Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation, 21203-21214 [2018-08679]

Download as PDF Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS (j) Replacement of the Reinforced Front Attachment Replacement of the reinforced front attachment on the wing side and/or replacement of the reinforced front attachment on the fuselage side, does not terminate the inspections required in paragraphs (h)(1) and (i)(1) of this AD. After replacement, the initial and repetitive inspection cycle starts over. (k) Credit for Previous Actions This AD allows credit for the initial inspection required in paragraphs (g)(1) and (i)(1) of this AD and any replacement that may have been required based on the initial inspection, if done before the effective date of this AD, following Socata Service Bulletin No. SB 10–081–57, Revison 1, dated August 1996 or Revision 2, dated January 2017. Any inspections or replacements done after the effective date must be done following SOCATA Daher Service Bulletin SB 10–081, Revision 3, December 2017 as specified in the Actions and Compliance of this AD. (l) Other FAA AD Provisions The following provisions also apply to this AD: (1) Alternative Methods of Compliance (AMOCs): The Manager, Small Airplane VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 Standards Branch, FAA, has the authority to approve AMOCs for this AD, if requested using the procedures found in 14 CFR 39.19. Send information to ATTN: Albert Mercado, Aerospace Engineer, FAA, Small Airplane Standards Branch, 901 Locust, Room 301, Kansas City, Missouri 64106; telephone: (816) 329–4119; fax: (816) 329–4090; email: albert.mercado@faa.gov. Before using any approved AMOC on any airplane to which the AMOC applies, notify your appropriate principal inspector (PI) in the FAA Flight Standards District Office (FSDO), or lacking a PI, your local FSDO. (2) Contacting the Manufacturer: For any requirement in this AD to obtain corrective actions from a manufacturer, the action must be accomplished using a method approved by the Manager, Small Airplane Standards Branch, FAA; or the European Aviation Safety Agency (EASA). Kansas City, Missouri 64106. For information on the availability of this material at the FAA, call (816) 329–4148. (m) Related Information Refer to MCAI EASA No. 2018–0030, dated January 31, 2018; and Daher Service Bulletin SB 10–081, Revision 3, dated December 2017, for related information. You may examine the MCAI on the internet at https:// www.regulations.gov by searching for and locating Docket No. FAA–2018–0326. For service information related to this AD, contact SOCATA, Direction des services, 65921 Tarbes Cedex 9, France; phone: +33 (0) 5 62 41 73 00; fax: +33 (0) 5 62 41 76 54; email: info@socata.daher.com; internet: https://www.mysocata.com/login/ accueil.php. You may review copies of the referenced service information at the FAA, Policy and Innovation Division, 901 Locust, Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation PO 00000 Frm 00016 Fmt 4702 Sfmt 4702 Issued in Kansas City, Missouri, on April 30, 2018. Melvin J. Johnson, Deputy Director, Policy & Innovation Division, Aircraft Certification Service. [FR Doc. 2018–09602 Filed 5–8–18; 8:45 am] BILLING CODE 4910–13–P SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 275 [Release No. IA–4889; File No. S7–09–18] RIN 3235–AM36 Securities and Exchange Commission. ACTION: Proposed interpretation; request for comment. AGENCY: The Securities and Exchange Commission (the ‘‘SEC’’ or the ‘‘Commission’’) is publishing for comment a proposed interpretation of the standard of conduct for investment SUMMARY: E:\FR\FM\09MYP1.SGM 09MYP1 EP09MY18.023</GPH> (4) Before or upon accumulating 12,000 landings after the reinforcement modification required in paragraph (i)(2) or (3) of this AD, replace the reinforced front attachment on the fuselage side following the Description of Accomplishment Instructions in SOCATA Daher Service Bulletin SB 10–081, Revision 3, December 2017. 21203 21204 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules advisers under the Investment Advisers Act of 1940 (the ‘‘Advisers Act’’ or the ‘‘Act’’). The Commission also is requesting comment on: Licensing and continuing education requirements for personnel of SEC-registered investment advisers; delivery of account statements to clients with investment advisory accounts; and financial responsibility requirements for SEC-registered investment advisers, including fidelity bonds. DATES: Comments should be received on or before August 7, 2018. ADDRESSES: Comments may be submitted by any of the following methods: amozie on DSK3GDR082PROD with PROPOSALS Electronic Comments • Use the Commission’s internet comment form (https://www.sec.gov/ rules/interp.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 09–18 on the subject line. Paper Comments • Send paper comments to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number S7–09–18. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s internet website (https://www.sec.gov/ rules/interp.shtml). Comments also are available for website viewing and printing in the Commission’s Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available. Studies, memoranda or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission’s website. To ensure direct electronic receipt of such notifications, sign up through the ‘‘Stay Connected’’ option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: Jennifer Songer, Senior Counsel, or Sara Cortes, Assistant Director, at (202) 551– VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 6787 or IArules@sec.gov, Investment Adviser Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–8549. SUPPLEMENTARY INFORMATION: The Commission is publishing for comment a proposed interpretation of the standard of conduct for investment advisers under the Advisers Act [15 U.S.C. 80b].1 Table of Contents II. Investment Advisers’ Fiduciary Duty A. Duty of Care i. Duty To Provide Advice That Is in the Client’s Best Interest ii. Duty To Seek Best Execution iii. Duty To Act and To Provide Advice and Monitoring Over the Course of the Relationship B. Duty of Loyalty C. Request for Comment III. Economic Considerations A. Background B. Economic Impacts IV. Request for Comment Regarding Areas of Enhanced Investment Adviser Regulation A. Federal Licensing and Continuing Education B. Provision of Account Statements C. Financial Responsibility I. Introduction An investment adviser is a fiduciary, and as such is held to the highest standard of conduct and must act in the best interest of its client.2 Its fiduciary obligation, which includes an affirmative duty of utmost good faith and full and fair disclosure of all material facts, is established under federal law and is important to the Commission’s investor protection efforts.3 The Commission also regulates broker-dealers, including the obligations that broker-dealers owe to their customers. Investment advisers and 1 15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b of the United States Code, at which the Advisers Act is codified, and when we refer to rules under the Advisers Act, or any paragraph of these rules, we are referring to title 17, part 275 of the Code of Federal Regulations [17 CFR 275], in which these rules are published. 2 SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963) (‘‘SEC v. Capital Gains’’). See also infra notes 26–32 and accompanying text; Investment Adviser Codes of Ethics, Investment Advisers Act Release No. 2256 (July 2, 2004); Compliance Programs of Investment Companies and Investment Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003) (‘‘Compliance Programs Release’’); Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV, Investment Advisers Act Release No. 1862 (Apr. 5, 2000). We acknowledge that investment advisers also have antifraud liability with respect to prospective clients under section 206 of the Advisers Act. 3 See SEC v. Capital Gains, supra note 2. PO 00000 Frm 00017 Fmt 4702 Sfmt 4702 broker-dealers provide advice and services to retail investors and are important to our capital markets and our economy more broadly. Broker-dealers and investment advisers have different types of relationships with their customers and clients and have different models for providing advice, which provide investors with choice about the levels and types of advice they receive and how they pay for the services that they receive. Today, the Commission is proposing a rule that would require all brokerdealers and natural persons who are associated persons of broker-dealers to act in the best interest of retail customers 4 when making a recommendation of any securities transaction or investment strategy involving securities to retail customers (‘‘Regulation Best Interest’’).5 We are also proposing to require registered investment advisers and registered broker-dealers to deliver to retail investors a relationship summary, which would provide these investors with information about the relationships and services the firm offers, the standard of conduct and the fees and costs associated with those services, specified conflicts of interest, and whether the firm and its financial professionals currently have reportable legal or disciplinary events.6 In light of the comprehensive nature of our proposed set of rulemakings, we believe it would be appropriate and beneficial to address in one release 7 and reaffirm—and in some cases clarify— certain aspects of the fiduciary duty that an investment adviser owes to its clients under section 206 of the Advisers Act.8 An investment adviser’s fiduciary duty is similar to, but not the same as, the proposed obligations of broker4 An investment adviser has a fiduciary duty to all of its clients, whether or not the client is a retail investor. 5 Regulation Best Interest, Exchange Act Release No. 34–83062 (April 18, 2018) (‘‘Regulation Best Interest Proposal’’). 6 Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles, Investment Advisers Act Release No. IA–4888 (April 18, 2018) (‘‘Form CRS Proposal’’). 7 This Release is intended to highlight the principles relevant to an adviser’s fiduciary duty. It is not, however, intended to be the exclusive resource for understanding these principles. 8 The Commission recognizes that many advisers provide impersonal investment advice. See, e.g., Advisers Act rule 203A–3 (defining ‘‘impersonal investment advice’’ in the context of defining ‘‘investment adviser representative’’ as ‘‘investment advisory services provided by means of written material or oral statements that do not purport to meet the objectives or needs of specific individuals or accounts’’). This Release does not address the extent to which the Advisers Act applies to different types of impersonal investment advice. E:\FR\FM\09MYP1.SGM 09MYP1 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules dealers under Regulation Best Interest.9 While we are not proposing a uniform standard of conduct for broker-dealers and investment advisers in light of their different relationship types and models for providing advice, we continue to consider whether we can improve protection of investors through potential enhancements to the legal obligations of investment advisers. Below, in addition to our interpretation of advisers’ existing fiduciary obligations, we request comment on three potential enhancements to their legal obligations by considering areas where the current broker-dealer framework provides investor protections that may not have counterparts in the investment adviser context. II. Investment Advisers’ Fiduciary Duty amozie on DSK3GDR082PROD with PROPOSALS The Advisers Act establishes a federal fiduciary standard for investment advisers.10 This fiduciary standard is based on equitable common law principles and is fundamental to advisers’ relationships with their clients under the Advisers Act.11 The fiduciary duty to which advisers are subject is not 9 Regulation Best Interest Proposal, supra note 5. In addition to the obligations proposed in Regulation Best Interest, broker-dealers have a variety of existing specific obligations, including, among others, suitability, best execution, and fair and reasonable compensation. See, e.g., Hanly v. SEC, 415 F.2d 589, 596–97 (2d Cir. 1969) (‘‘A securities dealer occupies a special relationship to a buyer of securities in that by his position he implicitly represents that he has an adequate and reasonable basis for the opinions he renders.’’); and FINRA rules 2111 (Suitability), 5310 (Best Execution and Interpositioning), and 2121 (Fair Prices and Commissions)). 10 Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) (‘‘Transamerica Mortgage v. Lewis’’) (‘‘§ 206 establishes federal fiduciary standards to govern the conduct of investment advisers.’’) (quotation marks omitted); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 471, n.11 (1977) (in discussing SEC v. Capital Gains, stating that the Supreme Court’s reference to fraud in the ‘‘equitable’’ sense of the term was ‘‘premised on its recognition that Congress intended the Investment Advisers Act to establish federal fiduciary standards for investment advisers’’); SEC v. Capital Gains, supra note 2; Amendments to Form ADV, Investment Advisers Act Release No. 3060 (July 28, 2010) (‘‘Investment Advisers Act Release 3060’’) (‘‘Under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,’’ citing Proxy Voting by Investment Advisers, Investment Advisers Act Release No. 2106 (Jan. 31, 2003) (‘‘Investment Advisers Act Release 2106’’)). 11 See SEC v. Capital Gains, supra note 2 (discussing the history of the Advisers Act, and how equitable principles influenced the common law of fraud and changed the suits brought against a fiduciary, ‘‘which Congress recognized the investment adviser to be’’). VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 specifically defined in the Advisers Act or in Commission rules, but reflects a Congressional recognition ‘‘of the delicate fiduciary nature of an investment advisory relationship’’ as well as a Congressional intent to ‘‘eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.’’ 12 An adviser’s fiduciary duty is imposed under the Advisers Act in recognition of the nature of the relationship between an investment adviser and a client and the desire ‘‘so far as is presently practicable to eliminate the abuses’’ that led to the enactment of the Advisers Act.13 It is made enforceable by the antifraud provisions of the Advisers Act.14 An investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. Several commenters responding to Chairman Clayton’s June 2017 request for public input 15 on the standards of SEC v. Capital Gains, supra note 2. SEC v. Capital Gains, supra note 2 (‘‘The Advisers Act thus reflects a congressional recognition ‘of the delicate fiduciary nature of an investment advisory relationship,’ as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.’’ and also noting that the ‘‘declaration of policy’’ in the original bill, which became the Advisers Act, declared that ‘‘the national public interest and the interest of investors are adversely affected when the business of investment advisers is so conducted as to defraud or mislead investors, or to enable such advisers to relieve themselves of their fiduciary obligations to their clients. It [sic] is hereby declared that the policy and purposes of this title, in accordance with which the provisions of this title shall be interpreted, are to mitigate and, so far as is presently practicable to eliminate the abuses enumerated in this section’’ (citing S. 3580, 76th Cong., 3d Sess., § 202 and Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, Pursuant to Section 30 of the Public Utility Holding Company Act of 1935, on Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 28). See also In the Matter of Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (‘‘Arleen Hughes’’) (discussing the relationship of trust and confidence between the client and a dual registrant and stating that the registrant was a fiduciary and subject to liability under the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act). 14 SEC v. Capital Gains, supra note 2; Transamerica Mortgage v. Lewis, supra note 10 (‘‘[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.’’). 15 Public Comments from Retail Investors and Other Interested Parties on Standards of Conduct for Investment Advisers and Broker-Dealers, 21205 conduct for investment advisers and broker-dealers acknowledged these duties.16 This fiduciary duty requires an adviser ‘‘to adopt the principal’s goals, objectives, or ends.’’ 17 This means the adviser must, at all times, serve the best interest of its clients and not subordinate its clients’ interest to its own.18 The federal fiduciary duty is imposed through the antifraud provisions of the Advisers Act.19 The duty follows the contours of the relationship between the adviser and its client, and the adviser and its client may shape that relationship through contract when the client receives full and fair disclosure and provides informed consent.20 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 12 See 13 See PO 00000 Frm 00018 Fmt 4702 Sfmt 4702 Chairman Jay Clayton (June 1, 2017), available at https://www.sec.gov/news/public-statement/ statement-chairman-clayton-2017-05-31 (‘‘Chairman Clayton’s Request for Public Input’’). 16 See, e.g., Comment letter of the Investment Adviser Association (Aug. 31, 2017) (‘‘IAA Letter’’) (‘‘The well-established fiduciary duty under the Advisers Act, which incorporates both a duty of loyalty and a duty of care, has been applied consistently over the years by courts and the SEC.’’); Comment letter of the Consumer Federation of America (Sept. 14, 2017) (‘‘an adviser’s fiduciary obligation ‘divides neatly into the duty of loyalty and the duty of care.’ The duty of loyalty is designed to protect against ‘malfeasance,’ or wrongdoing, on the part of the adviser, while the duty of care is designed to protect against ‘nonfeasance,’ such as neglect.’’). 17 Arthur B. Laby, The Fiduciary Obligations as the Adoption of Ends, 56 Buffalo Law Review 99 (2008). See also Restatement (Third) of Agency, § 2.02 Scope of Actual Authority (2006) (describing a fiduciary’s authority in terms of the fiduciary’s reasonable understanding of the principal’s manifestations and objectives). 18 Investment Advisers Act Release 3060, supra footnote 10 (adopting amendments to Form ADV and stating that ‘‘under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,’’ citing Investment Advisers Act Release 2106 supra note 10); SEC v. Tambone, 550 F.3d 106, 146 (1st Cir. 2008) (‘‘Section 206 imposes a fiduciary duty on investment advisers to act at all times in the best interest of the fund and its investors.’’); SEC v. Moran, 944 F. Supp. 286 (S.D.N.Y 1996) (‘‘Investment advisers are entrusted with the responsibility and duty to act in the best interest of their clients.’’). 19 See supra note 14. 