I. Introduction Widely considered to be the most sweeping fi nancial regulatory reform of the modern era, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) was signed into law nearly three years ago. Section 913 of Dodd-Frank granted the Securities and Exchange Commission (“SEC”) “discretionary rulemaking authority under the Securities Exchange Act of 1934 (“Exchange Act”) and the Advisers Act to adopt rules establishing a uniform fi duciary standard of conduct for all broker-dealers and investment advisers when providing investment advice.”1 Section 913 of Dodd-Frank further required that “any standard of conduct [adopted by the SEC] shall be no less stringent than the standard applicable to investment advisers under Sections 206(1) and 206(2) of the Advisers Act.”2 Since the SEC published its study of Investment Advisers and Broker-Dealers as mandated by Section 913 of Dodd-Frank3 over two years ago (“Study” or “SEC Study”), the fi nancial industry has been awaiting a determination by the SEC as to whether it will impose a heightened standard of care upon broker-dealers, similar to the fi duciary duty impliedly imposed on investment advisers pursuant to Th e Investment Advisers Act of 1940 (“Advisers Act”). Th e primary recommendations of the SEC Study were that the SEC should “engage in rulemaking to implement a uniform fi duciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers” and should “consider harmonizing certain regulatory requirements of broker-dealers and investment advisers where such harmonization appears likely to 36 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard enhance meaningful investor protection.”4 Th e Study did not, however, provide information regarding the costs and benefi ts of the current regulatory regime as compared to the costs and benefi ts that would likely be realized if the SEC were to exercise its rulemaking authority. Similarly, the Study did not generate comments regarding either of the aforementioned cost-benefi t analyses. Recently, the SEC took the next step towards a potential heightened standard when it released a Request for Data and Other Information regarding the Duties of Brokers, Dealers and Investment Advisers (“Request”). Th e Request specifi ed that the SEC intends to use the data and information collected to inform its “consideration of alternative standards of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers,” such as the potential establishment of a uniform fi duciary standard, as well as to inform its consideration of the “potential harmonization of certain other aspects of the regulation of broker-dealers and investment advisers.”5 Importantly, the Request also calls upon commenters to provide the SEC with a cost-benefi t analysis for a uniform fi duciary standard of conduct, and the various alternative approaches thereto, as outlined in the Request. As will be discussed in detail below, the potential implementation by the SEC of a uniform fi duciary standard, alternatives thereto and/or various other aspects of regulatory harmonization will have a substantial impact not only on fi nancial service professionals, but also on their customers and their employers. Th is article will provide an overview of the current regulatory regime and traditional duties of a fi duciary, as well as an overview of the practical implications of both a uniform fi duciary standard and alternative approaches to such a standard, as well as the overall eff ect of the potential standards on the various stakeholders in the industry. II. Current Regulatory Framework and Standard of Care Under the current framework, broker-dealers and investment advisers are subject to diff erent regulatory regimes, despite the fact that many of the services off ered by both groups overlap. Investment advisers are subject to the Advisers Act and, as a result, owe fi duciary duties to their clients. Broker-dealers, on the other hand, are subject to the Exchange Act and are not generally considered to be fi duciaries to their customers, with some exceptions.6 Broker-dealers are also subject to the rules of each and every self-regulatory organization (“SRO”) of which it is a member. However, applicable antifraud provisions and federal securities laws are applicable to both broker-dealers and investment advisers. Notably, studies have refl ected that many retail customers are not aware of the diff erences between broker-dealers and investment advisers, and the corresponding duties owed to the customer.7 Th is is most true in recent years where the “lines between full-service broker-dealers and investment advisers have become blurred,” a fact that is especially troublesome when “specifi c regulatory obligations depend on the statute under which a fi nancial intermediary is registered instead of the services provided.”8 Th e SEC Study and Request are an eff ort to both “enhance retail customer protections and decrease retail customers’ confusion about the standard of conduct owed to them when their fi nancial professional provides them with personalized investment advice,”9 potentially through the establishment of a uniform fi duciary standard or some variation thereof. III. Assumptions Underlying Potential Standards Being Considered by the SEC In its Request, the SEC set forth various assumptions that presumably would underlie any standard it ultimately decides to impose. Th e general assumptions below would, for the purposes of the SEC’s Request, underlie any proposed approach to adopting a uniform standard of conduct.10 A. “Personalized investment advice about securities” would “include a ‘recommendation’ as interpreted under existing broker-dealer regulation, and would include any other actions or communications that would be considered investment advice about securities under the Advisers Act.”11 “Personalized investment advice” would not, however, include “’impersonal investment advice’ as used for purposes of the Advisers Act,” nor would it include “general investor educational tools” so long as those tools “do not constitute a recommendation under current law.”12 B. “Retail customer” would be defi ned in the same way the term is defi ned under Dodd-Frank, which is “a natural person, or the legal representative of such natural person, who 1) receives personalized investment advice about securities from a broker or dealer or investment adviser; and 2) uses such advice primarily for personal, family or household purposes.”13 C. Any action taken by the SEC would be applicable to all “SEC-registered broker-dealers and all SEC-registered investment advisers.”14 PRACTICAL COMPL IANCE & RISK MANAGEMENT FOR THE SECURITI ES INDUSTRY | MAY–JUNE 2013 37 An Analysis of the Potential Impact of a Uniform Fiduciary Standard D. Th e uniform fi duciary standard would not require fi rms to charge an asset-based fee, but