SEC Requests Input for a Potential Uniform Fiduciary Standard of Conduct

March 12, 2013

The Dodd-Frank Act gave the SEC the authority to adopt, but did not require it to adopt, a uniform fiduciary standard of conduct for both broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers. On March 1, 2013, the SEC requested data and other information on such a uniform fiduciary standard of conduct, and also requested comments on proposed concepts for such a uniform standard for broker-dealers and investment advisers.1 The SEC requests potential respondents to quantify information and data in numerous areas, although in some instances the information requested does not easily lend itself to quantification. Nevertheless, responses to this request will be critical to the SEC’s analysis of its proposed standard of conduct. Therefore, while in the interest of brevity this alert does not list all of the information requested, it will be extremely important for investment advisers, broker-dealers and others to respond to the best of their abilities. Of equal importance will be comments on the proposed uniform standard of conduct, the main themes and components of which are discussed below.

1. Background

Section 913 of the Dodd-Frank Act gave the SEC the authority to adopt a uniform fiduciary standard of conduct for both broker-dealers and investment advisers and directed it to study the issue. In 2011, the SEC staff issued its Study on Investment Advisers and Broker-Dealers (the “2011 Study”) and recommended (1) rulemaking to implement a uniform fiduciary standard of conduct for broker-dealer and investment advisers when providing personalized investment advice about securities to retail investors, and (2) considering how to harmonize certain regulatory requirements of broker-dealers and investment advisers when the harmonization appears likely to enhance investor protection.2 Two of the SEC’s Commissioners dissented from the release of the 2011 Study, however, and argued that the SEC needed much more information in order to determine whether such a uniform fiduciary standard would be justified under a cost-benefit analysis. In the meantime, the SEC lost another in a long series of appellate decisions concerning its rulemaking authority on the basis of inadequate cost-benefit analysis.3 The primary stumbling block in proceeding with a uniform standard has been the SEC’s lack of data to make such an analysis.

The SEC in the Request Release states that, while it has the authority either to adopt a uniform standard or to harmonize broker-dealer and investment adviser rules pursuant to Section 913 of the Dodd-Frank Act, it is not mandated to do so. And the Request Release states that the SEC has not yet even decided whether to propose either a uniform standard or a harmonized set of rules. Rather, the SEC expects that the information gathered in response to the Request Release will assist in determining whether or not it should engage in rulemaking and, if so, what the rulemaking ought to be.

2. Uniform Fiduciary Standard of Conduct; Duty of Loyalty and Duty of Care

In order to provide useful data to the SEC, many industry participants requested more clarity about the potential terms of a uniform fiduciary standard of care. The Request Release addresses this issue. The Request Release tells the industry to assume a uniform fiduciary standard of conduct that would include a duty of loyalty and a duty of care. This proposed uniform standard would apply to “recommendations,” and also to other actions and communications considered investment advice under the Investment Advisers Act of 1940 (“Advisers Act”), and would apply to “natural persons or their representatives who receive personalized investment advice about securities from a broker-dealer or investment adviser,” and who use advice for personal, family or household purposes. The uniform fiduciary standard of conduct would not be dependent on fee structure and would explicitly integrate from §913 of the Dodd-Frank Act the recognition that commissions are permitted as a compensation structure. The uniform fiduciary standard would allow broker-dealers to conduct principal trades without the trade-by-trade informed consent requirements imposed under the Advisers Act. In addition, sales of proprietary products, or of a very limited set of products, would not, in and of themselves, be considered violations of the uniform fiduciary standard of conduct.

Significantly, the Request Release anticipates that the uniform fiduciary standard of conduct would not generally impose continuing duties of care or loyalty to a retail customer after personalized advice is given, absent contractual terms or other circumstances indicating such a continuing duty. Nor would the uniform standard require a broker-dealer or investment adviser to provide services beyond those explicitly agreed to with the client.

A. Duty of Loyalty

The Request Release states that a uniform fiduciary standard of conduct would be designed “to promote advice that is in the best interest of a retail customer by, at a minimum, requiring an investment adviser or a broker-dealer providing personalized investment advice to fulfill its duty of loyalty” by eliminating material conflicts of interest or by providing full and fair disclosure to retail customers about the conflicts of interest. While the SEC posits specific assumptions about a duty of loyalty in the Request Release, it also explicitly states that “the identification of particular assumptions does not suggest [the SEC’s] policy view or the ultimate direction of and proposed action by [the SEC].” The assumptions presume:

    a. Required disclosure of all material conflicts of interest;
    b. The use of a “general relationship guide” similar to Form ADV part 2A, delivered “at the time of entry into a retail customer relationship,” that would include information about the firm’s services, fees, scope of services, scope of products offered (proprietary and/or non-proprietary); and whether the firm would engage in principal transactions; and
    c. Oral or written disclosure, at the time personalized advice is provided, of any new material conflicts of interest or any material change of an existing conflict.

The Request Release does highlight that it assumes the duty of loyalty would mandate disclosure regarding principal trading practices. In addition, the Request Release assumes that investment advisers would remain subject to §§206(3) and 206(4) of the Advisers Act, and broker-dealers would remain subject to applicable laws and guidance, including SRO rules.

The Request Release also assumes that the proposed duty of loyalty would prohibit sales contests that permit receipt or payment of non-cash compensation in connection with provision of “personalized” investment advice about the purchase of securities.

B. Duty of Care

In addition to the proposed duty of loyalty, the Request Release discusses a proposed duty of care as a critical component of the uniform fiduciary standard of conduct. The duty of care would establish minimum professional obligations for broker-dealers and investment advisers, designed to promote personalized investment advice that is in the best interest of a retail customer. The SEC assumes that a duty of care would impose:

    a. Suitability obligations in which there is a duty to have a reasonable basis to believe that securities and investment strategies recommended are suitable for some customers as well as for the specific retail customer to whom the recommendation would be made, in light of financial needs, objectives and circumstances;
    b. Product-specific requirements, such as specific disclosure, due diligence and specific suitability requirements;
    c. A duty of best execution for broker-dealers and also investment advisers responsible for selecting the broker-dealers to execute a client’s trades; and
    d. Fair and reasonable compensation, whether fee-based or commission-based.

C. Continuing Applicability of Certain Fiduciary Standards

The Request Release proposes that the uniform fiduciary standard of conduct would not presume continued applicability of certain existing guidance and principles regarding fiduciary standards currently applicable to investment advisers under Sections 206(1) and 206(2) of the Advisers Act. Rather, the Request Release assumes that:

    a. Regarding allocation of investment opportunities, a fiduciary would be required to disclose to a retail customer how it would allocate “opportunities” among its customers and between customers and proprietary accounts. Examples the SEC references include a disclosure of IPO allocation methods as well as disclosure of how a fiduciary allocates from its principal account for principal transactions.
    b. A fiduciary may aggregate, or bunch, orders of multiple customers, as long as no one customer would be favored over another and the fiduciary discloses whether and under what conditions it aggregates orders. If a firm does not aggregate orders, then the firm would need to explain its practices and the costs to customers of not aggregating.

Although these allocation and bundling issues are familiar in the investment advisory context, historically broker-dealers often have not had written disclosed policies in these areas.

3. Harmonization

The Request Release also asks for data concerning the effect of rule harmonization between the broker-dealer and investment adviser regulatory schemes. The areas on which the Request Release focuses include advertising and communications, finders and solicitors, supervision, licensing and registration, continuing education, and books and records. The Requesting Release does not address the issue of examination oversight of investment advisers by the SEC or a potential SRO, which had been the subject of another controversial SEC Staff Study. The Request Release indicates that the SEC has not yet decided whether to treat the uniform fiduciary standard and regulatory harmonization as linked issues, or whether it should proceed with either project separately (or at all). Readers should note, however, that the proposed uniform standard, if imposed on both broker-dealers and investment advisers could result in new obligations for both.  Therefore, it is unclear whether the proposed uniform fiduciary standard of conduct would reflect congressional intent, or whether Congress actually intended only that harmonization would result in broker-dealers assuming the requirements already in place for investment advisers.

4. Request for Comments

Comments are due on or before July 5, 2013 and will be very important to the SEC’s consideration of any contemplated actions on a uniform fiduciary standard of conduct. The SEC states frequently in the Request Release that it is not wedded to the proposed duties and attendant proposed assumptions, or to the recommendations made previously by its staff in the 2011 Study. Rather, with each proposal in the Request Release, the SEC solicits comments and also proposals for alternative approaches. The Request Release particularly seeks data on the transition of fee-based brokerage accounts to non-discretionary advisory accounts after the court decision in Financial Planning Association v. SEC, 482 F.3d 481 (D.C. Cir. 2007) (“FPA”). The SEC appears to believe this transition is a particularly instructive test case for its cost-benefit analysis. It is also notable that the Request Release focuses primarily on retail accounts, and in particular on non-discretionary advisory accounts, and asks commenters to break out institutional or fully discretionary accounts separately in any data they submit.

In sum, the Request Release commands the attention of investment advisers and broker-dealers that are or would be deemed fiduciaries, as well as retail customers. Even if specific data requested by the SEC in the Request Release is not available, commenters should address the overarching concepts that the SEC is considering. If data is available, we urge commenters to provide the data because, without data, the SEC ultimately may make decisions regarding a uniform fiduciary standard of conduct based on “gut” more than fact. Commenters also may wish to comment on whether the harmonization proposal reflects congressional intent, in enacting Section 913 of the Dodd-Frank Act.

*This alert was co-authored by W. Hardy Callcott and Amy Natterson Kroll.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:


1 Duties of Brokers, Dealers and Investment Advisers, Securities Exchange Act, Release No. 69013 (March 1, 2013) (“Request Release”).
2 Study on Investment Advisers and Broker-Dealers as Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (January 2011).
3 Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).

This article was originally published by Bingham McCutchen LLP.