20 See infra note 40 and accompanying text for a discussion of informed consent. E:\FR\FM\09MYP1.SGM 09MYP1 21206 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS duty.21 We discuss our views 22 on an investment adviser’s fiduciary duty in more detail below.23 21 As an adviser’s federal fiduciary obligations are enforceable through section 206 of the Act, we would view a waiver of enforcement of section 206 as implicating section 215(a) of the Act, which provides that ‘‘any condition, stipulation or provision binding any person to waive compliance with any provision of this title . . . shall be void.’’ Some commenters on Chairman Clayton’s Request for Public Input and other Commission requests for comment also stated that an adviser’s fiduciary duty could not be disclosed away. See, e.g., IAA Letter supra note 16 (‘‘While disclosure of conflicts is crucial, it cannot take the place of the overarching duty of loyalty. In other words, an adviser is still first and foremost bound by its duty to act in its client’s best interest and disclosure does not relieve an adviser of this duty.’’); Comment letter of AARP (Sept. 6, 2017) (‘‘Disclosure and consent alone do not meet the fiduciary test.’’); Financial Planning Coalition Letter (July 5, 2013) responding to SEC Request for Data and Other Information, Duties of Brokers, Dealers, and Investment Advisers, Exchange Act Release No. 69013 (Mar. 1, 2013) (‘‘Financial Planning Coalition 2013 Letter’’) (‘‘[D]isclosure alone is not sufficient to discharge an investment adviser’s fiduciary duty; rather, the key issue is whether the transaction is in the best interest of the client.’’) (internal citations omitted). See also Restatement (Third) of Agency, § 8.06 Principal’s Consent (2006) (‘‘The law applicable to relationships of agency as defined in § 1.01 imposes mandatory limits on the circumstances under which an agent may be empowered to take disloyal action. These limits serve protective and cautionary purposes. Thus, an agreement that contains general or broad language purporting to release an agent in advance from the agent’s general fiduciary obligation to the principal is not likely to be enforceable. This is because a broadly sweeping release of an agent’s fiduciary duty may not reflect an adequately informed judgment on the part of the principal; if effective, the release would expose the principal to the risk that the agent will exploit the agent’s position in ways not foreseeable by the principal at the time the principal agreed to the release. In contrast, when a principal consents to specific transactions or to specified types of conduct by the agent, the principal has a focused opportunity to assess risks that are more readily identifiable.’’); Tamar Frankel, Arthur Laby & Ann Schwing, The Regulation of Money Managers, (updated 2017) (‘‘The Regulation of Money Managers’’) (‘‘Disclosure may, but will not always, cure the fraud, since a fiduciary owes a duty to deal fairly with clients.’’). 22 In various circumstances, other regulators, including the U.S. Department of Labor, and other legal regimes, including state securities law, impose obligations on investment advisers. In some cases, these standards may differ from the standard imposed and enforced by the Commission. 23 The interpretations discussed in this Release also apply to automated advisers, which are often colloquially referred to as ‘‘robo-advisers.’’ Roboadvisers, like all SEC-registered investment advisers, are subject to all of the requirements of the Advisers Act, including the requirement that they provide advice consistent with the fiduciary duty they owe to their clients. The staff of the Commission has issued guidance regarding how robo-advisers can meet their obligations under the Advisers Act, given the unique challenges and opportunities presented by their business models. See Division of Investment Management, SEC, Staff Guidance on Robo Advisers, (February 2017), available at https://www.sec.gov/investment/imguidance-2017-02.pdf. VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 A. Duty of Care As fiduciaries, investment advisers owe their clients a duty of care.24 The Commission has discussed the duty of care and its components in a number of contexts.25 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. i. Duty To Provide Advice That Is in the Client’s Best Interest We have addressed an adviser’s duty of care in the context of the provision of personalized investment advice. In this context, the duty of care includes a duty to make a reasonable inquiry into a client’s financial situation, level of financial sophistication, investment experience, and investment objectives (which we refer to collectively as the client’s ‘‘investment profile’’) and a duty to provide personalized advice that is suitable for and in the best interest of the client based on the client’s investment profile.26 24 See Investment Advisers Act Release No. 2106, supra note 10 (stating that under the Advisers Act, ‘‘an adviser is a fiduciary that owes each of its clients duties of care and loyalty with respect to all services undertaken on the client’s behalf, including proxy voting,’’ which is the subject of the release, and citing SEC v. Capital Gains supra note 2, to support this point). See also Restatement (Third) of Agency, § 8.08 (discussing the duty of care that an agent owes its principal as a matter of common law); The Regulation of Money Managers, supra note 21 (‘‘Advice can be divided into three stages. The first determines the needs of the particular client. The second determines the portfolio strategy that would lead to meeting the client’s needs. The third relates to the choice of securities that the portfolio would contain. The duty of care relates to each of the stages and depends on the depth or extent of the advisers’ obligation towards their clients.’’). 25 See, e.g., Suitability of Investment Advice Provided by Investment Advisers; Custodial Account Statements for Certain Advisory Clients, Investment Advisers Act Release No. 1406 (Mar. 16, 1994) (‘‘Investment Advisers Act Release 1406’’) (stating that advisers have a duty of care and discussing advisers’ suitability obligations); Securities; Brokerage and Research Services, Exchange Act Release No. 23170 (Apr. 23, 1986) (‘‘Exchange Act Release 23170’’) (‘‘an adviser, as a fiduciary, owes its clients a duty of obtaining the best execution on securities transactions.’’). We highlight certain contexts in which the Commission has addressed the duty of care but we note that there are others; for example, voting proxies when an adviser undertakes to do so. Investment Advisers Act Release 2106, supra note 10. 26 In 1994, the Commission proposed a rule that would make express the fiduciary obligation of investment advisers to make only suitable recommendations to a client. Investment Advisers Act Release 1406, supra note 25. Although never adopted, the rule was designed, among other things, to reflect the Commission’s interpretation of an PO 00000 Frm 00019 Fmt 4702 Sfmt 4702 An adviser must, before providing any personalized investment advice and as appropriate thereafter, make a reasonable inquiry into the client’s investment profile. The nature and extent of the inquiry turn on what is reasonable under the circumstances, including the nature and extent of the agreed-upon advisory services, the nature and complexity of the anticipated investment advice, and the investment profile of the client. For example, to formulate a comprehensive financial plan for a client, an adviser might obtain a range of personal and financial information about the client, including current income, investments, assets and debts, marital status, insurance policies, and financial goals.27 An adviser must update a client’s investment profile in order to adjust its advice to reflect any changed circumstances.28 The frequency with which the adviser must update the information in order to consider changes to any advice the adviser provides would turn on many factors, including whether the adviser is aware of events that have occurred that could render inaccurate or incomplete the investment profile on which it currently bases its advice. For example, a change in the relevant tax law or knowledge that the client has retired or experienced a change in marital status might trigger an obligation to make a new inquiry. An investment adviser must also have a reasonable belief that the personalized advice is suitable for and in the best interest of the client based on the client’s investment profile. A reasonable belief would involve considering, for example, whether investments are recommended only to those clients who can and are willing to tolerate the risks of those investments and for whom the potential benefits may justify the risks.29 adviser’s existing suitability obligation under the Advisers Act. We believe that this obligation, when combined with an adviser’s fiduciary duty to act in the best interest of its client, requires an adviser to provide investment advice that is suitable for and in the best interest of its client. 27 Investment Advisers Act Release 1406, supra note 25. After making a reasonable inquiry into the client’s investment profile, it generally would be reasonable for an adviser to rely on information provided by the client (or the client’s agent) regarding the client’s financial circumstances, and an adviser should not be held to have given advice not in its client’s best interest if it is later shown that the client had misled the adviser. 28 We note that this would not be done for a onetime financial plan or other investment advice that is not provided on an ongoing basis. See also infra note 37. 29 We note that Item 8 of Part 2A of Form ADV requires an investment adviser to describe its methods of analysis and investment strategies and disclose that investing in securities involves risk of loss which clients should be prepared to bear. This E:\FR\FM\09MYP1.SGM 09MYP1 amozie on DSK3GDR082PROD with PROPOSALS Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules Whether the advice is in a client’s best interest must be evaluated in the context of the portfolio that the adviser manages for the client and the client’s investment profile. For example, when an adviser is advising a client with a conservative investment objective, investing in certain derivatives may be in the client’s best interest when they are used to hedge interest rate risk in the client’s portfolio, whereas investing in certain directionally speculative derivatives on their own may not. For that same client, investing in a particular security on margin may not be in the client’s best interest, even if investing in that same security may be in the client’s best interest. When advising a financially sophisticated investor with a high risk tolerance, however, it may be consistent with the adviser’s duties to recommend investing in such directionally speculative derivatives or investing in securities on margin. The cost (including fees and compensation) associated with investment advice would generally be one of many important factors—such as the investment product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions—to consider when determining whether a security or investment strategy involving a security or securities is in the best interest of the client. 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 item also requires that an adviser explain the material risks involved for each significant investment strategy or method of analysis it uses and particular type of security it recommends, with more detail if those risks are significant or unusual. VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 consent to the conflict.30 Furthermore, an adviser would not satisfy its fiduciary duty to provide advice that is in the client’s best interest by simply advising its client to invest in the least expensive or least remunerative investment product or strategy without any further analysis of other factors in the context of the portfolio that the adviser manages for the client and the client’s investment profile. For example, it might be consistent with an adviser’s fiduciary duty to advise a client with a high risk tolerance and significant investment experience to invest in a private equity fund with relatively high fees if other factors about the fund, such as its diversification and potential performance benefits, cause it to be in the client’s best interest. We believe that a reasonable belief that investment advice is in the best interest of a client also requires that an adviser conduct a reasonable investigation into the investment sufficient to not base its advice on materially inaccurate or incomplete information.31 We have brought enforcement actions where an investment adviser did not independently or reasonably investigate securities before recommending them to clients.32 This obligation to provide advice that is suitable and in the best interest applies not just to potential investments, but to all advice the investment adviser provides to clients, including advice about an investment strategy or engaging a sub-adviser and advice about whether to rollover a retirement account so that the investment adviser manages that account. ii. Duty To Seek Best Execution We have addressed an investment adviser’s duty of care in the context of trade execution where the adviser has the responsibility to select brokerdealers to execute client trades (typically in the case of discretionary accounts). We have said that, in this context, an adviser has the duty to seek best execution of a client’s 30 See infra notes 48–52 and accompanying text (discussing an adviser’s duties related to disclosure and consent). 31 See, e.g., Concept Release on the U.S. Proxy System, Investment Advisers Act Release No. 3052 (July 14, 2010) (stating ‘‘as a fiduciary, the proxy advisory firm has a duty of care requiring it to make a reasonable investigation to determine that it is not basing its recommendations on materially inaccurate or incomplete information’’). 32 See In the Matter of Larry C. Grossman, Investment Advisers Act Release No. 4543 (Sept. 30, 2016) (Commission opinion) (imposing liability on a principal of a registered investment adviser for recommending offshore private investment funds to clients without a reasonable independent basis for his advice). PO 00000 Frm 00020 Fmt 4702 Sfmt 4702 21207 transactions.33 In meeting this obligation, an adviser must seek to obtain the execution of transactions for each of its clients such that the client’s total cost or proceeds in each transaction are the most favorable under the circumstances. An adviser fulfills this duty by executing securities transactions on behalf of a client with the goal of maximizing value for the client under the particular circumstances occurring at the time of the transaction. As noted below, maximizing value can encompass more than just minimizing cost. 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.34 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.35 iii. Duty To Act and To Provide Advice and Monitoring Over the Course of the Relationship An investment adviser’s duty of care also encompasses the duty to provide advice and monitoring over the course of a relationship with a client.36 An 33 See Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 54165 (July 18, 2006) (stating that investment advisers have ‘‘best execution obligations’’); Investment Advisers Act Release 3060, supra note 10 (discussing an adviser’s best execution obligations in the context of directed brokerage arrangements and disclosure of soft dollar practices). See also Advisers Act rule 206(3)–2(c) (referring to adviser’s duty of best execution of client transactions). 34 Exchange Act Release 23170, supra note 25. 35 Id. The Advisers Act does not prohibit advisers from using an affiliated broker to execute client trades. However, the adviser’s use of such an affiliate involves a conflict of interest that must be fully and fairly disclosed and the client must provide informed consent to the conflict. 36 See SEC v. Capital Gains, supra note 2 (describing advisers’ ‘‘basic function’’ as ‘‘furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments’’ (quoting Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, Pursuant to Section 30 of the Public Utility Holding Company Act of 1935, on Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 28)). Cf. Barbara Black, Brokers and AdvisersWhat’s in a Name?, 32 Fordham Journal of Corporate and Financial Law XI (2005) (‘‘[W]here E:\FR\FM\09MYP1.SGM Continued 09MYP1 21208 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules 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). Conversely, the steps needed to fulfill this duty may be relatively circumscribed for the adviser and client that have agreed to a relationship of limited duration via contract (for example, a financial planning relationship where the adviser is compensated with a fixed, one-time fee commensurate with the discrete, limited-duration nature of the advice provided).37 An adviser’s duty to monitor extends to all personalized advice it provides the client, including an evaluation of whether a client’s account or program type (for example, a wrap account) continues to be in the client’s best interest. amozie on DSK3GDR082PROD with PROPOSALS B. Duty of Loyalty The duty of loyalty requires an investment adviser to put its client’s interests first. An investment adviser must not favor its own interests over those of a client or unfairly favor one client over another.38 In seeking to meet its duty of loyalty, an adviser must make the investment adviser’s duties include management of the account, [the adviser] is under an obligation to monitor the performance of the account and to make appropriate changes in the portfolio.’’); Arthur B. Laby, Fiduciary Obligations of Broker-Dealers and Investment Advisers, 55 Villanova Law Review 701, at 728 (2010) (‘‘Laby Villanova Article’’) (‘‘If an adviser has agreed to provide continuous supervisory services, the scope of the adviser’s fiduciary duty entails a continuous, ongoing duty to supervise the client’s account, regardless of whether any trading occurs. This feature of the adviser’s duty, even in a nondiscretionary account, contrasts sharply with the duty of a broker administering a non-discretionary account, where no duty to monitor is required.’’) (internal citations omitted). 37 See Laby Villanova Article, supra note 36, at 728 (2010) (stating that the scope of an adviser’s activity can be altered by contract and that an adviser’s fiduciary duty would be commensurate with the scope of the relationship). 