instead “would be designed to accommodate diff erent business models and fee structures of fi rms, and would permit broker-dealers to continue to receive commissions.”15 Moreover, brokerdealers would continue to be allowed to be “engaged in, and receive compensation from, principal trades.” Also, “at a minimum, a broker-dealer or investment adviser would need to disclose material confl icts of interests, if any, presented by its compensation structure.”16 E. Th e uniform fi duciary standard “would not generally require a broker-dealer or investment adviser to either: 1) have a continuing duty of care or loyalty to a retail customer after providing him or her personalized investment advice about securities, or 2) provide services to a retail customer beyond those agreed to between the retail customer and the broker-dealer or investment adviser.”17 Rather, the question of whether the broker-dealer or investment adviser has a continuing duty, and the nature and scope of such duty, would be determined by the arrangement between the parties, whether contractual or otherwise, including the “totality of the circumstances of the relationship and course of dealing between the customer and the fi rm.”18 Moreover, the uniform fi duciary duty would not apply to, and the broker-dealer or investment adviser would not be required to provide, services beyond those agreed to through a contractual or other arrangement or understanding with the retail customer.”19 F. Th e fact that a fi rm off ers, or that a broker-dealer or investment adviser recommends, “only proprietary or a limited range of products would not in and of itself be considered a violation of the uniform fi duciary standard of conduct.”20 G. Th e rules applicable to investment advisers, namely Sections 206(3) and 206(4) of the Advisers Act would continue to apply to investment advisers but would not become applicable to broker-dealers. To satisfy the fi duciary standard, a broker-dealer would be required to “disclose any material confl icts of interest associated with its principal trading products.”21 H. Currently applicable “law and guidance governing broker-dealers, including SRO rules and guidance, would continue to apply to broker-dealers.”22 As with all the assumptions in the Request, including but not limited to those listed above, the SEC has expressly stated that such assumptions should not be taken as a suggestion of the agency’s policy view or the ultimate direction of any proposed action.23 It seems clear, however, that at a minimum, the assumptions provide a road map of the various factors that the SEC is taking into account while analyzing the potential implications of a uniform fi duciary standard, or alternatives thereto. IV. Potential Standards Under Consideration by the SEC24 A. Uniform Fiduciary Standard As discussed above, Section 913 of Dodd-Frank requires the SEC, if it determines to exercise its rulemaking authority to enact a uniform fi duciary standard (or some variation thereof), to adopt a standard no less stringent than the standard applicable to investment advisers under Sections 206(1) and 206(2) of the Advisers Act.25 Th ese sections of the Advisers Act have been interpreted by the Supreme Court as “requiring an investment adviser to fully disclose to its clients all material information that is intended to eliminate, or at least expose, all confl icts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.”26 Th e SEC Study recommended that any uniform standard should necessarily include both a duty of loyalty and a duty of care, as well as the extension of “existing guidance and precedence under the Advisers Act regarding fi duciary duty… where similar facts and circumstances would make guidance and precedent relevant and justify a similar outcome.” 1. Duty of Loyalty Section 913(g) of Dodd-Frank addresses the duty of loyalty as a crucial component of a uniform fi duciary standard, indicating that, at a minimum, when a broker-dealer or …[I]mplementation by the SEC of a uniform fi duciary standard, alternatives thereto and/or various other aspects of regulatory harmonization will have a substantial impact not only on fi nancial service professionals, but also on their customers and their employers. 38 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard investment adviser provides personalized investment advice, “any material confl icts of interest shall be disclosed and may be consented to by the customer.”27 Consistent with Dodd-Frank, the establishment of a uniform fi duciary standard would necessarily be “designed to promote advice that is in the best interest of a retail customer”28 by eliminating the “material confl icts of interest of a broker-dealer or investment adviser, or by “providing full and fair disclosure to retail customers about those confl icts of interest.”29 Th e SEC has stated that it should be assumed that the agency would provide specifi c guidelines as to how broker-dealers and investment advisers could comply with the duty of loyalty component of the uniform fi duciary duty standard. Th e SEC has further articulated that commenters may make several assumptions regarding the duty of loyalty. Firstly, any standard the SEC would impose would include details of various disclosure requirements, including, but not necessarily limited to, the disclosures listed below.30 a) A generalized obligation to disclose all material confl icts of interest with regard to that specifi c retail customer, which “could be made largely through the general relationship guide” described below.31 b) A “general relationship guide similar to Form ADV Part 2A” which would be delivered to the customer “at the time of entry into a retail customer relationship” and would contain, at a minimum, a description of the fi rm’s “services, fees and the scope of its services with the retail customer.”32 Th e description of the scope of the fi rm’s services would need to include, but not be limited to, the following: i) Whether “the advice related duties are limited in time or are ongoing, or are otherwise limited in scope (e.g. limited to certain accounts or transactions)”33 ii) Whether “the broker-dealer or investment adviser only off ers or recommends proprietary or other limited ranges of products;”34 and iii) Whether “the broker-dealer or investment adviser will seek to engage in principal trades with a retail customer”35 and if so, the circumstances in which he or she would seek to do so. c) Any rule imposed upon broker-dealers and investment advisers would “treat confl icts of interest arising from principal trades the same as other confl icts of interest.”36 This is in contrast to “transaction-by-transaction disclosures and consent requirements of Section 206(3) of the Advisers Act for principal trading.”37 Any rule established would expressly state that the