February 19, 2019

February 18, 2019

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SEC Issues Interpretive Guidance Regarding the Standard of Conduct for Investment Advisers

On April 18, 2018, the SEC proposed an interpretation of the “federal fiduciary standard” applicable to investment advisers under Section 206(1) and (2) of the Investment Advisers Act of 1940 (Advisers Act) in connection with the proposal that same day of new Regulation Best Interest, which would establish a standard of conduct applicable to broker-dealers. 1 The proposed interpretation is intended to provide additional guidance regarding the duties of loyalty and care applicable to investment advisers and to set forth a single description of the existing components of the fiduciary requirements under the Advisers Act.

Duty of Care

Under the proposed interpretation, an investment adviser’s duty of care would be clarified to include duties to (1) act and provide advice in a client’s best interest, (2) seek best execution of client transactions in circumstances in which the investment adviser may select broker-dealers and execute trades and (3) provide ongoing advice and monitoring over the course of the investment adviser’s relationship with the client. As set forth in the proposal, the duty to act in a client’s best interest includes the duty to make a reasonable inquiry to determine the client’s investment profile, including the client’s financial circumstances, level of sophistication, investment experience and objectives, and to provide personalized advice suitable to and in the best interest of the client based upon the client’s investment profile. The investment adviser must also update the client’s investment profile to reflect any changed circumstances. In determining whether investment advice is in the best interest of the client, the proposal indicates that an investment adviser should consider the cost, including fees and compensation, associated with the advice, as well as the investment product’s or strategy’s objectives, characteristics, liquidity, risks, potential benefits, volatility and expected performance under different market and economic conditions. With respect to an investment adviser’s duty to seek best execution, the proposal clarifies that “the determinative factor is not the lowest possible commission cost but whether the transaction represents that best qualitative execution.”

Duty of Loyalty

As stated in the proposed interpretation, an investment adviser’s duty of loyalty requires that the investment adviser must put its client’s interest first and neither favoring its own interests over those of a client nor unfairly favoring one client over another. The duty of loyalty also requires an investment adviser to “make full and fair disclosure to its clients of all material facts relating to the investment advisory relationship.” In addition, the duty of loyalty obligates an investment adviser to avoid conflicts of interest with clients and, at minimum, make “full and fair disclosure” with sufficient specificity of all material conflicts of interest. The SEC clarified that investment advisers have a duty either to obtain a client’s informed consent to disclosed conflicts of interest or to eliminate the conflict or mitigate it such that it can be better disclosed. The proposal states that consent to a conflict of interest (whether affirmative or implied) would not be appropriate in circumstances in which a client does not understand the nature of the conflict or in which the materials facts regarding the conflict are not fully and fairly disclosed.

Proposed Enhanced Regulation

In addition, pursuant to the proposal, the SEC is seeking comment on whether rules should be proposed to establish for investment advisers (1) federal licensing and continuing education requirements applicable to adviser representatives, (2) requirements to delivery periodic account statements and (3) certain financial responsibility requirements, which may include requirements to maintain minimum net capital levels, obtain fidelity bond coverage and/or segregate assets.

The public comment period will be open until August 7, 2018.

The proposed interpretation and request for comment described above, Advisers Act Release No. 4889, is available at: https://www.sec.gov/rules/proposed/2018/ia-4889.pdf

1See the summary under “SEC Proposes New Rule That Would Require Broker-Dealers to Act in Best Interest of Retail Customers”

© 2019 Vedder Price


About this Author

Vedder Price P.C. attorneys provide a full range of services to a diverse financial services clientele. Attorneys practicing in the firm’s Investment Services Group are experienced in all aspects of investment company and investment adviser securities regulations, broker-dealer regulatory and compliance matters, derivatives and financial product matters, and ERISA and tax matters. Clients include mutual fund complexes, hedge and other private funds, money managers, broker-dealers, independent directors, and many other types of institutions such as banks, savings and loans,...