38 See Investment Advisers Act Release 3060 (‘‘Under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,’’ citing Investment Advisers Act Release 2106 supra note 9). See also Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011), available at https://www.sec.gov/news/studies/2011/ 913studyfinal.pdf (‘‘913 Study’’). VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 full and fair disclosure to its clients of all material facts relating to the advisory relationship.39 In addition, an adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure of all material conflicts of interest that could affect the advisory relationship. The disclosure should be sufficiently specific so that a client is able to decide whether to provide informed consent to the conflict of interest.40 We discuss each of these aspects of the duty of loyalty below. Because an adviser must serve the best interests of its clients, it has an obligation not to subordinate its clients’ interests to its own. For example, an adviser cannot favor its own interests over those of a client, whether by favoring its own accounts or by favoring certain client accounts that pay higher fee rates to the adviser over other client 39 Investment Advisers Act Release 3060, supra note 6 (‘‘as a fiduciary, an adviser has an ongoing obligation to inform its clients of any material information that could affect the advisory relationship’’). See also General Instruction 3 to Part 2 of Form ADV (‘‘Under federal and state law, you are a fiduciary and must make full disclosure to your clients of all material facts relating to the advisory relationship.’’). 40 Arleen Hughes, supra note 13, at 4 and 8 (stating, ‘‘[s]ince loyalty to his trust is the first duty which a fiduciary owes to his principal, it is the general rule that a fiduciary must not put himself into a position where his own interests may come in conflict with those of his principal. To prevent any conflict and the possible subordination of this duty to act solely for the benefit of his principal, a fiduciary at common law is forbidden to deal as an adverse party with his principal. An exception is made, however, where the principal gives his informed consent to such dealings,’’ and adding that, ‘‘[r]egistrant has an affirmative obligation to disclose all material facts to her clients in a manner which is clear enough so that a client is fully apprised of the facts and is in a position to give his informed consent.’’). See also Hughes v. Securities and Exchange Commission, 174 F.2d 969 (1949) (affirming the SEC decision in Arleen Hughes). See also General Instruction 3 to Part 2 of Form ADV (stating that an adviser’s disclosure obligation ‘‘requires that [the adviser] provide the client with sufficiently specific facts so that the client is able to understand the conflicts of interest [the adviser has] and the business practices in which [the adviser] engage[s], and can give informed consent to such conflicts or practices or reject them’’); Investment Advisers Act Release 3060, supra note 10 (same); Restatement (Third) of Agency § 8.06 (‘‘Conduct by an agent that would otherwise constitute a breach of duty as stated in §§ 8.01, 8.02, 8.03, 8.04, and 8.05 [referencing the fiduciary duty] does not constitute a breach of duty if the principal consents to the conduct, provided that (a) in obtaining the principal’s consent, the agent (i) acts in good faith, (ii) discloses all material facts that the agent knows, has reason to know, or should know would reasonably affect the principal’s judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know them, and (iii) otherwise deals fairly with the principal; and (b) the principal’s consent concerns either a specific act or transaction, or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship’’). PO 00000 Frm 00021 Fmt 4702 Sfmt 4702 accounts.41 Accordingly, the duty of loyalty includes a duty not to treat some clients favorably at the expense of other clients. Thus, we believe that in allocating investment opportunities among eligible clients, an adviser must treat all clients fairly.42 This does not mean that an adviser must have a pro rata allocation policy, that the adviser’s allocation policies cannot reflect the differences in clients’ objectives or investment profiles, or that the adviser cannot exercise judgment in allocating investment opportunities among eligible clients. Rather, it means that an adviser’s allocation policies must be fair and, if they present a conflict, the adviser must fully and fairly disclose the conflict such that a client can provide informed consent. 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.43 Disclosure of a conflict alone is not always sufficient to satisfy the adviser’s duty of loyalty and section 206 of the Advisers Act.44 Any 41 The Commission has brought numerous enforcement actions against advisers that unfairly allocated trades to their own accounts and allocated less favorable or unprofitable trades to their clients’ accounts. See, e.g., SEC v. Strategic Capital Management, LLC and Michael J. Breton, Litigation Release No. 23867 (June 23, 2017) (partial settlement) (adviser placed trades through a master brokerage account and then allocated profitable trades to adviser’s account while placing unprofitable trades into the client accounts.). 42 See also Barry Barbash and Jai Massari, The Investment Advisers Act of 1940; Regulation by Accretion, 39 Rutgers Law Journal 627 (2008) (stating that under section 206 of the Advisers Act and traditional notions of fiduciary and agency law an adviser must not give preferential treatment to some clients or systematically exclude eligible clients from participating in specific opportunities without providing the clients with appropriate disclosure regarding the treatment). 43 See SEC v. Capital Gains, supra note 2 (advisers must fully disclose all material conflicts, citing Congressional intent ‘‘to eliminate, or at least expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested’’). See also Investment Advisers Act Release 3060, supra note 9. 44 See SEC v. Capital Gains, supra note 2 (in discussing the legislative history of the Advisers Act, citing ethical standards of one of the leading investment counsel associations, which provided that an investment counsel should remain ‘‘as free as humanly possible from the subtle influence of prejudice, conscious or unconscious’’ and ‘‘avoid any affiliation, or any act which subjects his position to challenge in this respect’’ and stating that one of the policy purposes of the Advisers Act is ‘‘to mitigate and, so far as is presently practicable to eliminate the abuses’’ that formed the basis of the Advisers Act). Separate and apart from potential liability under the antifraud provisions of the Advisers Act enforceable by the Commission for breaches of fiduciary duty in the absence of full and fair disclosure, investment advisers may also wish to consider their potential liability to clients under E:\FR\FM\09MYP1.SGM 09MYP1 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS 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.45 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.46 For example, an adviser disclosing that it ‘‘may’’ have a conflict is not adequate disclosure when the conflict actually exists.47 A client’s informed consent can be either explicit or, depending on the facts and circumstances, implicit. We believe, however, that it would not be consistent with an adviser’s fiduciary duty to infer or accept client consent to a conflict where either (i) the facts and circumstances indicate that the client did not understand the nature and import of the conflict, or (ii) the material facts concerning the conflict could not be fully and fairly disclosed.48 For state common law, which may vary from state to state. 45 See Arlene Hughes, supra at 13 (in finding that registrant had not obtained informed consent, citing to testimony indicating that ‘‘some clients had no understanding at all of the nature and significance’’ of the disclosure). 46 See General Instruction 3 to Part 2 of Form ADV. Cf. Arleen Hughes, supra note 13 (Hughes acted simultaneously in the dual capacity of investment adviser and of broker and dealer and conceded having a fiduciary duty. In describing the fiduciary duty and her potential liability under the antifraud provisions of the Securities Act and the Exchange Act, the Commission stated she had ‘‘an affirmative obligation to disclose all material facts to her clients in a manner which is clear enough so that a client is fully apprised of the facts and is in a position to give his informed consent.’’). 47 We have brought enforcement actions in such cases. See, e.g., In the Matter of The Robare Group, Ltd., et al., Investment Advisers Act Release No. 4566 (Nov. 7, 2016) (Commission Opinion) (appeal docketed) (finding, among other things, that adviser’s disclosure was inadequate because it stated that the adviser may receive compensation from a broker as a result of the facilitation of transactions on client’s behalf through such brokerdealer and that these arrangements may create a conflict of interest when adviser was, in fact, receiving payments from the broker and had such a conflict of interest). 48 See Arleen Hughes, supra note 13 (‘‘Registrant cannot satisfy this duty by executing an agreement with her clients which the record shows some clients do not understand and which, in any event, does not contain the essential facts which she must communicate.’’) Some commenters on Commission requests for comment agreed that full and fair disclosure and informed consent are important components of an adviser’s fiduciary duty. See, e.g., Financial Planning Coalition 2013 Letter, supra note 21 (‘‘[C]onsent is only informed if the customer has the ability fully to understand and to evaluate the information. Many complex products . . . are appropriate only for sophisticated and experienced investors. It is not sufficient for a fiduciary to make disclosure of potential conflicts of interest with respect to such products. The fiduciary must make a reasonable judgment that the customer is fully able to understand and to evaluate the product and the potential conflicts of interest that it presents— and then the fiduciary must make a judgment that VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 example, in some cases, conflicts may be of a nature and extent that it would be difficult to provide disclosure that adequately conveys the material facts or the nature, magnitude and potential effect of the conflict necessary to obtain informed consent and satisfy an adviser’s fiduciary duty. In other cases, disclosure may not be specific enough for clients to understand whether and how the conflict will affect the advice they receive. With some complex or extensive conflicts, it may be difficult to provide disclosure that is sufficiently specific, but also understandable, to the adviser’s clients. In all of these cases where full and fair disclosure and informed consent is insufficient, we expect an adviser to eliminate the conflict or adequately mitigate the conflict so that it can be more readily disclosed. Full and fair disclosure of all material facts that could affect an advisory relationship, including all material conflicts of interest between the adviser and the client, can help clients and prospective clients in evaluating and selecting investment advisers. Accordingly, we require advisers to deliver to their clients a ‘‘brochure,’’ under Part 2A of Form ADV, which sets out minimum disclosure requirements, including disclosure of certain conflicts.49 Investment advisers are required to deliver the brochure to a prospective client at or before entering into a contract so that the prospective client can use the information contained in the brochure to decide whether or not to enter into the advisory relationship.50 In a concurrent release, we are proposing to require all investment advisers to deliver to retail investors the product is in the best interests of the customer.’’). 49 Investment Advisers Act Release 3060, supra note 10; General Instruction 3 to Part 2 of Form ADV (‘‘Under federal and state law, you are a fiduciary and must make full disclosure to your clients of all material facts relating to the advisory relationship. As a fiduciary, you also must seek to avoid conflicts of interest with your clients, and, at a minimum, make full disclosure of all material conflicts of interest between you and your clients that could affect the advisory relationship. This obligation requires that you provide the client with sufficiently specific facts so that the client is able to understand the conflicts of interest you have and the business practices in which you engage, and can give informed consent to such conflicts or practices or reject them.’’). 50 Investment Advisers Act rule 204–3. Investment Advisers Act Release 3060, supra note 10 (adopting amendments to Form ADV and stating that ‘‘A client may use this disclosure to select his or her own adviser and evaluate the adviser’s business practices and conflicts on an ongoing basis. As a result, the disclosure clients and prospective clients receive is critical to their ability to make an informed decision about whether to engage an adviser and, having engaged the adviser, to manage that relationship.’’). PO 00000 Frm 00022 Fmt 4702 Sfmt 4702 21209 before or at the time the adviser enters into an investment advisory agreement a relationship summary which would include a summary of certain conflicts of interest.51 C. Request for Comment The Commission requests comment on our proposed interpretation regarding certain aspects of the fiduciary duty under section 206 of the Advisers Act. • Does the Commission’s proposed interpretation offer sufficient guidance with respect to the fiduciary duty under section 206 of the Advisers Act? • Are there any significant issues related to an adviser’s fiduciary duty that the proposed interpretation has not addressed? • Would it be beneficial for investors, advisers or broker-dealers for the Commission to codify any portion of our proposed interpretation of the fiduciary duty under section 206 of the Advisers Act? III. Economic Considerations The Commission is sensitive to the potential economic effects of the proposed interpretation provided above.52 In this section we discuss how the proposed Commission interpretation may benefit investors and reduce agency problems by reaffirming and clarifying the fiduciary duty an investment adviser owes to its clients. We also discuss some potential broader economic effects on the market for investment advice. A. Background The Commission’s interpretation of the standard of conduct for investment advisers under the Advisers Act set forth in this Release would affect investment advisers and their associated persons as well as the clients of those investment advisers, and the market for financial advice more broadly.53 There are 12,659 investment advisers registered with the Commission with over $72 trillion in assets under management as well as 17,635 investment advisers registered with states and 3,587 investment advisers who submit Form ADV as exempt reporting advisers.54 As of December 51 Form CRS Proposal, supra note 6. Commission, where possible, has sought to quantify the economic impacts expected to result from the proposed interpretations. However, as discussed more specifically below, the Commission is unable to quantify certain of the economic effects because it lacks information necessary to provide reasonable estimates. 53 See Form CRS Proposal, supra note 6, at Section IV.A (discussing the market for financial advice generally). 54 See Form CRS Proposal, supra note 6, at Section IV.A.1.b (discussing SEC-registered 52 The E:\FR\FM\09MYP1.SGM Continued 09MYP1 21210 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules 2017, there are approximately 36 million client accounts advised by SECregistered investment advisers. These investment advisers currently incur ongoing costs related to their compliance with their legal and regulatory obligations, including costs related to their understanding of the standard of conduct. We believe, based on the Commission’s experience, that the interpretations we are setting forth in this Release are generally consistent with investment advisers’ current understanding of the practices necessary to comply with their fiduciary duty under the Advisers Act; however, we recognize that there may be certain current investment advisers who have interpreted their fiduciary duty to require something less, or something more, than the Commission’s interpretation. We lack data to identify which investment advisers currently understand the practices necessary to comply with their fiduciary duty to be different from the standard of conduct in the Commission’s interpretation. Based on our experience, however, we generally believe that it is not a significant portion of the market. B. Economic Impacts Based on our experience as the longstanding regulator of the investment adviser industry, the Commission’s interpretation of the fiduciary duty under section 206 of the Advisers Act described in this Release generally reaffirms the current practices of investment advisers. Therefore, we expect there to be no significant economic impacts from the interpretation. We do acknowledge, however, to the extent certain investment advisers currently understand the practices necessary to comply with their fiduciary duty to be different from those discussed in this interpretation, there could be some potential economic effects, which we discuss below. amozie on DSK3GDR082PROD with PROPOSALS Clients of Investment Advisers The typical relationship between an investment adviser and a client is a principal-agent relationship, where the principal (the client) hires an agent (the investment adviser) to perform some service (investment advisory services) on the client’s behalf.55 Because investment advisers). Note, however, that because we are interpreting advisers’ fiduciary duties under section 206 of the Advisers Act, this interpretation would be applicable to both SEC- and stateregistered investment advisers, as well as other investment advisers that are exempt from registration or subject to a prohibition on registration under the Advisers Act. 55 See, e.g., James A. Brickley, Clifford W. Smith, Jr., Jerold L. Zimmerman, Managerial Economics VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 investors and investment advisers are likely to have different preferences and goals, the investment adviser relationship is subject to agency problems: That is, investment advisers may take actions that increase their well-being at the expense of investors, thereby imposing agency costs on investors.56 A fiduciary duty, such as the duty investment advisers owe their clients, can mitigate these agency problems and reduce agency costs by deterring agents from taking actions that expose them to legal liability.57 To the extent the Commission’s interpretation of investment adviser fiduciary duty would cause a change in behavior of those investment advisers, if any, who currently interpret their fiduciary duty to require something different from the Commission’s interpretation, we expect a potential reduction in agency problems and, consequently, a reduction of agency costs to the client. The extent to which agency costs would be reduced is difficult to assess given that we are unable to ascertain whether any investment advisers currently interpret their fiduciary duty to be something different from the Commission’s interpretation, and consequently we are not able to estimate the agency costs these advisers, if any, currently impose on investors. However, we believe that there may be potential benefits for clients of those investment advisers, if any, to the extent the Commission’s interpretation is effective at strengthening investment advisers’ understanding of their obligations to their clients. For example, to the extent that the Commission’s interpretation enhances the understanding of any investment advisers of their duty of care, it may potentially raise the quality of investment advice given and that advice’s fit with a client’s individual profile and preferences or lead to increased compliance with the duty to provide advice and monitoring over the course of the relationship. Additionally, to the extent the Commission’s interpretation enhances the understanding of any investment and Organizational Architecture (2004), at 265 (‘‘An agency relationship consists of an agreement under which one party, the principal, engages another party, the agent, to perform some service on the principal’s behalf.’’). See also Michael C. Jensen and William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, Journal of Financial Economics, Vol. 3, 305–360 (1976). 