aforementioned disclosures under Section 206(3) are not applicable, however “at a minimum, as with other confl icts of interests, the broker-dealer or investment adviser would be required to disclose material confl icts of interest arising from principal trades with retail customers.”38 d) Any rule would prohibit the “receipt or payment of noncash compensation (e.g., trips and pries) in connection with the provision of personalized investment advice.”39 2. Duty of Care Th e SEC indicated in its Request that it could utilize the duty of care to specify “certain minimum professional obligations of broker-dealers and investment advisers” in order to promote the dissemination of investment advice that is in the “best interests of the retail customer.”40 Th e duty of care likely would be used to set a minimum standard of care under both existing law and any new law imposed by the heightened standard. Additionally, as set forth in the SEC Request, the duty of care likely would incorporate the components below.41 a) Similar to the current regulatory regime, broker-dealers and investment advisers would be required to have a reasonable basis to “believe that [their] securities and investment strategy recommendations are suitable for at least some customer(s) as well as for the specifi c retail customer to whom it makes the recommendation in light of the retail customer’s fi nancial needs, objectives and circumstances.”42 b) Certain products recommended by investment advisers and broker-dealers would be subject to additional requirements, such as “specifi c disclosure, due diligence or suitability requirements.”43 Examples of products that would be subject to these product-specifi c requirements may include, but not be limited to, penny stocks, options, debt securities and bond funds, municipal securities, mutual fund share classes, interests in hedge funds and structured products.44 c) Broker-dealers and investment advisers (in cases where “the investment adviser has the responsibility to select broker-dealers to execute client trades”45) would be required to “seek to execute customer trades on the most favorable terms reasonably available under the circumstances.”46 d) Broker-dealers and investment advisers would be required to receive fair and reasonable compensation for their services, taking into account “all relevant circumstances.”47 PRACTICAL COMPL IANCE & RISK MANAGEMENT FOR THE SECURITI ES INDUSTRY | MAY–JUNE 2013 39 An Analysis of the Potential Impact of a Uniform Fiduciary Standard 3. Continuing Application of Existing Fiduciary Principles Th e SEC Study did recommend that “existing guidance and precedent under the Advisers Act regarding fi duciary duty should continue to apply to investment advisers and be extended to broker-dealers, as applicable, under a uniform fi duciary standard of conduct.”48 Nonetheless, the SEC noted in the Request that application of relevant guidance and precedence is a fact-specifi c determination based upon the circumstances surrounding each case and consequently, the guidance and procedures may not apply to brokerdealers in certain cases. At a minimum, the SEC Request identifi ed the principles listed below as those that would “continue to apply to investment advisers and be extended to broker-dealers.”49 a) Th e duty of loyalty inherent in a fi duciary duty standard would generally “require a fi rm to disclose to a retail customer how it would allocate investment opportunities among its customers, and between customers and the fi rm’s own account.”50 Th is would include, but not be limited to, disclosures regarding the fi rm’s “method of allocating shares of initial public off erings, as well as its methods of allocating out of its principal account to its customers when agency orders are placed on a riskless principal basis.”51 b) Orders may be aggregated or “bunched” by a fi rm on behalf of two or more retail customers, “so long as the fi rm does not favor one customer over another.”52 Th e fi rm would be required to disclose that it aggregates orders, and under what conditions it does so. If the fi rm does not aggregate orders, it would then be required to state why it does not when it has the opportunity to aggregate, as well as the practices and costs associated with not aggregating orders. B. Alternative Approaches In its Request, the SEC also identifi ed several alternatives to the uniform fi duciary standard previously discussed. Th e SEC hopes that it will receive comments, as well as a costbenefi t analysis of the alternative approaches detailed below. Th e purpose is to help the SEC evaluate whether the various alternatives meet the goals of enhancing retail customer protections and decreasing retail customers’ confusion about the standard of conduct owed to them in connection with the rendering of personalized investment advice. Th e SEC suggests the following alternatives in the Request: 1. Without imposing a fi duciary standard of conduct, the SEC may decide to apply a uniform requirement to broker-dealers and investment advisers which would require them “to provide disclosures about: a) key facets of the services they off er and the types of products or services they off er or have available to recommend; and b) material confl icts they may have with retail customers.”53 2. Th e SEC may decide to impose the uniform fi duciary standard of conduct on broker-dealers and investment advisers, but may decline to extend the existing fi duciary duty guidance and precedent under the Advisers Act to broker-dealers. However, the aforementioned guidance and precedent would still be applicable to investment advisers.54 As will be discussed in greater detail below, this is the approach advocated by Th e Securities Industry and Financial Markets Association (“SIFMA”). 3. Th e SEC may determine that it will leave the current regulatory scheme applicable to investment advisers unchanged, while applying the uniform fiduciary standard to broker-dealers, in part or as a whole. Th e SEC stated in the Request that this “‘broker-dealer only’ standard could involve establishing a ‘best interest’ standard of conduct for broker-dealers”55 that would still meet Dodd-Frank’s requirement that any heightened duty imposed on broker-dealers must be no less stringent than the standard currently applied to investment advisers. 