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The SEC's View on an RIA's Fiduciary Duty

Posted by RIA in a Box

Aug 8, 2018 12:32:56 PM

SEC staff interpretation of RIA fiduciary dutyOn April 18, 2018, the Securities and Exchange Commission ("SEC") released a series of rule proposals highlighted by the new Regulation Best Interest ("Reg BI") and the Form CRS - Relationship Summary, otherwise known as the Form ADV Part 3. While the proposed Reg BI has received the most attention to date from the broker dealer and registered investment adviser ("RIA" communities, what has received less attention is that along with the release of these new rule proposals, the SEC also released its latest views on an RIA's fiduciary duty which "reaffirms, and in some cases clarifies, certain aspects of the fiduciary duty that an investment adviser owes to its clients."

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Pages 6 through 19 of the SEC's "Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers" cover a range of investment adviser fiduciary obligations including:

  • Duty of Care
  • Duty to Provide Advice that is in the Client's Best Interest
  • Duty to Seek Best Execution
  • Duty to Act and to Provide Advice and Monitoring over the Course of the Relationship
  • Duty of Loyalty

As an overarching theme, the SEC staff notes, "Although the ability to tailor the terms means that the application of the fiduciary duty will vary with the terms of the relationship, the relationship in all cases remains that of a fiduciary to a client. In other words, the investment adviser cannot disclose or negotiate away, and the investor cannot waive, the federal fiduciary duty."

Some additional highlights from the SEC staff's latest views include:

Duty of Care

The duty of care includes, among other things: (i) the duty to act and to provide advice that is in the best interest of the client, (ii) 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 (iii) the duty to provide advice and monitoring over the course of the relationship.

Duty to Provide Advice that is in the Client's Best Interest

Accordingly, the fiduciary duty does not necessarily require an adviser to recommend the lowest cost investment product or strategy. We believe that an adviser could not reasonably believe that a recommended security is in the best interest of a client if it is higher cost than a security that is otherwise identical, including any special or unusual features, liquidity, risks and potential benefits, volatility and likely performance. For example, if an adviser advises its clients to invest in a mutual fund share class that is more expensive than other available options when the adviser is receiving compensation that creates a potential conflict and that may reduce the client’s return, the adviser may violate its fiduciary duty and the antifraud provisions of the Advisers Act if it does not, at a minimum, provide full and fair disclosure of the conflict and its impact on the client and obtain informed client consent to the conflict.

Duty to Seek Best Execution

When seeking best execution, an adviser should consider “the full range and quality of a broker’s services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness” to the adviser. In other words, the determinative factor is not the lowest possible commission cost but whether the transaction represents the best qualitative execution. Further, an investment adviser should “periodically and systematically” evaluate the execution it is receiving for clients.

Duty to Act and Provide Advice and Monitoring over the Course of the Relationship

An adviser is required to provide advice and services to a client over the course of the relationship at a frequency that is both in the best interest of the client and consistent with the scope of advisory services agreed upon between the investment adviser and the client. The duty to provide advice and monitoring is particularly important for an adviser that has an ongoing relationship with a client (for example, a relationship where the adviser is compensated with a periodic asset-based fee or an adviser with discretionary authority over client assets).

Duty of Loyalty

An adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure to its clients of all material conflicts of interest that could affect the advisory relationship. Disclosure of a conflict alone is not always sufficient to satisfy the adviser’s duty of loyalty and section 206 of the Advisers Act. Any disclosure must be clear and detailed enough for a client to make a reasonably informed decision to consent to such conflicts and practices or reject them. An adviser must provide the client with sufficiently specific facts so that the client is able to understand the adviser’s conflicts of interest and business practices well enough to make an informed decision. For example, an adviser disclosing that it “may” have a conflict is not adequate disclosure when the conflict actually exists.

We highly recommend that the Chief Compliance Officer ("CCO") and all advisory firm principals carefully review this latest SEC interpretative guidance. This SEC staff's current view on an investment adviser's fiduciary duty is likely to be demonstrated during upcoming examinations and potential enforcement actions. If any current business practices stand in conflict with this latest guidance, firms should look to make immediate changes to ensure that its fiduciary obligations are properly met. Firms may also want to consider how their fiduciary obligations can impact mutual fund share class selection given that mutual fund share class selection remains an RIA regulatory area of focus.

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RIA in a Box LLC is not a law firm, investment advisory firm, or CPA firm. RIA in a Box LLC does not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.

Topics: RIA Compliance, RIA Operations

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