56 See, e.g., Jensen and Meckling, supra note 55. See also the discussion on agency problems in the market for investment advice in Section IV.B. of the Regulation Best Interest Proposal, supra note 5. 57 See, e.g., Frank H. Easterbrook and Daniel R. Fischel, Contract and Fiduciary Duty, Journal of Law & Economics, Vol. 36, 425–46 (1993). PO 00000 Frm 00023 Fmt 4702 Sfmt 4702 advisers of their duty of loyalty it may potentially benefit the clients of those investment advisers. Specifically, to the extent this leads to a higher quality of disclosures about conflicts for clients of some investment advisers, the nature and extent of such conflict disclosures would help investors better assess the quality of the investment advice they receive, therefore providing an important benefit to investors. Further, to the extent that the interpretation causes some investment advisers to properly identify circumstances in which disclosure alone cannot cure a conflict of interest, the proposed interpretation may lead those investment advisers to take additional steps to mitigate or eliminate the conflict. The interpretation may also cause some investment advisers to conclude in some circumstances that even if disclosure would be enough to meet their fiduciary duty, such disclosure would have to be so expansive or complex that they instead voluntarily mitigate or eliminate the conflicts of interest. Thus, to the extent the Commission’s interpretation would cause investment advisers to better understand their obligations as part of their fiduciary duty and therefore to make changes to their business practices in ways that reduce the likelihood of conflicted advice or the magnitude of the conflicts, it may ameliorate the agency conflict between investment advisers and their clients and, in turn, may improve the quality of advice that the clients receive. This less-conflicted advice may therefore produce higher overall returns for clients and increase the efficiency of portfolio allocation. However, as discussed above, we would generally expect these effects to be minimal. Finally, this interpretation would also benefit clients of investment advisers to the extent it assists the Commission in its oversight of investment advisers’ compliance with their regulatory obligations. Investment Advisers and the Market for Investment Advice In general, we expect the Commission’s interpretation of an investment adviser’s fiduciary duty would affirm investment advisers’ understanding of the obligations they owe their clients, reduce uncertainty for advisers, and facilitate their compliance. Furthermore, by addressing in one release certain aspects of the fiduciary duty that an investment adviser owes to its clients, the Commission’s interpretation could reduce the costs associated with comprehensively assessing their compliance obligations. We acknowledge that, as with other E:\FR\FM\09MYP1.SGM 09MYP1 amozie on DSK3GDR082PROD with PROPOSALS Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules circumstances in which the Commission speaks to the legal obligations of regulated entities, affected firms, including those whose practices are consistent with the Commission’s interpretation, incur costs to evaluate the Commission’s interpretation and assess its applicability to them. Moreover, as discussed above, there may be certain investment advisers who currently understand the practices necessary to comply with their fiduciary duty to be different from the standard of conduct in the Commission’s interpretation. Those investment advisers if any, would experience an increase in their compliance costs as they change their systems, processes and behavior, and train their supervised persons, to align with the Commission’s interpretation. Moreover, to the extent any investment advisers that understood their fiduciary obligation to be different from the Commission’s interpretation change their behavior to align with this interpretation, there could potentially also be some economic effects on the market for investment advice. For example, any improved compliance may not only reduce agency costs in current investment advisory relationships and increase the value of those relationships to current clients, it may also increase trust in the market for investment advice among all investors, which may result in more investors seeking advice from investment advisers. This may, in turn, benefit investors by improving the efficiency of their portfolio allocation. To the extent it is costly or difficult, at least in the short term, to expand the supply of investment advisory services to meet an increase in demand, any such new demand for investment adviser services could potentially put some upward price pressure on fees. At the same time, however, if any such new demand increases the overall profitability of investment advisory services, then we expect it would encourage entry by new investment advisers—or hiring of new representatives, by current investment advisers—such that competition would increase over time. Indeed, we recognize that the recent growth in the investment adviser segment of the market, both in terms of firms and number of representatives,58 may suggest that the costs of expanding the supply of investment advisory services are currently relatively low. Additionally, we acknowledge that to the extent certain investment advisers recognize, due to the Commission’s 58 See Form CRS Proposal, supra note 6, at Section IV.A.1.d. VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 interpretation, that their obligations to clients are stricter than how they currently interpret their fiduciary duty, it could potentially affect competition. Specifically, the Commission’s interpretation of certain aspects of the standard of conduct for investment advisers may result in additional compliance costs to meet their fiduciary obligation under the Commission’s interpretation. This increase in compliance costs, in turn, may discourage competition for client segments that generate lower revenues, such as clients with relatively low levels of financial assets, which could reduce the supply of investment adviser services and raise fees for these client segments. However, the investment advisers who already are complying with the understanding of their fiduciary duty reflected in the Commission’s interpretation, and may therefore currently have a comparative cost disadvantage, could potentially find it more profitable to compete for the customers of those investment advisers who would face higher compliance costs as a result of the proposed interpretation, which would mitigate negative effects on the supply of investment adviser services. Furthermore, as noted above, there has been a recent growth trend in the supply of investment advisory services, which is likely to mitigate any potential negative supply effects from the Commission’s interpretation.59 Finally, to the extent the proposed interpretation would cause some investment advisers to reassess their compliance with their disclosure obligations, it could lead to a reduction in the expected profitability of certain products associated with particularly conflicted advice for which compliance costs would increase following the 59 Beyond having an effect on competition in the market for investment adviser services, it is possible that the Commission’s interpretation could affect competition between investment advisers and other providers of financial advice, such as brokerdealers, banks, and insurance companies. This may be the case if certain investors base their choice between an investment adviser and another provider of financial advice, at least in part, on their perception of the standards of conduct each owes to their customers. To the extent that the Commission’s interpretation increases investors’ trust in investment advisers’ overall compliance with their standard of conduct, certain of these investors may become more willing, to hire an investment adviser rather than one of their noninvestment adviser competitors. As a result, investment advisers as a group may increase their competitive situation compared to that of other types of providers of financial advice. On the other hand, if the Commission’s interpretation raises costs for investment advisers, they could become less competitive with other financial services providers. PO 00000 Frm 00024 Fmt 4702 Sfmt 4702 21211 reassessment.60 As a result, the number of investment advisers willing to advise a client to make these investments may be reduced. A decline in the supply of investment adviser advice on these investments could potentially reduce the efficiency of portfolio allocation of those investors who might otherwise benefit from investment adviser advice on these investments. IV. Request for Comment Regarding Areas of Enhanced Investment Adviser Regulation In 2011, the Commission issued the staff’s 913 Study, pursuant to section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, in which the staff recognized several areas for potential harmonization of broker-dealer and investment adviser regulation.61 We have identified a few discrete areas where the current broker-dealer framework provides investor protections that may not have counterparts in the investment adviser context, and request comment on those areas. The Commission intends to consider these comments in connection with any future proposed rules or other proposed regulatory actions with respect to these matters. A. Federal Licensing and Continuing Education Associated persons of broker-dealers that effect securities transactions are required to be registered with the Financial Industry Regulatory Authority (‘‘FINRA’’),62 and must meet 60 For example, such products could include highly complex, high cost products with risk and return characteristics that are hard to fully understand for retail investors or mutual funds or fund share classes that may pay higher compensation to investment advisers that are dual registrants, or that the investment adviser and its representatives may receive through payments to an affiliated broker-dealer or third party broker-dealer with which representatives of the investment adviser are associated. 61 The staff made two primary recommendations in the 913 Study. The first recommendation was that we engage in rulemaking to implement a uniform fiduciary standard of conduct for brokerdealers and investment advisers when providing personalized investment advice about securities to retail customers. The second recommendation was that we consider harmonizing certain regulatory requirements of broker-dealers and investment advisers where such harmonization appears likely to enhance meaningful investor protection, taking into account the best elements of each regime. In the 913 Study, the areas the staff suggested the Commission consider for harmonization included, among others, licensing and continuing education requirements for persons associated with firms. The staff stated that the areas identified were not intended to be a comprehensive or exclusive listing of potential areas of harmonization. See 913 Study supra note 38. 62 Generally, all registered broker-dealers that deal with the public must become members of E:\FR\FM\09MYP1.SGM Continued 09MYP1 21212 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS qualification requirements, which include passing a securities qualification exam and fulfilling continuing education requirements.63 The federal securities laws do not require investment adviser representatives to become licensed or to meet qualification requirements, but most states impose registration, licensing, or qualification requirements on investment adviser representatives who have a place of business in the state, regardless of whether the investment adviser is registered with the Commission or the state.64 These qualification requirements typically mandate that investment adviser representatives register and pass certain securities exams or hold certain designations (such as Chartered Financial Analyst credential).65 The staff recommended in the 913 Study that the Commission consider requiring investment adviser representatives to be subject to federal continuing education and licensing requirements.66 We request comment on whether there should be federal licensing and continuing education requirements for personnel of SEC-registered investment advisers. Such requirements could be designed to address minimum and ongoing competency requirements for the personnel of SEC-registered advisers.67 • Should investment adviser representatives be subject to federal FINRA, a registered national securities association, and may choose to become exchange members. See Exchange Act section 15(b)(8) and Exchange Act rule 15b9–1. FINRA is the sole national securities association registered with the SEC under section 15A of the Exchange Act. 63 See NASD Rule 1021 (‘‘Registration Requirements’’); NASD Rule 1031 (‘‘Registration Requirements’’); NASD Rule 1041 (‘‘Registration Requirements for Assistant Representatives’’); FINRA Rule 1250 (‘‘Continuing Education Requirements’’). 64 See 913 Study, supra note 38, at 86. See also Advisers Act rule 203A–3(a) (definition of ‘‘investment adviser representative’’). 65 See 913 Study, supra note 38, at 86–87, 138. The North American Securities Administrators Association (‘‘NASAA’’) is considering a potential model rule that would require that investment adviser representatives meet a continuing education requirement in order to maintain their state registrations. An internal survey of NASAA’s membership identified strong support for such a requirement along with significant regulatory need. NASAA is now conducting a nationwide survey of relevant stakeholders to get their input and views on such a requirement. For more information, see https://www.nasaa.org/industry-resources/ investment-advisers/nasaa-survey-regardingcontinuing-education-for-investment-adviserrepresentatives/. 66 Several commenters, cited in the 913 Study, suggested that this was a gap that should be addressed. See 913 Study, supra note 38, at 138 (citing letters from AALU, Bank of America, FSI, Hartford, LPL, UBS, and Woodbury). 67 See 913 Study, supra note 38, at 138. VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 continuing education and licensing requirements? • Which advisory personnel should be included in these requirements? For example, should persons whose functions are solely clerical or ministerial be excluded, similar to the exclusion in the FINRA rules regarding broker-dealer registered representatives? Should a subset of registered investment adviser personnel (such as supervised persons, individuals for whom an adviser must deliver a Form ADV brochure supplement, ‘‘investment adviser representatives’’ as defined in the Advisers Act, or some other group) be required to comply with such requirements? • How should the continuing education requirement be structured? How frequent should the certification be? How many hours of education should be required? Who should determine what qualifies as an authorized continuing education class? • How could unnecessary duplication of any existing continuing education requirement be avoided? • Should these individuals be required to register with the Commission? What information should these individuals be required to disclose on any registration form? Should the registration requirements mirror the requirements of existing Form U4 or require additional information? Should such registration requirements apply to individuals who provide advice on behalf of SEC-registered investment advisers but fall outside the definition of ‘‘investment adviser representative’’ in rule 203A–3 (because, for example, they have five or fewer clients who are natural persons, they provide impersonal investment advice, or ten percent or less of their clients are individuals other than qualified clients)? Should these individuals be required to pass examinations, such as the Series 65 exam required by most states, or to hold certain designations, as part of any registration requirements? Should other steps be required as well, such as a background check or fingerprinting? Would a competency or other examination be a meritorious basis upon which to determine competency and proficiency? Would a competency or other examination requirement provide a false sense of security to advisory clients of competency or proficiency? • If continuing education requirements are a part of any licensing requirements, should specific topics or types of training be required? For example, these individuals could be required to complete a certain amount of training dedicated to ethics, PO 00000 Frm 00025 Fmt 4702 Sfmt 4702 regulatory requirements or the firm’s compliance program. • What would the expected benefits of continuing education and licensing be? Would it be an effective way to increase the quality of advice provided to investors? Would it provide better visibility into the qualifications and education of personnel of SECregistered investment advisers? • What would the expected costs of continuing education and licensing be? How expensive would it be to obtain the continuing education or procure the license? Do those costs scale, or would they fall more heavily on smaller advisers? Would these requirements result in a barrier to entry that could decrease the number of advisers and advisory personnel (and thus potentially increase the cost of advice)? • What would the effects be of continuing education and licensing for investment adviser personnel in the market for investment advice (i.e., as compared to broker-dealers)? • What other types of qualification requirements should be considered, such as minimum experience requirements or standards regarding an individual’s fitness for serving as an investment adviser representative? B. Provision of Account Statements Fees and costs are important to retail investors,68 but many retail investors are uncertain about the fees they will pay.69 The relationship summary that we are proposing in a concurrent release would discuss certain differences between advisory and brokerage fees to provide investors more clarity concerning the key categories of fees and expenses they should expect to pay, but would not require more complete, specific or personalized disclosures or disclosures about the amount of fees and expenses.70 We believe that delivery of periodic account statements, if they specified the dollar amounts of 68 See Staff of the Securities and Exchange Commission, Study Regarding Financial Literacy Among Investors as required by Section 917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Aug. 2012), at iv, available at https://www.sec.gov/news/studies/2012/917financial-literacy-study-part1.pdf (‘‘With respect to financial intermediaries, investors consider information about fees, disciplinary history, investment strategy, conflicts of interest to be absolutely essential.’’). 