4. Alternatively, the SEC may decide that it will leave the current broker-dealer regulatory regime unchanged while specifying certain minimum professional obligations under an investment adviser’s duty of care, as currently such duties are not specifi ed by rule.56 If the SEC pursued this approach, “any rules or guidance would take into account Advisers Act fi duciary principles and … seek best execution where the adviser has the responsibility to select broker-dealers to execute client trades.”57 5. Th e SEC also could look abroad to successful models employed in other international markets. In the United Kingdom, the Financial Services Authority (“FSA”) requires “persons providing personalized investment advice to a retail client to act in the client’s best interests.”58 Th e FSA has also “set limits on the amount investment advisers charge for their services, including prohibiting (a) the receipt of ongoing charges unless there are ongoing services, and (b) the receipt of commissions from those providing the investment advice.”59 Similar yet distinguishable policies and standards are employed by Australia, as well as the European Securities and Markets Authority.60 40 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard 6. Finally, the SEC could take no action at all, and leave the current regulatory regime for broker-dealers and investment advisers unchanged. Consequently, the SEC seeks comments regarding the costs and benefi ts of leaving the current regulatory framework intact, as compared to implementing one of the aforementioned alternatives and/or a uniform fi duciary standard. V. A Fiduciary’s Duties: Obligations and Best Practices In order to determine how the various approaches discussed above would aff ect the personal fi nance industry, it is important to highlight the various obligations traditionally associated with a fiduciary, as these duties will likely be incorporated, to some degree, into any heightened standard which may be imposed on broker-dealers and investment advisers. An excellent resource for doing so is the Institute for the Fiduciary Standard (the “Institute”) which has identifi ed six core duties inherent in a fi duciary standard, and the various attributes accompanying each of the duties.61 a. Serve in the Client’s Best Interest A fi duciary is defi ned as “someone acting in a position of trust on behalf of, or for the benefi t of, a third party.”62 As such, a fi duciary owes the utmost duty of loyalty to his/her clients. Th is duty requires the fi duciary to place the client’s best interests fi rst, ahead of the interests of all other stakeholders, including the adviser and the fi rm. In order to satisfy, a fi duciary must ensure that there is no option available to the client which is “materially better.”63 In connection with serving the client’s best interests, there are several responsibilities that a fi duciary must undertake, including, but not limited to the following:64 i) “Determining investment goals and objectives; ii) Choosing an appropriate asset allocation strategy; iii) Establishing an explicit, written investment policy consistent with [the client’s] goals and objectives; iv) Monitoring the activities of the overall investment program for compliance with the investment policy.”65 A fi duciary also has the duty to select asset classes that are consistent with the identifi ed risk, return and time horizon specifi ed by the client.66 Th e “key fi duciary inputs” involved in asset allocation strategy may be defi ned by the acronym “TREAT: tax status, risk level, expected return, asset class performance and time horizon.”67 b. Act in the Utmost Good Faith A fi duciary is required to act in the utmost good faith of the client. Th is includes, but is not limited to, the duty to be truthful and straightforward in all communications. Communications include not only direct statements spoken to the client, but all statements, whether spoken or written, regarding the adviser, the adviser’s experience and recommendations, and the adviser’s fi rm.68 c. Avoid Confl icts of Interest Historically, concerns regarding confl icts of interest in large part prompted the enactment of the Advisers Act of 1940, as confl icts of interests abounded after the stock market crash of 1929.69 Since the enactment of the Advisers Act, the duty to avoid confl icts of interest has been a bedrock principle for fi duciaries. It has been noted that “even well-meaning advisers often cannot overcome a confl ict and give objective advice.”70 It is essential that advisers closely monitor any potential confl icts they may have. While it is impossible for an advisor to avoid every potential confl ict of interest, all advisers should take reasonable steps to avoid material confl icts and must “sharply minimize unavoidable [confl icts of interest] and effectively mitigate or manage confl icts in the best interests of the client.”71 As a practical matter, if a fi duciary suspects that he or she may have a confl ict of interest, it is likely such a confl ict does exist and it is the duty of the adviser to end and/or avoid the confl ict.72 To evaluate whether a confl ict exists, prior to selecting a particular investment or making a certain decision with regard to the client’s account, an adviser should determine who stands to benefi t most from the transaction or decision.73 If the adviser determines that anyone other than the client stands to gain the most benefi t, that fi duciary is on the verge of breaching his or her duties to the client. d. Disclose and Manage All Material Facts and Confl icts As part of their fiduciary duty, investment advisers have a duty to disclose and manage all material conflicts they encounter in the course of the relationship with their clients. What an adviser is required to disclose to his or her clients depends upon the surrounding facts and circumstances. Disclosure of all material facts and conflicts required to be made by an adviser must be “clear, complete and timely.”74 When an adviser discloses material facts and conflicts in this manner, it helps the adviser to manage the material conflict. The adviser must have a PRACTICAL COMPL IANCE & RISK MANAGEMENT FOR THE SECURITI ES INDUSTRY | MAY–JUNE 2013 41 An Analysis of the Potential Impact of a Uniform Fiduciary Standard reasonable basis to “think that the client fully understands the disclosure and the implication of the conflict(s), prior informed written consent if the client wishes to proceed with a transaction, and continued demonstration by the adviser that the recommendation is reasonable, fair and in the client’s best interests.”75 Pursuant to a recent rule proposal promulgated by the Financial Industry Regulatory Authority, Inc. (“FINRA”), brokers soon may be required to disclose incentives “to anyone they solicit for one year following their transfer to a new fi rm.”76 Th ese incentives would include, but not be limited to, signing bonuses, upfront or back-end bonuses, loans, accelerated payouts and transaction assistance, and would only apply to incentives totaling $50,000 or more.77 In response to FINRA’s proposal, SIFMA stated that, consistent with its support of a uniform standard of conduct, “in the context of recruiting-related bonus payments, the most important and relevant information for the client is to understand the