More On Legal & Compliancefrom The Advisor's Professional Library
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
The debate over the fiduciary standard that will become applicable to many financial professionals may be coming to a head as the looming deadline for comments on SEC proposals has motivated some advisors to express disapproval over a perceived weakening of the potential standard. Because a heightened fiduciary standard could increase advisors’ compliance costs, while simultaneously increasing consumer confidence in the quality of their advice, it is critical that advisors know the rules of the game. Recent indications that the SEC may deviate from its previously expressed intent to expand the traditional standard applicable to investment advisors, however, represent a curveball for advisors who are not currently subject to a strict fiduciary standard; the outcome once again seems up for grabs.
Today’s Bifurcated Approach to Fiduciary Regulation
Under the current regulatory regime, investment advisors governed by the Investment Advisers Act unquestionably owe their clients a fiduciary duty of care that requires the advisor to make recommendations that are in the client’s best interest, even if they are not in the best interest of the advisor.
Insurance producers and many other financial professionals, on the other hand, are governed by a less stringent suitability standard that is slightly less concrete. The suitability standard requires that the advisor have a reasonable basis for recommending products to the client based on an examination of the client’s financial position. While the suitability standard requires that advisors act fairly in dealing with clients, it is not as taxing as the fiduciary duty imposed upon investment advisors, and the resultant liability for failing to comply is less clearly defined.
SEC Proposals Indicate Possible Softening
Though many believed that the fiduciary duty of care owed by investment advisors would be expanded to cover financial professionals currently governed by the suitability standard under the Dodd-Frank Act, the SEC’s recent releases have indicated that it may be pulling back from this expansion. Many advisors and advisor groups have expressed disagreement with recent SEC pronouncements because they appear to eliminate or weaken the requirement that all financial professionals governed by the common standard act in the best interests of their clients when providing financial guidance.
For example, a recent SEC release indicates that it may allow an advisor’s duty of care toward his clients to be determined contractually between the advisor and client. This represents a substantial weakening of the traditional rule that the advisor always owes a duty of care to his clients and could cause much confusion among advisors and clients alike.
Further, some perceive the SEC’s release as representing a shift toward a disclosure-only standard, rather than a strict duty of care. Under this regime, it could be possible for financial professionals to avoid acting solely in the best interests of their clients so long as they have made full disclosure of all the relevant facts. Though this may be acceptable in the case of financially sophisticated clients, many have expressed concern over whether it would limit the ability of middle class clients (who may be less financially knowledgeable) to gain access to effective financial guidance.
The SEC has been careful to make clear that recently released information may not necessarily influence the eventual rules that will be put into place. Despite this, advisors should be aware of the possibility that the SEC’s path may not take them in the direction they have been anticipating over the past months.