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Is SEC About to Undermine Fiduciary Standard?

Samuels Yoelin Kantor LLP

A close analysis of recent SEC documents regarding the fiduciary standard indicates that the definition of that standard may be changing. While in theory a good idea, the proposed changes may have the effect of dramatically undermining investor protections.

This is worth an investor’s attention.

As it stands today, brokers (who are FINRA-licensed to sell investment products) are required to make “suitable” recommended transactions or investment strategies for a customer. This is defined under FINRA Rule 2111, where SEC-licensed Registered Investment Advisors (who advise their clients on a wide range of products) have by law fiduciary duties to their clients – the highest legal standard of care. Under this standard, RIAs have a high bar: they’re required to act in their clients’ best interests, to make full and fair disclosure of all material facts, and to always act with prudence regarding their clients’ investments.

For some time, in response to the Dodd-Frank Act, the SEC has discussed putting forward a uniform fiduciary standard of care applicable to both RIAs and brokers. This was regarded as good news for those who believe in better investor protection. Not only would it help ease customer confusion about what legal responsibilities their investment advisor has towards them, but the hope was to raise the bar for brokers to the fiduciary duties of loyalty and care.

That’s not how it’s shaping up.

On March 1, 2013, the SEC published a Release on this topic meant to request data on the costs and benefits of a uniform fiduciary standard rule, and to define that standard. Close reading of this March 1 Release has revealed a nasty surprise for investors and investor advocates. Yes, there would be a uniform fiduciary standard. But the standard would be changed, and loosened, with some new ambiguities introduced. New rules based on this standard would be one step forward and four steps back.

A good analysis comes from Knut A. Rostad of the non-profit Institute for the Fiduciary Standard. Rostad says in summary, “The SEC Release provides a picture of fiduciary duties that are different in kind from and far more restricted and far less stringent than the fiduciary duties required by the Investment Advisers Act of 1940. In a few short pages, this guidance effectively upends established legal precedent developed over 73 years.”

Take-away points from Rostad’s analysis show that the proposed new uniform standard:

  1. Sharply restricts communications clearly deemed fiduciary advice; creates new uncertainty about what may be fiduciary advice;
  2. Allows fiduciary duties to be waived;
  3. Suggests disclosure is the optimum action for addressing conflicts; omits acknowledging that disclosure and management of conflicts alone is insufficient;
  4. Omits mention or discussion of the most rigorous disclosure requirement that can provide meaningful investor protection; instead weakens disclosure requirements;
  5. Rebrands conflicts; and
  6. Redefines the concept of “loyalty”.

Rostad points out two further bits of interesting information. One, the new definition in the March 1 Release appears to contradict the explicit Dodd Frank requirement that a new uniform fiduciary standard be “no less stringent” than the existing 1940 standard currently governing RIAs. Two, the new definition appears to “closely mirror” recommendations provided to the SEC by the Securities Industry and Financial Markets Association (SIFMA), whose members include securities firms, banks, and asset managers.

The SEC is still in a position to accept comment on this matter. The official public comment period of 120 days is open through the end of June.

The March 1 Release can be found here.

And the analysis of the Institute for the Fiduciary Standard can be found here.

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