In 1963, the United States Supreme Court held in SEC v. Capital Gains Research Bureau Inc. that Section 206 of the Investment Advisers Act of 1940 imposes a fiduciary duty on investment advisors by operation of law. Section 206 of the Act (generally referred to as the “antifraud” provision) makes it unlawful for an advisor to engage in fraudulent, deceptive or manipulative conduct. The general purpose of an advisor’s fiduciary duty is to eliminate conflicts of interest and prevent an advisor from taking advantage of a client’s trust. In order to fulfill this duty, an advisor is required to always act in his clients’ best interests and to make full and fair disclosure of all material facts, especially when the advisor’s interests may conflict with those of his clients.
An advisor’s fiduciary responsibility permeates his entire business operations and client relationships. It requires more than a mere attempt at compliance; it requires that the advisor undertake ongoing and continuous efforts to comply with his obligations under the Advisers Act.
Although neither the Act nor SEC rules currently impose an express suitability requirement on investment advisors, the SEC maintains that advisors have a fiduciary duty to reasonably determine that the investment advice or services they provide are suitable, taking into consideration a client’s financial situation, investment experience and investment objectives. Accordingly, each firm should be prepared to demonstrate that it has a policy to obtain (and maintain) sufficient information regarding the client’s circumstances. Examples of documents that advisors may use to determine suitability include client questionnaires, fact sheets, investment objectives confirmation letters and investment policy statements.
Some written confirmations should be obtained and maintained by an investment advisor. However, longer does not mean better. Too many times, especially when defending advisory firms in litigation or arbitration proceedings, we see advisors falling victim to their own sloppy documents (a “canned” questionnaire or ambiguous form that is a minefield for conflicting responses). If the client indicates on page two that her objective is a 10% annual return, but on page five (clearly, in our view, too long a document already) that she can only tolerate a principal loss of 5%, we have a conflict. Therefore, the advisor, as a fiduciary, should not begin the investment management process until the client’s objectives and risk parameters are clarified and consistent and written confirmation thereof has been obtained.