The June 5 Releases
Today we focus on the new SEC interpretative release on the fiduciary duties of investment advisers and provide a brief summary of its contents (“The Fiduciary Duty Release”). This Release is part of a package of new rules and interpretations adopted by the SEC on June 5, 2019. In total, there are four new rules and interpretations:
- Regulation Best Interest (“BI”);
- Form CRS, a new form for advisers and brokers;
- the Fiduciary Duty Release; and
- the Release on the “solely incidental” investment adviser exclusion.
Together these four Releases total a mammoth 1336 pages and define and differentiate the duties owed by brokers and investment advisers.
We will address Regulation BI and Form CRS in a later blog post after we have had time to digest completely the four releases. In brief, Regulation BI establishes a new standard of broker-dealer conduct to address concerns that led to the now vacated DOL Fiduciary Rule. It requires that brokers act in the best interest of the client, but does not impose a fiduciary duty. It is essentially an extension of the existing suitability and fair dealing obligations of broker-dealers. Form CRS is a new disclosure form that broker-dealers and investment advisers will be required to deliver to retail clients. The form summarizes information about services, fees, costs, conflicts of interest, and disciplinary history of the firm and individuals. The compliance date for Regulation BI and Form CRS is June 30, 2020.
The Fiduciary Duty Release
The Fiduciary Duty Release in clear, readable, easy to understand language explains the duties of an investment adviser. The Fiduciary Release does not create any new duties, but “reaffirms, and in some cases clarifies, certain aspects of the federal fiduciary duty an investment adviser owes to its clients.” It is effective immediately. In the Release, the SEC emphasized that advisers owe a principle-based fiduciary duty of loyalty and care that is more substantial than a broker-dealers’ duties. The adviser’s duty is different not only because an adviser historically has owed a fiduciary duty to its clients, but also because of the fundamental difference in compensation between brokers and advisers — commission-based fees on a transaction-by-transaction basis versus asset-based fees over a long-term relationship.
The SEC divides the advisers’ fiduciary duty into two branches: (1) a duty of loyalty and (2) a duty of care. The overarching principal of both duties is that the adviser must act in the best interest of the client at all times. The duties are not limited to just the giving of investment advice and apply to the entire adviser-client relationship. Moreover, the duties cannot be waived, although the scope of the duties can be limited by agreement and by the nature of the client (institutional vs. retail). In fact, under the SEC’s interpretation, blanket waivers of conflicts, fiduciary duties, or obligations under the Advisers Act violate the Advisers Act. The SEC offered this example to illustrate the different duties based on the scope of the adviser-client relationship:
For example, the obligations of an adviser providing comprehensive, discretionary advice in an ongoing relationship with a retail client (e.g., monitoring and periodically adjusting a portfolio of equity and fixed income investments with limited restrictions on allocation) will be significantly different from the obligations of an adviser to a registered investment company or private fund where the contract defines the scope of the adviser’s services and limitations on its authority with substantial specificity (e.g., a mandate to manage a fixed income portfolio subject to specified parameters, including concentration limits and credit quality and maturity ranges).
Duty of Care
The SEC breaks down the duty of care into three components:
- Duty to provide advice in the best interest of client;
- Duty to seek best execution; and
- Duty to provide advice and monitoring over course of relationship.
The duty of best interest requires that the adviser (i) make a reasonable inquiry into the client’s objectives and (ii) have a reasonable belief that the advice given is in the best interest of the client (which includes a reasonable investigation into the investments recommended). The duty extends to advice about account type (commission-based or fee), roll-overs, and strategy. The duty of best execution requires that an adviser seek to obtain the “execution of transactions for each of its clients such that the client’s total cost or proceeds in each transaction are the most favorable under the circumstances.” The duty to provide advice and monitoring depends on the type of relationship. Advisers receiving periodic fees will have an extensive duty (i) to monitor and to evaluate the account and (ii) to provide advice based on that evaluation. An adviser that provides a one-time plan will not have a monitoring duty.
Duty of Loyalty
With regard to its duty of loyalty, an adviser must “eliminate or make full and fair disclosure of all conflicts of interest.” The SEC distilled the essence of the duty of loyalty as “an investment adviser must not place its own interest ahead of its client’s interests.” To meet this duty of loyalty, an adviser must make full and fair disclosure of all material facts in the advisory relationship, including the nature of the relationship and any conflicts of interest. The disclosure must be “sufficiently specific so that a client is able to understand the material fact or conflict of interest and make an informed decision whether to provide consent.” The SEC specifically found the use of the word “may” with regard to a particular conflict is inappropriate if in fact the conflict exists. Like the duty of care, whether disclosure is sufficient will depend on the nature of the client, the scope of the services, and the conflict. Sufficient disclosure for a retail client will be more involved than for an institutional client. The disclosure of conflicts can be in the advisory agreement, the ADV Pt.2, or other documents. The client’s consent can either be explicit or implicit A client, after receiving a disclosure, would implicitly consent, for example, by entering into or continuing the relationship with the adviser.
We urge advisers to review the Release. In the SEC’s words, “advisers should have greater clarity about their obligations after reading it.” This document would be ideal to distribute to new employees and certainly will be cited often in the future.
 “Commission Interpretation Regarding Standard of Conduct for Investment Advisers,” SEC Advisers Act Release No. IA-5248 (June 5, 2019) (https://www.sec.gov/rules/interp/2019/ia-5248.pdf).
 Earlier versions of the rules and releases were published April 18, 2018.
 “SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals,” Securities and Exchange Commission Press Release 2019-89 (June 5, 2019). https://www.sec.gov/news/press-release/2019-89.
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