69 See Angela A. Hung, et al., RAND Institute for Civil Justice, Investor and Industry Perspectives on Investment Advisers and Broker-Dealers (2008), at xix, available at https://www.sec.gov/news/press/ 2008/2008-1_randiabdreport.pdf (‘‘In fact, focusgroup participants with investments acknowledged uncertainty about the fees they pay for their investments, and survey responses also indicate confusion about the fees.’’). 70 See Form CRS Proposal, supra note 6, at Section II.B.4. E:\FR\FM\09MYP1.SGM 09MYP1 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS fees and expenses, would allow clients to readily see and understand the fees and expenses they pay for an adviser’s services. Clients would receive account statements close in time to the assessment of periodic account fees, which could be an effective way for clients to understand and evaluate the cost of the services they are receiving from their advisers. Broker-dealers are required to provide confirmations of transactions with detailed information concerning commissions and certain other remuneration, as well as account statements containing a description of any securities positions, money balances or account activity during the period since the last statement was sent to the customer.71 Broker-dealers generally must provide account statements no less than once every calendar quarter. Brokerage customers must receive periodic account statements even when not receiving immediate trade confirmations.72 Although we understand that many advisers do provide clients with account statements, advisers are not directly required to provide account statements under the federal securities laws. Notably, however, the custody rule requires advisers with custody of a client’s assets to have a reasonable basis for believing that the qualified custodian sends an account statement at least quarterly.73 In addition, in any separately managed account program relying on rule 3a–4 under the Investment Company Act of 1940, the program sponsor or another person designated by the sponsor must provide clients statements at least quarterly containing specified information.74 We request comment on whether we should propose rules to require registered investment advisers to provide account statements, either directly or via the client’s custodian, regardless of whether the adviser is deemed to have custody of client assets under Advisers Act Rule 206(4)–2 or the adviser is a sponsor (or a designee of a sponsor) of a managed account program 71 See, e.g., NASD Rule 2340; FINRA Rule 2232; MSRB Rule G–15. See also Exchange Act rule 15c3–2 (account statements); Exchange Act rule 10b–10 (confirmation of transactions). 72 See Confirmation of Transactions, Securities Exchange Act Release No. 34962 (November 10, 1994). 73 Advisers Act rule 206(4)–2(a)(3) (custody rule). The Commission also has stated that an adviser’s policies and procedures, at a minimum, should address the accuracy of disclosures made to investors, clients, and regulators, including account statements. 74 Investment Company Act of 1940 [15 U.S.C. 80a–1 et seq.] (‘‘Investment Company Act’’) rule 3a– 4(a)(4). VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 relying on the safe harbor in Investment Company Act rule 3a–4. • To what extent do retail clients of registered investment advisers already receive account statements? To what extent do those account statements specify the dollar amounts charged for advisory fees and other fees (e.g., brokerage fees) and expenses? Would retail clients benefit from a requirement that they receive account statements from registered investment advisers? If clients are uncertain about what fees and expenses they will pay, would they benefit from a requirement that, before receiving advice from a registered investment adviser, they enter into a written (including electronic) agreement specifying the fees and expenses to be paid? • What information, in addition to fees and expenses, would be most useful for retail clients to receive in account statements? Should any requirement to provide account statements have prescriptive requirements as to presentation, content, and delivery? Should they resemble the account statements required to be provided by broker-dealers, under NASD Rule 2340 with the addition of fee disclosure? • How often should clients receive account statements? • How costly would it be to provide account statements? Does that cost depend on how those account statements could be delivered (e.g., via U.S. mail, electronic delivery, notice and access)? Are there any other factors that would impact cost? C. Financial Responsibility Broker-dealers are subject to a comprehensive financial responsibility program. Pursuant to Exchange Act rule 15c3–1 (the net capital rule), brokerdealers are required to maintain minimum levels of net capital designed to ensure that a broker-dealer under financial stress has sufficient liquid assets to satisfy all non-subordinated liabilities without the need for a formal liquidation proceeding.75 Exchange Act rule 15c3–3 (the customer protection rule) requires broker-dealers to segregate customer assets and maintain them in a manner designed to ensure that should the broker-dealer fail, those assets are readily available to be returned to customers.76 Broker-dealers are also subject to extensive recordkeeping and reporting requirements, including an annual audit requirement as well as a requirement to make their audited 75 See 76 See PO 00000 Exchange Act rule 15c3–1. Exchange Act rule 15c3–3. Frm 00026 Fmt 4702 Sfmt 4702 21213 balance sheets available to customers.77 Broker-dealers are required to be members of the Securities Investor Protection Corporation (‘‘SIPC’’), which is responsible for overseeing the liquidation of member broker-dealers that close due to bankruptcy or financial trouble and customer assets are missing. When a brokerage firm is closed and customer assets are missing, SIPC, within certain limits, works to return customers’ cash, stock, and other securities held by the firm. If a firm closes, SIPC protects the securities and cash in a customer’s brokerage account up to $500,000, including up to $250,000 protection for cash in the account.78 Finally, FINRA rules require that broker-dealers obtain fidelity bond coverage from an insurance company.79 Under Advisers Act rule 206(4)–2, investment advisers with custody must generally maintain client assets with a ‘‘qualified custodian,’’ which includes banks and registered broker-dealers, and must comply with certain other requirements.80 In 2009 the Commission adopted amendments to the custody requirements for investment advisers that, among other enhancements, required all registered investment advisers with custody of client assets to undergo an annual surprise examination by an independent public accountant. SEC-registered investment advisers, however, are not subject to any net capital requirements comparable to those applicable to broker-dealers, although they must disclose any material financial condition that impairs their ability to provide services to their clients.81 Many investment advisers have relatively small amounts of capital, particularly compared to the amount of assets that they have under management.82 When we discover a serious fraud by an adviser, often the assets of the adviser are insufficient to compensate clients for their loss. In addition, investment advisers are not required to obtain fidelity bonds, unlike 77 See Exchange Act rules 17a–3, 17a–4, and 17a– 5. 78 See Securities Investor Protection Act of 1970, Public Law 91–598, 84 Stat. 1636 (Dec. 30, 1970), 15 U.S.C. 78aaa through 15 U.S.C. 78lll. 79 See FINRA Rule 4360, (‘‘Fidelity Bonds’’). 80 See Advisers Act rule 206(4)–2. 81 See Form ADV. Many states have imposed fidelity bonding and/or net capital requirements on state-registered investment advisers. Rule 17g–1 under the Investment Company Act of 1940 requires registered investment companies to obtain fidelity bonds covering their officers and employees who may have access to the investment companies’ assets. 82 See Custody of Funds or Securities of Clients by Investment Advisers, Investment Advisers Act Release No. 2968 (Dec. 30, 2009). E:\FR\FM\09MYP1.SGM 09MYP1 21214 Federal Register / Vol. 83, No. 90 / Wednesday, May 9, 2018 / Proposed Rules amozie on DSK3GDR082PROD with PROPOSALS many other financial service providers that have access to client assets.83 In light of these disparities, we request comment on whether SECregistered investment advisers should be subject to financial responsibility requirements along the lines of those that apply to broker-dealers. • What is the frequency and severity of client losses due to investment advisers’ inability to satisfy a judgment or otherwise compensate a client for losses due to the investment adviser’s wrongdoing? • Should investment advisers be subject to net capital or other financial responsibility requirements in order to ensure they can meet their obligations, including compensation for clients if the adviser becomes insolvent or advisory personnel misappropriate clients’ assets? 84 Do the custody rule and other rules 85 under the Advisers 83 Fidelity bonds are required to be obtained by broker-dealers (FINRA Rule 4360; New York Stock Exchange Rule 319; American Stock Exchange Rule 330); transfer agents (New York Stock Exchange Rule Listed Company Manual § 906); investment companies (17 CFR 270.17g–1); national banks (12 CFR 7.2013); federal savings associations (12 CFR 563.190). 84 We note that Congress and the Commission have considered such requirements in the past. In 1973, a Commission advisory committee recommended that Congress authorize the Commission to adopt minimum financial responsibility requirements for investment advisers, including minimum capital requirements. See Report of the Advisory Committee on Investment Management Services for Individual Investors, Small Account Investment Management Services, Fed. Sec. L. Rep. (CCH) No. 465, Pt. III, 64–66 (Jan. 1973) (‘‘Investment Management Services Report’’). Three years later, in 1976, the Senate Committee on Banking, Housing and Urban Affairs considered a bill that, among other things, would have authorized the Commission to adopt rules requiring investment advisers (i) with discretionary authority over client assets, or (ii) that advise registered investment companies, to meet financial responsibility standards. S. Rep. No. 94–910, 94th Cong. 2d Sess. (May 20, 1976) (reporting favorably S. 2849). S. 2849 was never enacted. In 1992, both the Senate and House of Representatives passed bills that would have given the Commission the explicit authority to require investment advisers with custody of client assets to obtain fidelity bonds. S. 226, 102d Cong., 2d Sess. (Aug. 12, 1992) and H.R. 5726, 102d Cong. Ed (Sept. 23, 1992). Differences in these two bills were never reconciled and thus neither became law. In 2003, the Commission requested comment on whether to require a fidelity bonding requirement for advisers as a way to increase private sector oversight of the compliance by funds and advisers with the federal securities laws. The Commission decided not to adopt a fidelity bonding requirement at that time, but noted that it regarded such a requirement as a viable option should the Commission wish to further strengthen compliance programs of funds and advisers. Compliance Programs of Investment Companies and Investment Advisers, Investment Company Act Release No. 25925 (Feb. 5, 2003). 85 See, e.g., Advisers Act rule 206(4)–7 (requires each investment adviser registered or required to be registered with the Commission to adopt and implement written policies and procedures reasonably designed to prevent violations of the VerDate Sep<11>2014 17:09 May 08, 2018 Jkt 244001 Act adequately address the potential for misappropriation of client assets and other financial responsibility concerns for advisers? Should investment advisers be subject to an annual audit requirement? • Should advisers be required to obtain a fidelity bond from an insurance company? If so, should some advisers be excluded from this requirement? 86 Is there information or data that demonstrates fidelity bonding requirements provide defrauded clients with recovery, and if so what amount or level of recovery is evidenced? • Alternatively, should advisers be required to maintain a certain amount of capital that could be the source of compensation for clients? 87 What amount of capital would be adequate? 88 • What would be the expected cost of either maintaining some form of reserve capital or purchasing a fidelity bond? Specifically, in addition to setting aside the initial sum or purchasing the initial bond, what would be the ongoing cost and the opportunity cost for investment advisers? Would one method or the other be more feasible for certain types of investment advisers (particularly, smaller advisers)? • Would the North American Securities Administrators Association Minimum Financial Requirements For Investment Advisers Model Rule 202(d)–1 89 (which requires, among other things, an investment adviser who has custody of client funds or securities Advisers Act and Advisers Act rules, review those policies and procedures annually, and designate an individual to serve as a chief compliance officer). 86 As noted above, the 1992 legislation would have given us the explicit authority to require bonding of advisers that have custody of client assets or that have discretionary authority over client assets. Section 412 of ERISA [29 U.S.C. 1112] and related regulations (29 CFR 2550.412–1 and 29 CFR 2580) generally require that every fiduciary of an employee benefit plan and every person who handles funds or other property of such a plan shall be bonded. Registered investment advisers exercising investment discretion over assets of plans covered by title I of ERISA are subject to this requirement; it does not apply to advisers who exercise discretion with respect to assets in an individual retirement account or other non-ERISA retirement account. In 1992, only approximately three percent of Commission registered advisers had discretionary authority over client assets; as of March 31, 2018, according to data collected on Form ADV, 91 percent of Commission registered advisers have that authority. 87 See supra note 84. 88 Section 412 of ERISA provides that the bond required under that section must +be at least ten percent of the amount of funds handled, with a maximum required amount of $500,000 (increased to $1,000,000,000 for plans that hold securities issued by an employer of employees covered by the plan). 89 NASAA Minimum Financial Requirements For Investment Advisers Model Rule 202(d)–1 (Sept. 11, 2011), available at https://www.nasaa.org/wpcontent/uploads/2011/07/IA-Model-Rule-MinimumFinancial-Requirements.pdf. PO 00000 Frm 00027 Fmt 4702 Sfmt 4702 to maintain at all times a minimum net worth of $35,000 (with some exceptions), an adviser who has discretionary authority but not custody over client funds or securities to maintain at all times a minimum net worth of $10,000, and an adviser who accepts prepayment of more than $500 per client and six or more months in advance to maintain at all times a positive net worth), provide an appropriate model for a minimum capital requirement? Why or why not? • Although investment advisers are required to report specific information about the assets that they manage on behalf of clients, they are not required to report specific information about their own assets.90 Should advisers be required to obtain annual audits of their own financials and to provide such information on Form ADV? Would such a requirement raise privacy concerns for privately held advisers? By the Commission. Dated: April 18, 2018. Brent J. Fields, Secretary. [FR Doc. 2018–08679 Filed 5–8–18; 8:45 am] BILLING CODE 8011–01–P DEPARTMENT OF HOMELAND SECURITY Coast Guard 33 CFR Part 151 [Docket No. USCG–2018–0245] RIN 1625–AC45 Ballast Water Management—Annual Reporting Requirement Coast Guard, DHS. Notice of proposed rulemaking. AGENCY: ACTION: The Coast Guard proposes to amend its regulations on ballast water management by eliminating the requirement for vessels operating on voyages exclusively between ports or places within a single Captain of the Port Zone to submit an Annual Ballast Water Summary Report for calendar year 2018. The Coast Guard views this current reporting requirement as unnecessary to analyze and understand ballast water management practices. This proposal would also serve to reduce the administrative burden on the SUMMARY: 90 Form ADV only requires that advisers with significant assets (at least $1 billion) report the approximate amount of their assets within one of the three ranges ($1 billion to less than $10 billion, $10 billion to less than $50 billion, and $50 billion or more). Item 1.O of Part 1A of Form ADV. E:\FR\FM\09MYP1.SGM 09MYP1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 83, Number 90 (Wednesday, May 9, 2018)]
[Proposed Rules]
[Pages 21203-21214]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-08679]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-4889; File No. S7-09-18]
RIN 3235-AM36