potential confl ict associated with the payment.”78 In the event the proposed FINRA rule is adopted, brokers would have the duty to disclose compensation incentives, as such incentives would constitute confl icts of interest. e. Act Prudently with the Care, Skill and Judgment of a Professional Th e requirement that advisers act prudently, and with due care, with regard to his or her clients encompasses not only following “a prudent process” but also having the requisite “knowledge to make appropriate recommendations.”79 Advisers not only must possess the requisite knowledge, but also must ensure that their knowledge base and expertise are regularly updated. In order to exercise due care, an adviser’s process with regard to making and monitoring investments must be prudent, and requires “investigating and assessing an investment’s or fi rm’s characteristics based on objective criteria”, as well as employing industry best practices to “investigate, evaluate and construct a portfolio or recommendation.”80 f. Control Investment Expenses A fi duciary also has an obligation reasonably to control investment-related costs and expenses. Inherent in this duty is the obligation of the adviser to ensure all investment-related expenses are both “fair and reasonable in relation to the services and investments off ered.”81 Importantly, any inappropriate or unnecessary expenses are unambiguously considered to evidence a breach of the duty of loyalty.82 To fulfi ll its duty to manage investment decisions with the “requisite level of care, skill and prudence”, a fi duciary is required to establish a process by which to ensure that the client is responsible only for reasonable and necessary expenses.83 Such expenses may include, but are not limited to, trading costs, consulting and administrative fees and custodial charges.84 Finally, another key principle of the concept of a fi duciary is that the fi duciary duty is incapable of being superseded by agreement. A fi duciary is under an absolute obligation to “act in good faith and deal fairly with and for the principal.”85 Consequently, a “principal could not authorize a fi duciary to act in bad faith.”86 VI. Industry Considerations Regarding A Heightened Duty In response to the SEC Study, several industry groups have fi led comment letters advocating the adoption of various standards. In particular, an analysis of two notable commentators, SIFMA and the Institute for the Fiduciary Standard (the “Institute”), provides insight into several important considerations regarding the aforementioned approaches. SIFMA has taken the position that a wholesale extension of the fi duciary standard currently applicable to investment advisers pursuant to Section 206 of the Advisers Act would result in adverse consequences for both investors and the industry. While the Institute advocates for a uniform standard as well, its position diff ers fundamentally from the position of SIFMA. SIFMA SIFMA supports “the adoption of a new uniform fi duciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.”87 To support its position, SIFMA notes that a wholesale extension of the current The uniform fi duciary standard would not require fi rms to charge an asset-based fee, but instead “would be designed to accommodate different business models and fee structures of fi rms, and would permit broker-dealers to continue to receive commissions. 42 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard fi duciary standard would not be in the best interests of retail customers, as it would “impact choice, product access and aff ordability of customer services.”88 Moreover, according to SIFMA, wholesale extension of the current standard would also cause commercial, legal, compliance and supervisory”89 problems for broker-dealers. SIFMA notes that the inherent diffi culty in extending the standard is evidenced in part by the core diff erences between the services provided by investment advisers and brokerdealers. While investment advisers are generally “engaged in the business of providing advice about securities for a fee, or managing assets on a discretionary basis,”90 broker-dealers provide securities-related advice in addition to a host of other products and services which are benefi cial to customers and securities markets as a whole. Th ose additional activities engaged in by broker-dealers “often carry inherent (though generally accepted and well-managed) confl icts of interest” and the current fiduciary duty standard implied under the Advisers Act “provides incompatible and insuffi cient guidance for broker-dealers on how to manage, disclose or obtain consents to these confl icts.”91 Notably, the fact that commission-based brokerage accounts are the “preferred model for retail customers”92 could result in reduced access for customers, as numerous potential confl icts may arise in such accounts. Although Dodd-Frank provides that commissionbased compensation in and of itself would not constitute a violation of a uniform fi duciary standard, SIFMA’s position is that “undiff erentiated application of existing Advisers Act case law, guidance and other precedents to broker-dealers could result in reduced access to brokerage accounts”93 since presumably such precedence may support a fi nding that a material confl ict existed in a commission-based account, depending upon the circumstances. SIFMA has outlined several key reasons why, in its opinion, the fi duciary standard under the Advisers Act should not extend to broker-dealers. Notably, Congress “recognized that the uniform fi duciary standard should ‘appropriately adapt to the differences between broker-dealers and registered investment advisers.’”94 Also, SIFMA has stated that extending the “inability to gauge compliance with, or legal exposure under, the Advisers Act” would undermine the current business model of broker-dealers.95 In situations where the “business and legal risks are unmanageable, broker-dealers will withdraw from off ering the aff ected products and services, which would disserve the interests of retail customers.”96 Th e undiff erentiated extension of the current fi duciary standard also would signifi cantly increase the costs associated with retail customers’ accounts and consequently would reduce the aff ordability of advisory services, in SIFMA’s opinion, as such an extension would reduce both options and access to certain products for retail investors.97 According to SIFMA, the optimal approach would be a new uniform standard that would prioritize and protect investors’ interests and preserve the choice and access investors currently have. Th e new standard also would need to be capable of adapting to the diff erent business models employed by brokerdealers and investment advisers, meaning that any standard enacted would be business-model neutral. Another guiding principle of SIFMA’s approach would be that in the case of a material confl ict of interest, the SEC should articulate ways for broker-dealers and investment advisers to provide clear and eff ective disclosures to customers in a manner which would comport with the new standard, and receive the customer’s consent, if required. With regard to disclosure, SIFMA suggests that customers may consent to a material confl ict of interest, subsequent to mandatory disclosure by the broker-dealer or investment adviser. Not only should disclosures be required to be clear and concise, but SIFMA’s position is that the SEC should also take a “layered approach to disclosure” in order to “provide retail customers with the clearest, most relevant information at the time it is most important to [the customers’] decision making, and therefore most likely to be read, with greater detail simultaneously made available to the customer if desired.”98 Any disclosure updates would be provided through an annual notifi cation to customers, where such disclosures were deemed “necessary or appropriate.”99 In articulating the new standard of conduct, under SIFMA’s approach, the SEC necessarily would provide the “detail, structure and guidance necessary to enable broker-dealers to apply the fi duciary standard to their distinct operational model.”100 Th e success of the new standard of conduct will depend in important part upon the SEC’s articulation of the scope of the obligations of broker-dealers and investment advisers, including but not limited to: 1) when the standard of conduct should commence;101 2) specification of the broker-dealer’s obligations under the new standard in the customer agreement,102 including but not limited to which disclosures are required and when such disclosures are required; 3) application of the uniform standard on an “account-byaccount basis”;103 and 4) “inclusion of traditional product sales and compensation arrangements for broker-dealers.”104 SIFMA further stated that while the current legal precedence and guidance pursuant to the Advisers Act still would apply to PRACTICAL COMPL IANCE & RISK MANAGEMENT FOR THE SECURITI ES INDUSTRY | MAY–JUNE 2013 43 An Analysis of the Potential Impact of a Uniform Fiduciary Standard investment advisers, it would not apply to broker-dealers.105 In particular, SIFMA noted that broker-dealers should continue to have the ability to engage in principal transactions under the new standard, as it was the intent of Congress to preserve this ability.106 The Institute Contrarily, the Institute stated that “the rich history of law, policy and experience provides a backdrop for extending the fi duciary standard to brokers rendering personalized investment advice to retail investors.”107 Th e Institute calls into question SIFMA’s aim to prioritize investors’ interests by highlighting areas in which SIFMA’s suggested framework seeks to “ensure that the fi duciary standards adopted by the SEC will fi t broker-dealers’ existing business practices and business models”108 instead of promoting and protecting investors’ interests. According to the Institute, the fact that SIFMA does not advocate for a modifi cation or discontinuation of the products and services off ered by broker-dealers to investors is problematic as SIFMA advocates the articulation of a new standard “without any corresponding change in the advice and recommendations that may be provided [to investors].”109 In essence, the Institute takes issue with SIFMA’s position that “suitable product recommendations suffi ce, and that a fi duciary ‘due care’ screening and investment selection process to meet the ‘best interest’ standard is not required”110, as such a position is not consistent with putting investors’ interests fi rst. With regard to confl icts of interests, the Institute’s view of SIFMA’s position is clear, stating that “at its core, SIFMA, it appears, unabashedly champions the benefi ts of confl icted advice.”111 Moreover, the Institute states that: “SIFMA’s absolute and unconditional support of broker-dealers’ ability to continue to have confl icts with customers’ interests makes it hard not to conclude that SIFMA’s (1) position is based more on the economic and business concerns associated with a fi duciary standard than on customers’ best interests and (2) argument that customers interests would be harmed if broker-dealers decided not to provide certain products or services that involve confl icts of interest is based on the economic and business repercussions of imposing a true fi duciary standard on broker-dealers.”112 Th e Institute takes issue with SIFMA’s departure from the established and unambiguous view of the SEC that advisors are strongly urged to “avoid confl icts.”113 Furthermore, the Institute takes issue with SIFMA’s position on required disclosures. Th e Institute argues that SIFMA’s position with regard to disclosures, including fl exibility and the layered approach discussed above, would favor broker-dealers, investment advisers and their employers, while undermining the best interests of customers. Moreover, the Institute states that it is “necessary, but not suffi cient, under a fi duciary standard for a customer to provide informed consent to a confl ict of interest” because even where consent has been obtained, “such consent does not obviate the need for the fi duciary to also determine that the proposed transaction is in the best interests of the client.”114 SIFMA’s position that the standard may apply on an account-by-account basis, as specifi ed within the investor’s contract, is also problematic for the Institute, as “the fi duciary duty may not be negotiated and contracted away or otherwise limited by contract.”115 Moreover, taking SIFMA’s approach to the standard could, in the Institute’s opinion, result in the switching of standards by broker-dealers without informing the customer that the switch is occurring, the reason underlying the switch and how the switch will aff ect the broker-dealer’s relationship with the customer.116 Based upon the foregoing (in addition to the numerous other comment letters received by the SEC in response to its Study) it is clear that there is signifi cant dissention among industry commentators and stakeholders as to whether a new standard should be adopted. Likewise, if a new standard is adopted, it is clear that there is signifi cant dissention as to what the new standard should be, as well as the underlying reasons why various aspects of such a standard are crucial to industry stakeholders. VII. Other Considerations Safe Harbor Provisions In the event a uniform fiduciary standard ultimately is imposed, it is unclear whether there would be a “safe harbor provision” put in place which would “insulate broker-dealers from any unforeseen consequences of a uniform fi duciary standard.”117 According to industry expert Donald B. Trone, any uniform standard, or alternatives thereto, likely would include a safe harbor provision as the vast majority of federal regulatory agencies have similar procedures in place.118 Th e practical eff ect of a safe harbor provision would be that so long as a fi rm was able to prove it had complied with the safe harbor provisions set forth by the regulatory agency, it would be shielded from liability under the new regulation(s). 44 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard Based upon other safe harbor provisions in existing regulations, a safe harbor provision in the uniform fi duciary standard may resemble the following model: 1. For those who wish to serve in a fi duciary capacity, the fi rm must “defi ne minimum qualifi cations (in terms of experience, licensing and training)”119; 2. Advisors would be required to “accept and acknowledge his or her fi duciary status in writing”120; 3. Advisors serving in an advisory capacity would be required to agree to “use only investment procedures, databases, software and technology approved by his or her fi rm”121; 4. Advisors would be required to “agree to maintain records demonstrating their procedural prudence (the details of their decision making process)”122; and 5. Th e fi rm would be required to monitor the activities of the advisors.123 Th e above model is business-model neutral and is similar to “supervisory procedures already being followed by FINRA member fi rms and to procedures SEC-registered investment advisory firms should have in place.”124 While many in the industry would advocate the inclusion of a safe harbor provision in order to enable fi rms to limit their exposure to liability to the “conduct of the advisor and to the fi rm’s oversight, supervision and monitoring”125 of the registered representative or adviser, critics worry that a safe harbor provision would result in the client’s interests not being prioritized. However, any fi rms not prioritizing client interests would arguably be “easy to spot” and consequently would be “at risk of losing their safe harbor insulation.”126 Effect of Heightened Duty on Dually-Registered Advisers Regardless of what form the uniform standard of conduct might take, if the SEC determines it will exercise its rulemaking authority and enact such a standard, duallyregistered advisers may fi nd it diffi cult to determine which standard should be applicable to them. Th e SEC indicated that it should be assumed, at least for purposes of the Request, that any rule which would be enacted “would not relieve an investment adviser who is also registered as a broker-dealer from its obligation to comply with Advisers Act Section 206(3) or the rules thereunder.”127 Based upon the SEC’s Request, it seems likely that if enacted, the new uniform standard, or alternative thereto, would serve as a baseline standard of conduct. Investment advisers may also be subject to any heightened requirements imposed upon them by the Advisers Act. If the standards were to confl ict, this would indicate potential areas where harmonization would be necessary. However, practically speaking, the rule could specify that the investment advisers could default to whichever rule is more protective of the investor. It seems that any rule established would need to include guidelines for what to do in the event of an undiscovered confl ict, while the body of law and precedence still was being developed. Department of Labor Fiduciary Investment Advice Re-Proposal On a related note, the Department of Labor (“DOL”) is expected to issue a re-proposal of its defi nition of an “investment advice fi duciary” sometime during July 2013 as part of its “campaign to expose and minimize confl icts of interest in the retirement plan industry.”128 Commentators have noted that the DOL re-proposal likely will be coordinated with the SEC’s rulemaking regarding the potential imposition of a uniform fiduciary standard, or alternatives thereto, upon broker-dealers and investment advisers.129 Th e DOL and the SEC may exercise their rulemaking authority at or around the same time, as both the DOL fi duciary re-proposal and the SEC’s decision regarding whether it will implement a uniform fi duciary standard for broker-dealers and investment advisers are both expected in the second half of 2013. Currently, under the Employee Retirement Income Security Act (“ERISA”), if an advisor provides investment advice, the advisor is “automatically deemed to be a fi duciary.”130 Under ERISA, an advisor provides investment advice and is consequently deemed a fi duciary if: (1) “such person renders advice to the plan as to the value or advisability of making an investment in securities or other property, (2) on a regular basis, (3) pursuant to mutual agreement or understanding (written or otherwise), (4) that such services will serve as a primary basis for investment decisions, and (5) that such person will render advice based on the particular needs of the pan.”131 Importantly, “investment advice” is more narrowly defi ned under ERISA than under federal securities laws. If the DOL’s re-proposal follows the changes set forth in its initial proposal on the defi nition of whether an advisor is providing fi duciary investment advice, it is expected that the defi nition will be PRACTICAL COMPL IANCE & RISK MANAGEMENT FOR THE SECURITI ES INDUSTRY | MAY–JUNE 2013 45 An Analysis of the Potential Impact of a Uniform Fiduciary Standard broadened to include situations where there is “an understanding or agreement that the advice ‘may be considered’ in connection with a plan investment decision, regardless of whether it is provided on a regular basis.”132 Clearly, such a change could impose a fi duciary duty on advisors providing “casual or even one time investment advice.”133 However, under the current and proposed defi nitions, in order for an advisor to be deemed a fi duciary, the investment advice given must necessarily be “individualized advice for the particular plan client.”134 It also is expected that the DOL re-proposal will include some form of a safe harbor provision where advisors may avoid fi duciary status by providing various “in your face” disclaimers to clients. While the DOL’s initial proposal did not require these disclaimers to be in writing, it “clearly contemplated some type of notice or acknowledgement form for the plan client.”135 Essentially, in order to avoid fi duciary status, an advisor would need to state to his or her client(s) that the fi nancial advisor is not “providing impartial advice.”136 It seems that any fi nancial advisor who does not agree to making the appropriate disclosures and disclaimers to his or her clients may “be forced out of the retirement plan business.”137 Due to the crossover of fi nancial advisors who service retail investors as well as retirement plans, it is clear that any rules or guidelines imposed by the DOL will have a profound impact upon the entire fi nancial services industry. Consequently, additional harmonization of industry rules and regulations likely will be required. VIII. Conclusion While the SEC repeatedly has stated that the various approaches and underlying assumptions included in its Request do not suggest the agency’s policy view or the ultimate direction of any proposed action, it seems that the detailed approaches can fairly be taken as a fundamental core idea base upon which any policy or rulemaking may be formulated. Given the enormity of the task of changing the regulatory framework of the fi nancial services industry, it is no surprise that the SEC eff ectively has taken two years to issue this Request. Undoubtedly, the Request will foster much needed analysis and debate as to whether a heightened standard should be imposed upon broker-dealers and investment advisers, what sort of standard should be imposed and how the regulatory changes would aff ect the fi nancial services industry, as a whole. Ultimately the fact that the rulemaking process will have taken several years both should benefi t investors and put reasonable burdens on the fi nancial services industry. ENDNOTES 1 Securities and Exchange Commission’s Request for Data and Other Information regarding the Duties of Brokers, Dealers and Investment Advisers (“SEC Request”), March 1, 2013, available at www.sec.gov/rules/other/2013/34-69013. pdf. 2 SEC Request p. 29. 3 Securities and Exchange Commission study on Investment Advisers and Broker-Dealers (“SEC Study”), January 2011, available at www.sec.gov/news/ studies/2011/913studyfi nal.pdf. 4 SEC Request p. 6. 5 SEC Request p. 1. 6 Brokers may be considered fi duciaries under certain circumstances and certain state laws. As a general matter, brokers have been found by courts to have fi duciary status when the brokers: “exercise discretion or control over customer assets, or have a relationship of trust and confi dence with their customers” (SEC Request p.3 footnote 3). See, e.g., United States v. Skelly, 442 F.3d 94, 98 (2d Cir. 2006); United States v. Szur, 289 F.3d 200, 211 (2d Cir. 2002); Associated Randall Bank v. Griffi n, Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 212 (7th Cir. 1993); MidAmerica Fed. Savings & Loan Ass’n v. Shearson/American Express Inc., 886 F.2d 1249, 1257 (10th Cir. 1989); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F. Supp. 951, 953-954 (E.D. Mich. 1978), aff’d, 647 F.2d 165 (6th Cir. 1981). 7 SEC Request p. 4. 8 SEC Request p. 5. 9 SEC Request p. 6. 10 SEC Request p. 25-29. 11 SEC Request p. 25. 12 Id. 13 SEC Request p. 26. 14 Id. 15 SEC Request p. 26. 16 SEC Request p. 27. 17 Id. Notably, if this assumption were included in any rule that was enacted by the SEC, harmonization with certain Financial Industry Regulatory Authority Inc. (“FINRA”) rules currently in force likely would be required. In particular, FINRA Rule 2111, which sets forth FINRA members’ duties regarding the suitability of investment recommendations and investment strategies for customers, includes a continuing suitability obligation after the provision of investment advice. 18 SEC Request p. 27. 19 Id. 20 Id. 21 SEC Request p. 29. 22 SEC Request p. 29. 23 SEC Request p. 25. 24 Importantly, the SEC stated in its Request that the potential standards and alternative approaches discussed are non-exclusive (see SEC Request p. 24). 25 SEC Request p. 29. 26 SEC Request p. 29, citing SEC v. Capital Gains Research Bureau, Inc.,375 U.S. 180, 194 (1963). 27 SEC Request p. 31. 28 Id at footnote 44. 29 SEC Request p. 31. 30 SEC Request p.32-34. 31 SEC Request p.32-33. 32 SEC Request p. 33. 33 Id. 34 Id. 35 Id. 36 Id. 37 SEC Request p. 34. 46 MAY–JUNE 2013 | PRACTICAL COMPLIANCE & RISK MANAGEMENT FOR THE SECURITIES INDUSTRY An Analysis of the Potential Impact of a Uniform Fiduciary Standard 38 Id. 39 Id. 40 SEC Request p. 35. 41 SEC Request p. 35-36. 42 SEC Request p. 35. 43 Id. 44 SEC Request p. 35-36. 45 SEC Request p. 36. 46 Id. 47 Id. 48 SEC Request p. 37. 49 Id. 50 SEC Request p. 37-38. 51 SEC Request p. 38. 52 Id. 53 SEC Request p. 39. 54 SEC Request p. 40. 55 Id. 56 Id. 57 Id.. 58 SEC Request p. 41. 59 Id. 60 Id. 61 Knut A. Rostad, What Fiduciaries Should Be Reminded Of On Valentine’s Day, Investment News, at p. 12 (February 11, 2013). 62 Foundation for Fiduciary Studies, Prudent Investment Practices: A Handbook for Investment Fiduciaries (“Handbook”) at p. 15 (2003). 63 See Rostad. 64 Handbook p. 15. 65 Id. 66 Handbook p. 23. 67 Id. 68 See Rostad. 69 Id. 70 Id. 71 Id. 72 Handbook p. 16. 73 Id. 74 See Rostad. 75 Id. 76 Mark Schoeff Jr., FINRA’s Broker-Comp Proposal Raises Hackles, Investment News, available at www.investmentnews.com/article/20130305/FREE/130309958# (March 5, 2013). 77 Id. 78 Id. 79 See Rostad. 80 Id. 81 Id. 82 Id. 83 Handbook p. 30. 84 Id. 85 Comment Letter from Ira D. Hammerman, Senior Managing Director and General Counsel, Securities Industry and Financial Markets Association (July 14, 2011) (“SIFMA Letter”) at p. 17 footnote 37, available at www.sec.gov/ comments/4-606/4606-2952.pdf. 86 Id. 87 SIFMA Letter p.1, Introduction. 88 SIFMA Letter p. 5. 89 Id. 90 Id. 91 Id. 92 SIFMA Letter p. 11. 93 SIFMA Letter p. 14. 94 SIFMA Letter p. 11. 95 Id. 96 Id. 97 SIFMA Letter p. 14. 98 SIFMA Letter p. 20. 99 SIFMA Letter p. 22. 100 SIFMA Letter p. 15. 101 Id. 102 SIFMA Letter p. 17. 103 Id. 104 Id. 105 SIFMA Letter p. 15. 106 SIFMA Letter p. 23. 107 Comment Letter from Knut A. Rostad, President of The Institute for the Fiduciary Standard (April 9, 2012) (“Institute Letter”), at p. 4, available at www.sec.gov/ comments/4-606/4606-2972.pdf. 108 Institute Letter p. 5. 109 Institute Letter p. 6. 110 Id. 111 Institute Letter p. 7. 112 Id. 113 Id. 114 Institute Letter p. 10. 115 Institute Letter p. 11. 116 Id. 117 Donald B. Trone, Standard Issue: What needs to be done to advance a fi duciary standard?, Financial Advisor Magazine p. 48 (January 2013). 118 Id. 119 Id. 120 Id. 121 Id. 122 Id. 123 Id. 124 Trone at p. 85. 125 Id. 126 Id. 127 SEC Request p. 34, footnote 48. 128 Marcia S. Wagner, Broader “Fiduciary” Defi nition: Legal Update, at p. 2, available at discover.byallaccounts.com/rs/byallaccounts/images/ERISA-Fudiciary- Defi nition-Legal-Update-WP.pdf. 129 Wagner p. 5. 130 Wagner p. 3. 131 Id. 132 Wagner p. 4. 133 Id. 134 Id. 135 Id. 136 Id. 137 Wagner p. 6. This article is reprinted with permission from Practical Compliance and Risk Management for the Securities Industry, a professional journal published by Wolters Kluwer Financial Services, Inc. This article may not be further re-published without permission from Wolters Kluwer Financial Services, Inc. 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