable understanding of the client’s objective within that portfolio, but not the client’s objectives within its entire investment portfolio.

There’s no waiving away the fiduciary duty

An adviser’s fiduciary duty is principles-based, applies to the entire relationship between the adviser and its client, and follows the contours of the relationship—so that the adviser and its client may shape the relationship by agreement, provided there is full and fair disclosure and informed consent.  The Release opines that this principles-based fiduciary duty has provided sufficient flexibility to serve as an effective standard of conduct for advisers, regardless of the clients they serve.  Although the scope of the fiduciary duty will vary with the scope of the relationship, it may not be waived.  Rather, it will apply in a manner that reflects the agreed-upon scope of the relationship.  An agreement to waive an adviser’s federal fiduciary duty generally, such as (i) a statement that the adviser will not act as a fiduciary, (ii) a blanket waiver of all conflicts, or (iii) a waiver of any specific obligation under the Advisers Act, would be inconsistent with the Advisers Act, regardless of the sophistication of the client.  This is perhaps uncontroversial; but one can imagine many specific types of waivers that will be accepted as appropriate between clients and their adviser, and this language presents at least the possibility of second-guessing.

Our Take

Setting aside Commissioner Jackson’s dissent and some very negative reactions to the broader rulemaking package by a number of politicians and consumer groups, the Release appears to have been accepted as at least broadly in line with common understanding of an investment adviser’s fiduciary duty.  As such, and given that the entire document clocks in at a trim 41 pages (hundreds less than the typical SEC release), and its concepts permeate the operations of virtually every investment advisory business, we expect it will become widely read by investment adviser legal, compliance and executive staff across the industry.  We also expect, however, that some points highlighted above hold the potential for confused results over time.

Footnotes

1 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963).

2 Securities and Exchange Commission, Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-4889 (proposed April 18, 2018).

Read the SEC’s Statement on Final Rules Governing Investment Advice (June 5, 2019).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Akin Gump Strauss Hauer & Feld LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Akin Gump Strauss Hauer & Feld LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions