The SEC Defined “Fiduciary Duty,” and a Year Later, Advisers are Still Waiting for Clarity

Update: 

After receiving thousands of comments from financial institutions, industry groups, advisers, investors and others, on June 5, 2019, the SEC voted three to one to adopt Regulation Best Interest and its interpretative guidance on an investment adviser’s “fiduciary duty” under the Adviser’s Act. The adoption of the purposed interpretation as is came as a surprise to many, given the plethora of commentary from the industry. Many thought the SEC would submit additional proposals after assessing the input provided by a variety of sources, especially given the broad effect of the rule and interpretation. However, according to SEC Chairman Jay Clayton, the implementation of the pending Regulation Best Interest rule and the SEC’s interpretation of “fiduciary duty” should have come as no surprise. Per the June 5, 2019 press release, Chairman Clayton stated “[t]he rules and interpretations we are adopting today address issues that the Commission has been actively considering for nearly two decades.” [https://www.sec.gov/news/press-release/2019-89]. In coming to its decision, the SEC also made clear that the feedback it received was “carefully evaluated.”

The final interpretation reaffirms and clarifies certain aspects of an adviser’s fiduciary duty owed to its clients. The SEC’s interpretation of “fiduciary duty” will be effective as soon as it is published in the Federal Register.

In an April 18, 2018 release, the SEC again provided a lengthy definition of an adviser’s fiduciary duty, but this time, seemingly compiled all its resources and prior guidance in one place to “reaffirm” and “clarify” certain aspects of an adviser’s fiduciary duty.

Why is there a need for continual clarification?

There has been some industry confusion between the SEC’s proposed “best interest” rule for broker-dealers (“Regulation Best Interest”)[2] and the SEC’s existing fiduciary duty rule for investment advisers under Section 206 of The Investment Advisers Act of 1940 (“Adviser’s Act”).

Over a year later and after hundreds of individuals, organizations and firms large and small submitted comments to the SEC, the industry is still left waiting for clarity and is concerned about how Regulation Best Interest and the SEC’s more fulsome definition of fiduciary duty will be implemented.

Many of these commenters provided feedback that the terms “best interest” and “fiduciary duty” create “blurred lines” in the industry – after all, are they not the same thing?

The SEC was clear: “[a]n investment adviser’s fiduciary duty is similar to, but not the same as, the proposed obligations of broker-dealers under Regulation Best Interest” [emphasis added].

An adviser’s fiduciary duty is superior.

The term “fiduciary duty” is not defined in the Advisers Act or SEC rules. It is instead, based in “equitable common law principals” – or, basically, the definition is fluid and to be decided by the relevant governing body in each case based on principles of fairness. In any given situation, an adviser’s fiduciary duty is determined by reasonableness under the particular circumstances – including the advisory agreement, the complexity of the investments and the client’s investment profile, among other factors.

What is the SEC’s definition of “fiduciary duty?” Admittedly complicated, acting in the “best interest of clients” is just one part of an adviser’s fiduciary duty.

We have narrowed it down to six main aspects. In order for an adviser to meet its fiduciary duty, it must:

• Act in the best interest and utmost good faith of clients.
• Refrain from personal securities transactions inconsistent with client interests.
• Provide full and fair disclosure of all material facts.
• Provide personalized, suitable investment advice.
• Seek the best execution of a client’s transactions.
• Provide financial advice and monitoring of client accounts in perpetuity.

The SEC’s interpretation of an adviser’s fiduciary duty is perhaps one of its best weapons in its arsenal against advisers in enforcement actions. The definition of “fiduciary duty” is broad and long-standing, yet ever-changing and applicable to almost any action or inaction by an adviser. Thus, it is usually the case that a violation of one section of the Adviser’s Act and the rules promulgated under it is oftentimes a violation of an adviser’s fiduciary duty under Section 206. Further, if there is no rule associated with an adviser’s conduct, the violation is almost always brought under Section 206.

Advisers, do not be confused. Your fiduciary duty has not changed.

[1] SEC v. Capital Gains Research Bureau, Inc. 375 U.S. 180, 194 (1963).

[2] Regulation Best Interest, Exchange Act Release No. 34-83062 (April 18, 2018) (proposed rule requiring all broker-dealers and associated persons to act in the best interest of retail customers when making a recommendation of any securities transaction or investment strategy involving securities to retail customers).