Proposed Commission Interpretation Regarding Standard of Conduct 
for Investment Advisers; Request for Comment on Enhancing Investment 
Adviser Regulation

AGENCY: Securities and Exchange Commission.

ACTION: Proposed interpretation; request for comment.

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SUMMARY: The Securities and Exchange Commission (the ``SEC'' or the 
``Commission'') is publishing for comment a proposed interpretation of 
the standard of conduct for investment

[[Page 21204]]

advisers under the Investment Advisers Act of 1940 (the ``Advisers 
Act'' or the ``Act''). The Commission also is requesting comment on: 
Licensing and continuing education requirements for personnel of SEC-
registered investment advisers; delivery of account statements to 
clients with investment advisory accounts; and financial responsibility 
requirements for SEC-registered investment advisers, including fidelity 
bonds.

DATES: Comments should be received on or before August 7, 2018.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/interp.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-09-18 on the subject line.

Paper Comments

     Send paper comments to Brent J. Fields, Secretary, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549-1090.

All submissions should refer to File Number S7-09-18. This file number 
should be included on the subject line if email is used. To help the 
Commission process and review your comments more efficiently, please 
use only one method. The Commission will post all comments on the 
Commission's internet website (https://www.sec.gov/rules/interp.shtml). 
Comments also are available for website viewing and printing in the 
Commission's Public Reference Room, 100 F Street NE, Washington, DC 
20549, on official business days between the hours of 10:00 a.m. and 
3:00 p.m. All comments received will be posted without change. Persons 
submitting comments are cautioned that we do not redact or edit 
personal identifying information from comment submissions. You should 
submit only information that you wish to make publicly available.
    Studies, memoranda or other substantive items may be added by the 
Commission or staff to the comment file during this rulemaking. A 
notification of the inclusion in the comment file of any such materials 
will be made available on the Commission's website. To ensure direct 
electronic receipt of such notifications, sign up through the ``Stay 
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Jennifer Songer, Senior Counsel, or 
Sara Cortes, Assistant Director, at (202) 551-6787 or [email protected], 
Investment Adviser Regulation Office, Division of Investment 
Management, Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is publishing for comment a 
proposed interpretation of the standard of conduct for investment 
advisers under the Advisers Act [15 U.S.C. 80b].\1\
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    \1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the 
Advisers Act, or any paragraph of the Advisers Act, we are referring 
to 15 U.S.C. 80b of the United States Code, at which the Advisers 
Act is codified, and when we refer to rules under the Advisers Act, 
or any paragraph of these rules, we are referring to title 17, part 
275 of the Code of Federal Regulations [17 CFR 275], in which these 
rules are published.
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Table of Contents

II. Investment Advisers' Fiduciary Duty
    A. Duty of Care
    i. Duty To Provide Advice That Is in the Client's Best Interest
    ii. Duty To Seek Best Execution
    iii. Duty To Act and To Provide Advice and Monitoring Over the 
Course of the Relationship
    B. Duty of Loyalty
    C. Request for Comment
III. Economic Considerations
    A. Background
    B. Economic Impacts
IV. Request for Comment Regarding Areas of Enhanced Investment 
Adviser Regulation
    A. Federal Licensing and Continuing Education
    B. Provision of Account Statements
    C. Financial Responsibility

I. Introduction

    An investment adviser is a fiduciary, and as such is held to the 
highest standard of conduct and must act in the best interest of its 
client.\2\ Its fiduciary obligation, which includes an affirmative duty 
of utmost good faith and full and fair disclosure of all material 
facts, is established under federal law and is important to the 
Commission's investor protection efforts.\3\ The Commission also 
regulates broker-dealers, including the obligations that broker-dealers 
owe to their customers. Investment advisers and broker-dealers provide 
advice and services to retail investors and are important to our 
capital markets and our economy more broadly. Broker-dealers and 
investment advisers have different types of relationships with their 
customers and clients and have different models for providing advice, 
which provide investors with choice about the levels and types of 
advice they receive and how they pay for the services that they 
receive.
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    \2\ SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 
194 (1963) (``SEC v. Capital Gains''). See also infra notes 26-32 
and accompanying text; Investment Adviser Codes of Ethics, 
Investment Advisers Act Release No. 2256 (July 2, 2004); Compliance 
Programs of Investment Companies and Investment Advisers, Investment 
Advisers Act Release No. 2204 (Dec. 17, 2003) (``Compliance Programs 
Release''); Electronic Filing by Investment Advisers; Proposed 
Amendments to Form ADV, Investment Advisers Act Release No. 1862 
(Apr. 5, 2000). We acknowledge that investment advisers also have 
antifraud liability with respect to prospective clients under 
section 206 of the Advisers Act.
    \3\ See SEC v. Capital Gains, supra note 2.
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    Today, the Commission is proposing a rule that would require all 
broker-dealers and natural persons who are associated persons of 
broker-dealers to act in the best interest of retail customers \4\ when 
making a recommendation of any securities transaction or investment 
strategy involving securities to retail customers (``Regulation Best 
Interest'').\5\ We are also proposing to require registered investment 
advisers and registered broker-dealers to deliver to retail investors a 
relationship summary, which would provide these investors with 
information about the relationships and services the firm offers, the 
standard of conduct and the fees and costs associated with those 
services, specified conflicts of interest, and whether the firm and its 
financial professionals currently have reportable legal or disciplinary 
events.\6\ In light of the comprehensive nature of our proposed set of 
rulemakings, we believe it would be appropriate and beneficial to 
address in one release \7\ and reaffirm--and in some cases clarify--
certain aspects of the fiduciary duty that an investment adviser owes 
to its clients under section 206 of the Advisers Act.\8\
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    \4\ An investment adviser has a fiduciary duty to all of its 
clients, whether or not the client is a retail investor.
    \5\ Regulation Best Interest, Exchange Act Release No. 34-83062 
(April 18, 2018) (``Regulation Best Interest Proposal'').
    \6\ Form CRS Relationship Summary; Amendments to Form ADV; 
Required Disclosures in Retail Communications and Restrictions on 
the use of Certain Names or Titles, Investment Advisers Act Release 
No. IA-4888 (April 18, 2018) (``Form CRS Proposal'').
    \7\ This Release is intended to highlight the principles 
relevant to an adviser's fiduciary duty. It is not, however, 
intended to be the exclusive resource for understanding these 
principles.
    \8\ The Commission recognizes that many advisers provide 
impersonal investment advice. See, e.g., Advisers Act rule 203A-3 
(defining ``impersonal investment advice'' in the context of 
defining ``investment adviser representative'' as ``investment 
advisory services provided by means of written material or oral 
statements that do not purport to meet the objectives or needs of 
specific individuals or accounts''). This Release does not address 
the extent to which the Advisers Act applies to different types of 
impersonal investment advice.
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    An investment adviser's fiduciary duty is similar to, but not the 
same as, the proposed obligations of broker-

[[Page 21205]]

dealers under Regulation Best Interest.\9\ While we are not proposing a 
uniform standard of conduct for broker-dealers and investment advisers 
in light of their different relationship types and models for providing 
advice, we continue to consider whether we can improve protection of 
investors through potential enhancements to the legal obligations of 
investment advisers. Below, in addition to our interpretation of 
advisers' existing fiduciary obligations, we request comment on three 
potential enhancements to their legal obligations by considering areas 
where the current broker-dealer framework provides investor protections 
that may not have counterparts in the investment adviser context.
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    \9\ Regulation Best Interest Proposal, supra note 5. In addition 
to the obligations proposed in Regulation Best Interest, broker-
dealers have a variety of existing specific obligations, including, 
among others, suitability, best execution, and fair and reasonable 
compensation. See, e.g., Hanly v. SEC, 415 F.2d 589, 596-97 (2d Cir. 
1969) (``A securities dealer occupies a special relationship to a 
buyer of securities in that by his position he implicitly represents 
that he has an adequate and reasonable basis for the opinions he 
renders.''); and FINRA rules 2111 (Suitability), 5310 (Best 
Execution and Interpositioning), and 2121 (Fair Prices and 
Commissions)).
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II. Investment Advisers' Fiduciary Duty

    The Advisers Act establishes a federal fiduciary standard for 
investment advisers.\10\ This fiduciary standard is based on equitable 
common law principles and is fundamental to advisers' relationships 
with their clients under the Advisers Act.\11\ The fiduciary duty to 
which advisers are subject is not specifically defined in the Advisers 
Act or in Commission rules, but reflects a Congressional recognition 
``of the delicate fiduciary nature of an investment advisory 
relationship'' as well as a Congressional intent to ``eliminate, or at 
least to expose, all conflicts of interest which might incline an 
investment adviser--consciously or unconsciously--to render advice 
which was not disinterested.'' \12\ An adviser's fiduciary duty is 
imposed under the Advisers Act in recognition of the nature of the 
relationship between an investment adviser and a client and the desire 
``so far as is presently practicable to eliminate the abuses'' that led 
to the enactment of the Advisers Act.\13\ It is made enforceable by the 
antifraud provisions of the Advisers Act.\14\
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    \10\ Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 
17 (1979) (``Transamerica Mortgage v. Lewis'') (``Sec.  206 
establishes federal fiduciary standards to govern the conduct of 
investment advisers.'') (quotation marks omitted); Santa Fe 
Industries, Inc. v. Green, 430 U.S. 462, 471, n.11 (1977) (in 
discussing SEC v. Capital Gains, stating that the Supreme Court's 
reference to fraud in the ``equitable'' sense of the term was 
``premised on its recognition that Congress intended the Investment 
Advisers Act to establish federal fiduciary standards for investment 
advisers''); SEC v. Capital Gains, supra note 2; Amendments to Form 
ADV, Investment Advisers Act Release No. 3060 (July 28, 2010) 
(``Investment Advisers Act Release 3060'') (``Under the Advisers 
Act, an adviser is a fiduciary whose duty is to serve the best 
interests of its clients, which includes an obligation not to 
subrogate clients' interests to its own,'' citing Proxy Voting by 
Investment Advisers, Investment Advisers Act Release No. 2106 (Jan. 
31, 2003) (``Investment Advisers Act Release 2106'')).
    \11\ See SEC v. Capital Gains, supra note 2 (discussing the 
history of the Advisers Act, and how equitable principles influenced 
the common law of fraud and changed the suits brought against a 
fiduciary, ``which Congress recognized the investment adviser to 
be'').
    \12\ See SEC v. Capital Gains, supra note 2.
    \13\ See SEC v. Capital Gains, supra note 2 (``The Advisers Act 
thus reflects a congressional recognition `of the delicate fiduciary 
nature of an investment advisory relationship,' as well as a 
congressional intent to eliminate, or at least to expose, all 
conflicts of interest which might incline an investment adviser--
consciously or unconsciously--to render advice which was not 
disinterested.'' and also noting that the ``declaration of policy'' 
in the original bill, which became the Advisers Act, declared that 
``the national public interest and the interest of investors are 
adversely affected when the business of investment advisers is so 
conducted as to defraud or mislead investors, or to enable such 
advisers to relieve themselves of their fiduciary obligations to 
their clients. It [sic] is hereby declared that the policy and 
purposes of this title, in accordance with which the provisions of 
this title shall be interpreted, are to mitigate and, so far as is 
presently practicable to eliminate the abuses enumerated in this 
section'' (citing S. 3580, 76th Cong., 3d Sess., Sec.  202 and 
Investment Trusts and Investment Companies, Report of the Securities 
and Exchange Commission, Pursuant to Section 30 of the Public 
Utility Holding Company Act of 1935, on Investment Counsel, 
Investment Management, Investment Supervisory, and Investment 
Advisory Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 
28). See also In the Matter of Arleen W. Hughes, Exchange Act 
Release No. 4048 (Feb. 18, 1948) (``Arleen Hughes'') (discussing the 
relationship of trust and confidence between the client and a dual 
registrant and stating that the registrant was a fiduciary and 
subject to liability under the antifraud provisions of the 
Securities Act of 1933 and the Securities Exchange Act).
    \14\ SEC v. Capital Gains, supra note 2; Transamerica Mortgage 
v. Lewis, supra note 10 (``[T]he Act's legislative history leaves no 
doubt that Congress intended to impose enforceable fiduciary 
obligations.'').
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    An investment adviser's fiduciary duty under the Advisers Act 
comprises a duty of care and a duty of loyalty. Several commenters 
responding to Chairman Clayton's June 2017 request for public input 
\15\ on the standards of conduct for investment advisers and broker-
dealers acknowledged these duties.\16\ This fiduciary duty requires an 
adviser ``to adopt the principal's goals, objectives, or ends.'' \17\ 
This means the adviser must, at all times, serve the best interest of 
its clients and not subordinate its clients' interest to its own.\18\ 
The federal fiduciary duty is imposed through the antifraud provisions 
of the Advisers Act.\19\ The duty follows the contours of the 
relationship between the adviser and its client, and the adviser and 
its client may shape that relationship through contract when the client 
receives full and fair disclosure and provides informed consent.\20\ 
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

[[Page 21206]]

duty.\21\ We discuss our views \22\ on an investment adviser's 
fiduciary duty in more detail below.\23\
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    \15\ Public Comments from Retail Investors and Other Interested 
Parties on Standards of Conduct for Investment Advisers and Broker-
Dealers, Chairman Jay Clayton (June 1, 2017), available at https://www.sec.gov/news/public-statement/statement-chairman-clayton-2017-05-31 (``Chairman Clayton's Request for Public Input'').
    \16\ See, e.g., Comment letter of the Investment Adviser 
Association (Aug. 31, 2017) (``IAA Letter'') (``The well-established 
fiduciary duty under the Advisers Act, which incorporates both a 
duty of loyalty and a duty of care, has been applied consistently 
over the years by courts and the SEC.''); Comment letter of the 
Consumer Federation of America (Sept. 14, 2017) (``an adviser's 
fiduciary obligation `divides neatly into the duty of loyalty and 
the duty of care.' The duty of loyalty is designed to protect 
against `malfeasance,' or wrongdoing, on the part of the adviser, 
while the duty of care is designed to protect against `nonfeasance,' 
such as neglect.'').
    \17\ Arthur B. Laby, The Fiduciary Obligations as the Adoption 
of Ends, 56 Buffalo Law Review 99 (2008). See also Restatement 
(Third) of Agency, Sec.  2.02 Scope of Actual Authority (2006) 
(describing a fiduciary's authority in terms of the fiduciary's 
reasonable understanding of the principal's manifestations and 
objectives).
    \18\ Investment Advisers Act Release 3060, supra footnote 10 
(adopting amendments to Form ADV and stating that ``under the 
Advisers Act, an adviser is a fiduciary whose duty is to serve the 
best interests of its clients, which includes an obligation not to 
subrogate clients' interests to its own,'' citing Investment 
Advisers Act Release 2106 supra note 10); SEC v. Tambone, 550 F.3d 
106, 146 (1st Cir. 2008) (``Section 206 imposes a fiduciary duty on 
investment advisers to act at all times in the best interest of the 
fund and its investors.''); SEC v. Moran, 944 F. Supp. 286 (S.D.N.Y 
1996) (``Investment advisers are entrusted with the responsibility 
and duty to act in the best interest of their clients.'').
    \19\ See supra note 14.
    \20\ See infra note 40 and accompanying text for a discussion of 
informed consent.
    \21\ As an adviser's federal fiduciary obligations are 
enforceable through section 206 of the Act, we would view a waiver 
of enforcement of section 206 as implicating section 215(a) of the 
Act, which provides that ``any condition, stipulation or provision 
binding any person to waive compliance with any provision of this 
title . . . shall be void.'' Some commenters on Chairman Clayton's 
Request for Public Input and other Commission requests for comment 
also stated that an adviser's fiduciary duty could not be disclosed 
away. See, e.g., IAA Letter supra note 16 (``While disclosure of 
conflicts is crucial, it cannot take the place of the overarching 
duty of loyalty. In other words, an adviser is still first and 
foremost bound by its duty to act in its client's best interest and 
disclosure does not relieve an adviser of this duty.''); Comment 
letter of AARP (Sept. 6, 2017) (``Disclosure and consent alone do 
not meet the fiduciary test.''); Financial Planning Coalition Letter 
(July 5, 2013) responding to SEC Request for Data and Other 
Information, Duties of Brokers, Dealers, and Investment Advisers, 
Exchange Act Release No. 69013 (Mar. 1, 2013) (``Financial Planning 
Coalition 2013 Letter'') (``[D]isclosure alone is not sufficient to 
discharge an investment adviser's fiduciary duty; rather, the key 
issue is whether the transaction is in the best interest of the 
client.'') (internal citations omitted). See also Restatement 
(Third) of Agency, Sec.  8.06 Principal's Consent (2006) (``The law 
applicable to relationships of agency as defined in Sec.  1.01 
imposes mandatory limits on the circumstances under which an agent 
may be empowered to take disloyal action. These limits serve 
protective and cautionary purposes. Thus, an agreement that contains 
general or broad language purporting to release an agent in advance 
from the agent's general fiduciary obligation to the principal is 
not likely to be enforceable. This is because a broadly sweeping 
release of an agent's fiduciary duty may not reflect an adequately 
informed judgment on the part of the principal; if effective, the 
release would expose the principal to the risk that the agent will 
exploit the agent's position in ways not foreseeable by the 
principal at the time the principal agreed to the release. In 
contrast, when a principal consents to specific transactions or to 
specified types of conduct by the agent, the principal has a focused 
opportunity to assess risks that are more readily identifiable.''); 
Tamar Frankel, Arthur Laby & Ann Schwing, The Regulation of Money 
Managers, (updated 2017) (``The Regulation of Money Managers'') 
(``Disclosure may, but will not always, cure the fraud, since a 
fiduciary owes a duty to deal fairly with clients.'').
    \22\ In various circumstances, other regulators, including the 
U.S. Department of Labor, and other legal regimes, including state 
securities law, impose obligations on investment advisers. In some 
cases, these standards may differ from the standard imposed and 
enforced by the Commission.
    \23\ The interpretations discussed in this Release also apply to 
automated advisers, which are often colloquially referred to as 
``robo-advisers.'' Robo-advisers, like all SEC-registered investment 
advisers, are subject to all of the requirements of the Advisers 
Act, including the requirement that they provide advice consistent 
with the fiduciary duty they owe to their clients. The staff of the 
Commission has issued guidance regarding how robo-advisers can meet 
their obligations under the Advisers Act, given the unique 
challenges and opportunities presented by their business models. See 
Division of Investment Management, SEC, Staff Guidance on Robo 
Advisers, (February 2017), available at https://www.sec.gov/investment/im-guidance-2017-02.pdf.
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A. Duty of Care

