Standards of Conduct for Investment Professionals

April 26, 2018

On April 18, 2018 the Securities Exchange Commission (“SEC”) held a meeting in which they requested comment regarding the “Standards of Conduct for Investment Professionals” proposal that would affect how services are provided to retail customers of Broker-Dealers (“BDs”) and Investment Advisers (“IAs”). The comment period for the proposal is open for 90 days after it is published in the Federal Register.

The proposal consists of three sections:

  1. Adoption of Regulation Best Interest for BDs
  2. Form CRS – Required Customer disclosure document for both BDs and IAs
  3. Interpretation of fiduciary level of care for IAs

Below are some of the highlights of the proposal:

Regulation Best Interest

  • The regulation applies strictly with respect to dealing with retail customers
  • “Best Interest” is not the same as “Fiduciary Duty”
  • Best Interest applies to BDs when making a recommendation of any securities transaction or investment strategy to a retail customer
  • Best Interest does not apply to institutional accounts as they are defined in FINRA rules. Interactions with institutional customers would still be subject to suitability rules.
  • Best Interest is comprised of four components:
    • Disclosure Obligation
      • The requirement that the BD provides a written disclosure statement to retail customers either before or at the time of a recommendation that states the material facts relating to the scope and terms of the customer relationship and any material conflicts of interest that occur as a result of the relationship and/or recommendation;
    • Care Obligation
      • The BD and its associated persons are required to exercise reasonable diligence, care, skill, and prudence to: (1) understand the potential risks and rewards associated with the recommendation, and has a reasonable basis to believe that the recommendation could be in the best interest of at least some retail customers; (2) has a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; and (3) has a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile;
    • Two Conflict of Interest Obligations
      • The BD must establish and maintain written policies and procedures to identify, disclose and mitigate, or eliminate, all material conflicts of interest that arise as a result of any recommendations made to retail customers; and
      • These written policies and procedures must also identify, disclose and mitigate, or eliminate, material conflicts of interest that occur as a result of financial incentives associated with any recommendations made to retail customers.
  • Regulation Best Interest does not apply to advice provided by a dually-registered BD/IA associated person who is acting in the capacity of an investment adviser. It would not apply in this instance even if the customer also has a brokerage account or the transactions are executed through the dually-registered BD/IA.

Form CRS: Customer Relationship Summary

  • Form CRS would require BDs and IAs to provide a brief relationship summary to retail investors at the beginning of a relationship and would be updated due to material changes. The CRS would include the following information:
    • The type of relationship
    • The type of services offered
    • Standard of conduct (i.e., whether acting in a “fiduciary” or “best interests” capacity)
    • Fees and costs associated with the services offered
    • Specified conflicts of interest
    • Whether the firm and its financial professionals currently have reportable legal or disciplinary events.
  • The relationship summary would be subject to SEC filing and recordkeeping requirements
  • Associated persons of BDs would be restricted from using the term “advisor” or “adviser” in their communications with customers under specified circumstances

The SEC has provided examples of Form CRS for the following situations:

  • Stand-alone IA,
  • Stand-alone BD, and
  • Dually-registered BD/IA

Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers

The proposal offers clarification regarding an IA’s fiduciary duty in the following areas:

  • Duty of Care
    • Duty to provide advice that is in the client’s best interest
    • Duty to seek best execution
    • Duty to act and provide advice and monitoring over the course of the relationship
  • Duty of Loyalty

The SEC has also requested comment on three potential enhancements to the legal obligations of IAs by considering areas where the BD requirements provide investors with protections not currently required of IAs:

  • Whether there should be federal licensing and continuing education requirements for SEC-registered IA personnel
  • Requirement that all advisers provide account statements to customers, regardless of whether the adviser has “custody” of the account. Some of the questions to which the SEC elicits comment include:
    • If statements are provided, do they specify the dollar amounts charged for advisory fees, as well as any other fees (e.g., brokerage fees) and expenses, the customer will pay?
    • Would retail clients benefit from a requirement that, before receiving advice from an IA, they enter into an agreement, whether written or electronic, disclosing fees and expenses they will pay?
    • In addition to fees and expenses, is there any other information that would be most useful for retail clients to receive in account statements?
  • Whether IAs should be subject to financial responsibility similar to BDs. Some the questions for comment are:
    • Should IAs be subject to net capital or other financial responsibility requirements so they can meet their financial obligations?
    • Do the Custody Rule and other rules under the Advisers Act adequately address the potential for misappropriation of client assets and other financial responsibility concerns for IAs?
    • Should IAs be subject to an annual audit requirement?
    • Should IAs have a fidelity bond insurance requirement similar to BDs?
    • Should IAs be required to maintain a certain amount of capital that could be the source of compensation for clients?

The comment period will open once the proposal is filed in the Federal Register. ACA encourages clients to review the proposal and submit comments during the 90 day period for any areas of concern or clarification requested by the SEC.

For More Information

For more information, please contact Dee Stafford with questions pertaining to broker-dealers or Lynne Carreiro for questions pertaining to advisers.