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August 09, 2019 at 10:40 AM
On June 5, the Securities and Exchange Commission adopted a rulemaking package that is applicable to investment advisers and broker-dealers. The package includes two final rules and two interpretations — Regulation Best Interest, the Investment Adviser Standard of Conduct Interpretation, Form CRS – Relationship Summary, and Solely Incidental Broker-Dealer Exclusion Interpretation. This is the second in a series of articles describing the SEC’s rulemaking package. Check out the first installment here: SEC’s Regulation Best Interest: A Breakdown.
In an effort to clarify and reaffirm the fiduciary duty that SEC-registered investment advisers owe their clients under the Investment Advisers Act of 1940, the SEC published for comment a proposed interpretation of the standard last year. The final interpretation of the standard of conduct is consistent with the proposal.
The fiduciary duty owed by investment advisers to their clients is based on congressional intent and is enforceable under the anti-fraud provisions of the Advisers Act. This fiduciary duty requires investment advisers to act in the best interest of their clients through their duty of care and duty of loyalty.
The SEC believes that the duty of care “requires an investment adviser to provide investment advice in the best interest of its client, based on the client’s objectives.” The duty of loyalty dictates that “an investment adviser must eliminate or make full and fair disclosure of all conflicts of interest which might incline an investment adviser — consciously or unconsciously — to render advice which is not disinterested such that a client can provide informed consent to the conflict.”
In describing each of these obligations, the SEC recognized that an investment adviser’s fiduciary duty must be viewed in the context of the scope of the relationship between the adviser and the client. However, the SEC also determined that the fiduciary duty is principles-based. Thus, the duty is flexible enough to apply regardless of the type of client or service provided.
Duty of Care
The SEC describes an investment adviser’s duty of care to include three components: (1) The duty to provide advice that is in the best interest of the client, (2) the duty to seek best execution of a client’s transactions where the adviser has the responsibility to select broker-dealers to execute client trades, and (3) the duty to provide advice and monitoring over the course of the relationship.
An investment adviser’s duty to provide advice in the best interest of the client includes a duty to provide advice that is suitable for the client. To fulfill these duties, the SEC believes that an investment adviser must develop a reasonable understanding of the client’s objectives. Thus, an investment adviser should reasonably inquire into the client’s financial situation, level of financial sophistication, investment experience and financial goals so that the adviser understands the client’s investment profile (or investment mandate for institutional clients) before providing advice.
An investment adviser is also required to maintain its understanding of the client’s investment profile by periodically updating the profile to incorporate any change in the client’s circumstances. The SEC acknowledges that the frequency for updating a client’s profile is a facts-and-circumstances analysis.
For example, the interpretation clarifies that “… updating would not be needed with one-time investment advice.” Thus, the nature and extent of the client relationship will impact the frequency with which updates are required.
In addition to understanding a client’s investment profile, an investment adviser “must have a reasonable belief that the advice it provides is in the best interest of the client based on the client’s objectives.” To establish a reasonable belief, an investment adviser should evaluate the advice in the context of the client’s portfolio for which the adviser is providing services.