    As fiduciaries, investment advisers owe their clients a duty of 
care.\24\ The Commission has discussed the duty of care and its 
components in a number of contexts.\25\ 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.
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    \24\ See Investment Advisers Act Release No. 2106, supra note 10 
(stating that under the Advisers Act, ``an adviser is a fiduciary 
that owes each of its clients duties of care and loyalty with 
respect to all services undertaken on the client's behalf, including 
proxy voting,'' which is the subject of the release, and citing SEC 
v. Capital Gains supra note 2, to support this point). See also 
Restatement (Third) of Agency, Sec.  8.08 (discussing the duty of 
care that an agent owes its principal as a matter of common law); 
The Regulation of Money Managers, supra note 21 (``Advice can be 
divided into three stages. The first determines the needs of the 
particular client. The second determines the portfolio strategy that 
would lead to meeting the client's needs. The third relates to the 
choice of securities that the portfolio would contain. The duty of 
care relates to each of the stages and depends on the depth or 
extent of the advisers' obligation towards their clients.'').
    \25\ See, e.g., Suitability of Investment Advice Provided by 
Investment Advisers; Custodial Account Statements for Certain 
Advisory Clients, Investment Advisers Act Release No. 1406 (Mar. 16, 
1994) (``Investment Advisers Act Release 1406'') (stating that 
advisers have a duty of care and discussing advisers' suitability 
obligations); Securities; Brokerage and Research Services, Exchange 
Act Release No. 23170 (Apr. 23, 1986) (``Exchange Act Release 
23170'') (``an adviser, as a fiduciary, owes its clients a duty of 
obtaining the best execution on securities transactions.''). We 
highlight certain contexts in which the Commission has addressed the 
duty of care but we note that there are others; for example, voting 
proxies when an adviser undertakes to do so. Investment Advisers Act 
Release 2106, supra note 10.
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i. Duty To Provide Advice That Is in the Client's Best Interest
    We have addressed an adviser's duty of care in the context of the 
provision of personalized investment advice. In this context, the duty 
of care includes a duty to make a reasonable inquiry into a client's 
financial situation, level of financial sophistication, investment 
experience, and investment objectives (which we refer to collectively 
as the client's ``investment profile'') and a duty to provide 
personalized advice that is suitable for and in the best interest of 
the client based on the client's investment profile.\26\
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    \26\ In 1994, the Commission proposed a rule that would make 
express the fiduciary obligation of investment advisers to make only 
suitable recommendations to a client. Investment Advisers Act 
Release 1406, supra note 25. Although never adopted, the rule was 
designed, among other things, to reflect the Commission's 
interpretation of an adviser's existing suitability obligation under 
the Advisers Act. We believe that this obligation, when combined 
with an adviser's fiduciary duty to act in the best interest of its 
client, requires an adviser to provide investment advice that is 
suitable for and in the best interest of its client.
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    An adviser must, before providing any personalized investment 
advice and as appropriate thereafter, make a reasonable inquiry into 
the client's investment profile. The nature and extent of the inquiry 
turn on what is reasonable under the circumstances, including the 
nature and extent of the agreed-upon advisory services, the nature and 
complexity of the anticipated investment advice, and the investment 
profile of the client. For example, to formulate a comprehensive 
financial plan for a client, an adviser might obtain a range of 
personal and financial information about the client, including current 
income, investments, assets and debts, marital status, insurance 
policies, and financial goals.\27\
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    \27\ Investment Advisers Act Release 1406, supra note 25. After 
making a reasonable inquiry into the client's investment profile, it 
generally would be reasonable for an adviser to rely on information 
provided by the client (or the client's agent) regarding the 
client's financial circumstances, and an adviser should not be held 
to have given advice not in its client's best interest if it is 
later shown that the client had misled the adviser.
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    An adviser must update a client's investment profile in order to 
adjust its advice to reflect any changed circumstances.\28\ The 
frequency with which the adviser must update the information in order 
to consider changes to any advice the adviser provides would turn on 
many factors, including whether the adviser is aware of events that 
have occurred that could render inaccurate or incomplete the investment 
profile on which it currently bases its advice. For example, a change 
in the relevant tax law or knowledge that the client has retired or 
experienced a change in marital status might trigger an obligation to 
make a new inquiry.
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    \28\ We note that this would not be done for a one-time 
financial plan or other investment advice that is not provided on an 
ongoing basis. See also infra note 37.
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    An investment adviser must also have a reasonable belief that the 
personalized advice is suitable for and in the best interest of the 
client based on the client's investment profile. A reasonable belief 
would involve considering, for example, whether investments are 
recommended only to those clients who can and are willing to tolerate 
the risks of those investments and for whom the potential benefits may 
justify the risks.\29\

[[Page 21207]]

Whether the advice is in a client's best interest must be evaluated in 
the context of the portfolio that the adviser manages for the client 
and the client's investment profile. For example, when an adviser is 
advising a client with a conservative investment objective, investing 
in certain derivatives may be in the client's best interest when they 
are used to hedge interest rate risk in the client's portfolio, whereas 
investing in certain directionally speculative derivatives on their own 
may not. For that same client, investing in a particular security on 
margin may not be in the client's best interest, even if investing in 
that same security may be in the client's best interest. When advising 
a financially sophisticated investor with a high risk tolerance, 
however, it may be consistent with the adviser's duties to recommend 
investing in such directionally speculative derivatives or investing in 
securities on margin.
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    \29\ We note that Item 8 of Part 2A of Form ADV requires an 
investment adviser to describe its methods of analysis and 
investment strategies and disclose that investing in securities 
involves risk of loss which clients should be prepared to bear. This 
item also requires that an adviser explain the material risks 
involved for each significant investment strategy or method of 
analysis it uses and particular type of security it recommends, with 
more detail if those risks are significant or unusual.
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    The cost (including fees and compensation) associated with 
investment advice would generally be one of many important factors--
such as the investment product's or strategy's investment objectives, 
characteristics (including any special or unusual features), liquidity, 
risks and potential benefits, volatility and likely performance in a 
variety of market and economic conditions--to consider when determining 
whether a security or investment strategy involving a security or 
securities is in the best interest of the client. 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.\30\ Furthermore, an adviser 
would not satisfy its fiduciary duty to provide advice that is in the 
client's best interest by simply advising its client to invest in the 
least expensive or least remunerative investment product or strategy 
without any further analysis of other factors in the context of the 
portfolio that the adviser manages for the client and the client's 
investment profile. For example, it might be consistent with an 
adviser's fiduciary duty to advise a client with a high risk tolerance 
and significant investment experience to invest in a private equity 
fund with relatively high fees if other factors about the fund, such as 
its diversification and potential performance benefits, cause it to be 
in the client's best interest. We believe that a reasonable belief that 
investment advice is in the best interest of a client also requires 
that an adviser conduct a reasonable investigation into the investment 
sufficient to not base its advice on materially inaccurate or 
incomplete information.\31\ We have brought enforcement actions where 
an investment adviser did not independently or reasonably investigate 
securities before recommending them to clients.\32\ This obligation to 
provide advice that is suitable and in the best interest applies not 
just to potential investments, but to all advice the investment adviser 
provides to clients, including advice about an investment strategy or 
engaging a sub-adviser and advice about whether to rollover a 
retirement account so that the investment adviser manages that account.
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    \30\ See infra notes 48-52 and accompanying text (discussing an 
adviser's duties related to disclosure and consent).
    \31\ See, e.g., Concept Release on the U.S. Proxy System, 
Investment Advisers Act Release No. 3052 (July 14, 2010) (stating 
``as a fiduciary, the proxy advisory firm has a duty of care 
requiring it to make a reasonable investigation to determine that it 
is not basing its recommendations on materially inaccurate or 
incomplete information'').
    \32\ See In the Matter of Larry C. Grossman, Investment Advisers 
Act Release No. 4543 (Sept. 30, 2016) (Commission opinion) (imposing 
liability on a principal of a registered investment adviser for 
recommending offshore private investment funds to clients without a 
reasonable independent basis for his advice).
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ii. Duty To Seek Best Execution
    We have addressed an investment adviser's duty of care in the 
context of trade execution where the adviser has the responsibility to 
select broker-dealers to execute client trades (typically in the case 
of discretionary accounts). We have said that, in this context, an 
adviser has the duty to seek best execution of a client's 
transactions.\33\ In meeting this obligation, an adviser must seek to 
obtain the execution of transactions for each of its clients such that 
the client's total cost or proceeds in each transaction are the most 
favorable under the circumstances. An adviser fulfills this duty by 
executing securities transactions on behalf of a client with the goal 
of maximizing value for the client under the particular circumstances 
occurring at the time of the transaction. As noted below, maximizing 
value can encompass more than just minimizing cost. 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.\34\ 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.\35\
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    \33\ See Commission Guidance Regarding Client Commission 
Practices Under Section 28(e) of the Securities Exchange Act of 
1934, Exchange Act Release No. 54165 (July 18, 2006) (stating that 
investment advisers have ``best execution obligations''); Investment 
Advisers Act Release 3060, supra note 10 (discussing an adviser's 
best execution obligations in the context of directed brokerage 
arrangements and disclosure of soft dollar practices). See also 
Advisers Act rule 206(3)-2(c) (referring to adviser's duty of best 
execution of client transactions).
    \34\ Exchange Act Release 23170, supra note 25.
    \35\ Id. The Advisers Act does not prohibit advisers from using 
an affiliated broker to execute client trades. However, the 
adviser's use of such an affiliate involves a conflict of interest 
that must be fully and fairly disclosed and the client must provide 
informed consent to the conflict.
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iii. Duty To Act and To Provide Advice and Monitoring Over the Course 
of the Relationship
    An investment adviser's duty of care also encompasses the duty to 
provide advice and monitoring over the course of a relationship with a 
client.\36\ An

[[Page 21208]]

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). Conversely, the steps needed to fulfill this duty may be 
relatively circumscribed for the adviser and client that have agreed to 
a relationship of limited duration via contract (for example, a 
financial planning relationship where the adviser is compensated with a 
fixed, one-time fee commensurate with the discrete, limited-duration 
nature of the advice provided).\37\ An adviser's duty to monitor 
extends to all personalized advice it provides the client, including an 
evaluation of whether a client's account or program type (for example, 
a wrap account) continues to be in the client's best interest.
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    \36\ See SEC v. Capital Gains, supra note 2 (describing 
advisers' ``basic function'' as ``furnishing to clients on a 
personal basis competent, unbiased, and continuous advice regarding 
the sound management of their investments'' (quoting Investment 
Trusts and Investment Companies, Report of the Securities and 
Exchange Commission, Pursuant to Section 30 of the Public Utility 
Holding Company Act of 1935, on Investment Counsel, Investment 
Management, Investment Supervisory, and Investment Advisory 
Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 28)). Cf. 
Barbara Black, Brokers and Advisers-What's in a Name?, 32 Fordham 
Journal of Corporate and Financial Law XI (2005) (``[W]here the 
investment adviser's duties include management of the account, [the 
adviser] is under an obligation to monitor the performance of the 
account and to make appropriate changes in the portfolio.''); Arthur 
B. Laby, Fiduciary Obligations of Broker-Dealers and Investment 
Advisers, 55 Villanova Law Review 701, at 728 (2010) (``Laby 
Villanova Article'') (``If an adviser has agreed to provide 
continuous supervisory services, the scope of the adviser's 
fiduciary duty entails a continuous, ongoing duty to supervise the 
client's account, regardless of whether any trading occurs. This 
feature of the adviser's duty, even in a non-discretionary account, 
contrasts sharply with the duty of a broker administering a non-
discretionary account, where no duty to monitor is required.'') 
(internal citations omitted).
    \37\ See Laby Villanova Article, supra note 36, at 728 (2010) 
(stating that the scope of an adviser's activity can be altered by 
contract and that an adviser's fiduciary duty would be commensurate 
with the scope of the relationship).
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B. Duty of Loyalty

