On April 18, 2018, the SEC proposed an interpretation to reaffirm and clarify the Commission’s views regarding the fiduciary duty that investment advisers owe to their clients. In discussing this fiduciary duty, the SEC hopes to clarify for both advisers and their clients the legal obligations investment advisers have to their clients. In addition, the SEC proposed Form CRS, which would require advisers (and broker-dealers) to provide a “relationship summary” to retail investors.
Interpretation on Advisers’ Fiduciary Duty
Although it is well known that investment advisers owe a fiduciary duty to their clients — a duty that has been confirmed by the Supreme Court – the SEC is seeking to reaffirm and further clarify this duty for the benefit of both clients and advisers. Specifically, the Commission is providing an interpretation that provides certain general standards with respect to advisers’ fiduciary duty.
Duty of Care and Acting in the Best Interest
The SEC’s proposal states that advisers’ fiduciary duty involves a duty of care, including a duty to provide advice that is in the client’s best interest, a duty to seek best execution, and a duty to act and to provide advice and monitoring over the course of the relationship with a client. With respect to acting in the best interest of clients, the SEC proposal states that advisers, before providing any personalized investment advice, should make a reasonable inquiry into the client’s investment profile, update the profile in order to adjust its advice to reflect any changed circumstances, and have a reasonable belief that the personalized advice is suitable for and in the best interest of the client based on the client’s profile. The cost (including fees and compensation) associated with the investment advice would generally be one of many important factors (e.g, investment objectives, risk, liquidity, etc.) to consider when determining whether a security or investment strategy is in the best interest of the client.
Duty of Loyalty and Conflicts of Interest
The proposal also states that advisers have a duty of loyalty to their clients under their fiduciary duty, requiring them to put their clients’ interest first. In particular, an adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure of all material conflicts of interest that could affect the advisory relationship. This disclosure, the SEC states, should be sufficiently specific so that a client is able to decide whether to provide informed consent to the conflict of interest. The SEC goes on to state that “an adviser disclosing that it ‘may’ have a conflict is not adequate disclosure when the conflict actually exists.”
Continuing Education
The SEC also made a number of requests for comments with respect to certain potential requirements. First, the SEC is inquiring whether there should be federal licensing and continuing education requirements for personnel of SEC-registered investment advisers and, if so, whether this should be limited to investment adviser representatives or include other personnel as well.
Account Statements
The SEC is also asking for comments regarding advisers’ account statements. Specifically, would retail clients benefit from a requirement that they receive account statements from registered investment advisers that include information regarding fees and expenses (including dollar amounts for advisory fees, commissions, and other expenses) and other information.
Financial Responsibility
Finally, the SEC asks whether investment advisers should be subject to certain financial responsibility requirements in order to ensure they can meet their obligations, including compensation for clients if the adviser becomes insolvent or advisory personnel misappropriate clients’ assets. The SEC inquires, among other things, whether advisers should be required to maintain a fidelity bond from an insurance company or a certain amount of net capital.
Form CRS – Relationship Summary
The SEC also made a proposal that would impact both investment advisers and broker-dealers that with retail clients. Under Form CRS, investment advisers and broker-dealers, and their respective associated persons, would be required to provide retail clients a relationship summary. This summary would be a standardized, short-form disclosure up to a maximum of 4 pages that would highlight key differences in the principal types of services offered, the legal standards of conduct that apply to each, the fees a customer might pay, and certain conflicts of interest that may exist.
In addition, certain broker-dealers, and their associated persons, would be prohibited from using the terms “adviser” and “advisor” in their name or title, since such terms could mislead retail customers into believing their firm or professional is a registered investment adviser.
For more information about the proposals discussed above, please contact NCA Compliance. Hayley Nelson is the President and Principal Consultant of NCA Compliance, Inc., a compliance consulting firm providing a wide range of customized compliance solutions for investment advisors. Ms. Nelson previously worked for the Securities and Exchange Commission and a large investment manager in New York.