    The duty of loyalty requires an investment adviser to put its 
client's interests first. An investment adviser must not favor its own 
interests over those of a client or unfairly favor one client over 
another.\38\ In seeking to meet its duty of loyalty, an adviser must 
make full and fair disclosure to its clients of all material facts 
relating to the advisory relationship.\39\ In addition, an adviser must 
seek to avoid conflicts of interest with its clients, and, at a 
minimum, make full and fair disclosure of all material conflicts of 
interest that could affect the advisory relationship. The disclosure 
should be sufficiently specific so that a client is able to decide 
whether to provide informed consent to the conflict of interest.\40\ We 
discuss each of these aspects of the duty of loyalty below.
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    \38\ See Investment Advisers Act Release 3060 (``Under the 
Advisers Act, an adviser is a fiduciary whose duty is to serve the 
best interests of its clients, which includes an obligation not to 
subrogate clients' interests to its own,'' citing Investment 
Advisers Act Release 2106 supra note 9). See also Staff of the U.S. 
Securities and Exchange Commission, Study on Investment Advisers and 
Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act (Jan. 2011), available at 
https://www.sec.gov/news/studies/2011/913studyfinal.pdf (``913 
Study'').
    \39\ Investment Advisers Act Release 3060, supra note 6 (``as a 
fiduciary, an adviser has an ongoing obligation to inform its 
clients of any material information that could affect the advisory 
relationship''). See also General Instruction 3 to Part 2 of Form 
ADV (``Under federal and state law, you are a fiduciary and must 
make full disclosure to your clients of all material facts relating 
to the advisory relationship.'').
    \40\ Arleen Hughes, supra note 13, at 4 and 8 (stating, 
``[s]ince loyalty to his trust is the first duty which a fiduciary 
owes to his principal, it is the general rule that a fiduciary must 
not put himself into a position where his own interests may come in 
conflict with those of his principal. To prevent any conflict and 
the possible subordination of this duty to act solely for the 
benefit of his principal, a fiduciary at common law is forbidden to 
deal as an adverse party with his principal. An exception is made, 
however, where the principal gives his informed consent to such 
dealings,'' and adding that, ``[r]egistrant has an affirmative 
obligation to disclose all material facts to her clients in a manner 
which is clear enough so that a client is fully apprised of the 
facts and is in a position to give his informed consent.''). See 
also Hughes v. Securities and Exchange Commission, 174 F.2d 969 
(1949) (affirming the SEC decision in Arleen Hughes).
    See also General Instruction 3 to Part 2 of Form ADV (stating 
that an adviser's disclosure obligation ``requires that [the 
adviser] provide the client with sufficiently specific facts so that 
the client is able to understand the conflicts of interest [the 
adviser has] and the business practices in which [the adviser] 
engage[s], and can give informed consent to such conflicts or 
practices or reject them''); Investment Advisers Act Release 3060, 
supra note 10 (same); Restatement (Third) of Agency Sec.  8.06 
(``Conduct by an agent that would otherwise constitute a breach of 
duty as stated in Sec. Sec.  8.01, 8.02, 8.03, 8.04, and 8.05 
[referencing the fiduciary duty] does not constitute a breach of 
duty if the principal consents to the conduct, provided that (a) in 
obtaining the principal's consent, the agent (i) acts in good faith, 
(ii) discloses all material facts that the agent knows, has reason 
to know, or should know would reasonably affect the principal's 
judgment unless the principal has manifested that such facts are 
already known by the principal or that the principal does not wish 
to know them, and (iii) otherwise deals fairly with the principal; 
and (b) the principal's consent concerns either a specific act or 
transaction, or acts or transactions of a specified type that could 
reasonably be expected to occur in the ordinary course of the agency 
relationship'').
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    Because an adviser must serve the best interests of its clients, it 
has an obligation not to subordinate its clients' interests to its own. 
For example, an adviser cannot favor its own interests over those of a 
client, whether by favoring its own accounts or by favoring certain 
client accounts that pay higher fee rates to the adviser over other 
client accounts.\41\ Accordingly, the duty of loyalty includes a duty 
not to treat some clients favorably at the expense of other clients. 
Thus, we believe that in allocating investment opportunities among 
eligible clients, an adviser must treat all clients fairly.\42\ This 
does not mean that an adviser must have a pro rata allocation policy, 
that the adviser's allocation policies cannot reflect the differences 
in clients' objectives or investment profiles, or that the adviser 
cannot exercise judgment in allocating investment opportunities among 
eligible clients. Rather, it means that an adviser's allocation 
policies must be fair and, if they present a conflict, the adviser must 
fully and fairly disclose the conflict such that a client can provide 
informed consent.
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    \41\ The Commission has brought numerous enforcement actions 
against advisers that unfairly allocated trades to their own 
accounts and allocated less favorable or unprofitable trades to 
their clients' accounts. See, e.g., SEC v. Strategic Capital 
Management, LLC and Michael J. Breton, Litigation Release No. 23867 
(June 23, 2017) (partial settlement) (adviser placed trades through 
a master brokerage account and then allocated profitable trades to 
adviser's account while placing unprofitable trades into the client 
accounts.).
    \42\ See also Barry Barbash and Jai Massari, The Investment 
Advisers Act of 1940; Regulation by Accretion, 39 Rutgers Law 
Journal 627 (2008) (stating that under section 206 of the Advisers 
Act and traditional notions of fiduciary and agency law an adviser 
must not give preferential treatment to some clients or 
systematically exclude eligible clients from participating in 
specific opportunities without providing the clients with 
appropriate disclosure regarding the treatment).
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    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.\43\ Disclosure of a conflict alone is not always 
sufficient to satisfy the adviser's duty of loyalty and section 206 of 
the Advisers Act.\44\ Any

[[Page 21209]]

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.\45\ 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.\46\ For example, an adviser disclosing 
that it ``may'' have a conflict is not adequate disclosure when the 
conflict actually exists.\47\ A client's informed consent can be either 
explicit or, depending on the facts and circumstances, implicit. We 
believe, however, that it would not be consistent with an adviser's 
fiduciary duty to infer or accept client consent to a conflict where 
either (i) the facts and circumstances indicate that the client did not 
understand the nature and import of the conflict, or (ii) the material 
facts concerning the conflict could not be fully and fairly 
disclosed.\48\ For example, in some cases, conflicts may be of a nature 
and extent that it would be difficult to provide disclosure that 
adequately conveys the material facts or the nature, magnitude and 
potential effect of the conflict necessary to obtain informed consent 
and satisfy an adviser's fiduciary duty. In other cases, disclosure may 
not be specific enough for clients to understand whether and how the 
conflict will affect the advice they receive. With some complex or 
extensive conflicts, it may be difficult to provide disclosure that is 
sufficiently specific, but also understandable, to the adviser's 
clients. In all of these cases where full and fair disclosure and 
informed consent is insufficient, we expect an adviser to eliminate the 
conflict or adequately mitigate the conflict so that it can be more 
readily disclosed.
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    \43\ See SEC v. Capital Gains, supra note 2 (advisers must fully 
disclose all material conflicts, citing Congressional intent ``to 
eliminate, or at least expose, all conflicts of interest which might 
incline an investment adviser--consciously or unconsciously--to 
render advice which was not disinterested''). See also Investment 
Advisers Act Release 3060, supra note 9.
    \44\ See SEC v. Capital Gains, supra note 2 (in discussing the 
legislative history of the Advisers Act, citing ethical standards of 
one of the leading investment counsel associations, which provided 
that an investment counsel should remain ``as free as humanly 
possible from the subtle influence of prejudice, conscious or 
unconscious'' and ``avoid any affiliation, or any act which subjects 
his position to challenge in this respect'' and stating that one of 
the policy purposes of the Advisers Act is ``to mitigate and, so far 
as is presently practicable to eliminate the abuses'' that formed 
the basis of the Advisers Act). Separate and apart from potential 
liability under the antifraud provisions of the Advisers Act 
enforceable by the Commission for breaches of fiduciary duty in the 
absence of full and fair disclosure, investment advisers may also 
wish to consider their potential liability to clients under state 
common law, which may vary from state to state.
    \45\ See Arlene Hughes, supra at 13 (in finding that registrant 
had not obtained informed consent, citing to testimony indicating 
that ``some clients had no understanding at all of the nature and 
significance'' of the disclosure).
    \46\ See General Instruction 3 to Part 2 of Form ADV. Cf. Arleen 
Hughes, supra note 13 (Hughes acted simultaneously in the dual 
capacity of investment adviser and of broker and dealer and conceded 
having a fiduciary duty. In describing the fiduciary duty and her 
potential liability under the antifraud provisions of the Securities 
Act and the Exchange Act, the Commission stated she had ``an 
affirmative obligation to disclose all material facts to her clients 
in a manner which is clear enough so that a client is fully apprised 
of the facts and is in a position to give his informed consent.'').
    \47\ We have brought enforcement actions in such cases. See, 
e.g., In the Matter of The Robare Group, Ltd., et al., Investment 
Advisers Act Release No. 4566 (Nov. 7, 2016) (Commission Opinion) 
(appeal docketed) (finding, among other things, that adviser's 
disclosure was inadequate because it stated that the adviser may 
receive compensation from a broker as a result of the facilitation 
of transactions on client's behalf through such broker-dealer and 
that these arrangements may create a conflict of interest when 
adviser was, in fact, receiving payments from the broker and had 
such a conflict of interest).
    \48\ See Arleen Hughes, supra note 13 (``Registrant cannot 
satisfy this duty by executing an agreement with her clients which 
the record shows some clients do not understand and which, in any 
event, does not contain the essential facts which she must 
communicate.'') Some commenters on Commission requests for comment 
agreed that full and fair disclosure and informed consent are 
important components of an adviser's fiduciary duty. See, e.g., 
Financial Planning Coalition 2013 Letter, supra note 21 (``[C]onsent 
is only informed if the customer has the ability fully to understand 
and to evaluate the information. Many complex products . . . are 
appropriate only for sophisticated and experienced investors. It is 
not sufficient for a fiduciary to make disclosure of potential 
conflicts of interest with respect to such products. The fiduciary 
must make a reasonable judgment that the customer is fully able to 
understand and to evaluate the product and the potential conflicts 
of interest that it presents--and then the fiduciary must make a 
judgment that the product is in the best interests of the 
customer.'').
---------------------------------------------------------------------------

    Full and fair disclosure of all material facts that could affect an 
advisory relationship, including all material conflicts of interest 
between the adviser and the client, can help clients and prospective 
clients in evaluating and selecting investment advisers. Accordingly, 
we require advisers to deliver to their clients a ``brochure,'' under 
Part 2A of Form ADV, which sets out minimum disclosure requirements, 
including disclosure of certain conflicts.\49\ Investment advisers are 
required to deliver the brochure to a prospective client at or before 
entering into a contract so that the prospective client can use the 
information contained in the brochure to decide whether or not to enter 
into the advisory relationship.\50\ In a concurrent release, we are 
proposing to require all investment advisers to deliver to retail 
investors before or at the time the adviser enters into an investment 
advisory agreement a relationship summary which would include a summary 
of certain conflicts of interest.\51\
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    \49\ Investment Advisers Act Release 3060, supra note 10; 
General Instruction 3 to Part 2 of Form ADV (``Under federal and 
state law, you are a fiduciary and must make full disclosure to your 
clients of all material facts relating to the advisory relationship. 
As a fiduciary, you also must seek to avoid conflicts of interest 
with your clients, and, at a minimum, make full disclosure of all 
material conflicts of interest between you and your clients that 
could affect the advisory relationship. This obligation requires 
that you provide the client with sufficiently specific facts so that 
the client is able to understand the conflicts of interest you have 
and the business practices in which you engage, and can give 
informed consent to such conflicts or practices or reject them.'').
    \50\ Investment Advisers Act rule 204-3. Investment Advisers Act 
Release 3060, supra note 10 (adopting amendments to Form ADV and 
stating that ``A client may use this disclosure to select his or her 
own adviser and evaluate the adviser's business practices and 
conflicts on an ongoing basis. As a result, the disclosure clients 
and prospective clients receive is critical to their ability to make 
an informed decision about whether to engage an adviser and, having 
engaged the adviser, to manage that relationship.'').
    \51\ Form CRS Proposal, supra note 6.
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C. Request for Comment

    The Commission requests comment on our proposed interpretation 
regarding certain aspects of the fiduciary duty under section 206 of 
the Advisers Act.
     Does the Commission's proposed interpretation offer 
sufficient guidance with respect to the fiduciary duty under section 
206 of the Advisers Act?
     Are there any significant issues related to an adviser's 
fiduciary duty that the proposed interpretation has not addressed?
     Would it be beneficial for investors, advisers or broker-
dealers for the Commission to codify any portion of our proposed 
interpretation of the fiduciary duty under section 206 of the Advisers 
Act?

III. Economic Considerations

    The Commission is sensitive to the potential economic effects of 
the proposed interpretation provided above.\52\ In this section we 
discuss how the proposed Commission interpretation may benefit 
investors and reduce agency problems by reaffirming and clarifying the 
fiduciary duty an investment adviser owes to its clients. We also 
discuss some potential broader economic effects on the market for 
investment advice.
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    \52\ The Commission, where possible, has sought to quantify the 
economic impacts expected to result from the proposed 
interpretations. However, as discussed more specifically below, the 
Commission is unable to quantify certain of the economic effects 
because it lacks information necessary to provide reasonable 
estimates.
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A. Background

    The Commission's interpretation of the standard of conduct for 
investment advisers under the Advisers Act set forth in this Release 
would affect investment advisers and their associated persons as well 
as the clients of those investment advisers, and the market for 
financial advice more broadly.\53\ There are 12,659 investment advisers 
registered with the Commission with over $72 trillion in assets under 
management as well as 17,635 investment advisers registered with states 
and 3,587 investment advisers who submit Form ADV as exempt reporting 
advisers.\54\ As of December

[[Page 21210]]

2017, there are approximately 36 million client accounts advised by 
SEC-registered investment advisers.
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    \53\ See Form CRS Proposal, supra note 6, at Section IV.A 
(discussing the market for financial advice generally).
    \54\ See Form CRS Proposal, supra note 6, at Section IV.A.1.b 
(discussing SEC-registered investment advisers). Note, however, that 
because we are interpreting advisers' fiduciary duties under section 
206 of the Advisers Act, this interpretation would be applicable to 
both SEC- and state-registered investment advisers, as well as other 
investment advisers that are exempt from registration or subject to 
a prohibition on registration under the Advisers Act.
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    These investment advisers currently incur ongoing costs related to 
their compliance with their legal and regulatory obligations, including 
costs related to their understanding of the standard of conduct. We 
believe, based on the Commission's experience, that the interpretations 
we are setting forth in this Release are generally consistent with 
investment advisers' current understanding of the practices necessary 
to comply with their fiduciary duty under the Advisers Act; however, we 
recognize that there may be certain current investment advisers who 
have interpreted their fiduciary duty to require something less, or 
something more, than the Commission's interpretation. We lack data to 
identify which investment advisers currently understand the practices 
necessary to comply with their fiduciary duty to be different from the 
standard of conduct in the Commission's interpretation. Based on our 
experience, however, we generally believe that it is not a significant 
portion of the market.

B. Economic Impacts

    Based on our experience as the long-standing regulator of the 
investment adviser industry, the Commission's interpretation of the 
fiduciary duty under section 206 of the Advisers Act described in this 
Release generally reaffirms the current practices of investment 
advisers. Therefore, we expect there to be no significant economic 
impacts from the interpretation. We do acknowledge, however, to the 
extent certain investment advisers currently understand the practices 
necessary to comply with their fiduciary duty to be different from 
those discussed in this interpretation, there could be some potential 
economic effects, which we discuss below.
Clients of Investment Advisers
    The typical relationship between an investment adviser and a client 
is a principal-agent relationship, where the principal (the client) 
hires an agent (the investment adviser) to perform some service 
(investment advisory services) on the client's behalf.\55\ Because 
investors and investment advisers are likely to have different 
preferences and goals, the investment adviser relationship is subject 
to agency problems: That is, investment advisers may take actions that 
increase their well-being at the expense of investors, thereby imposing 
agency costs on investors.\56\ A fiduciary duty, such as the duty 
investment advisers owe their clients, can mitigate these agency 
problems and reduce agency costs by deterring agents from taking 
actions that expose them to legal liability.\57\
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    \55\ See, e.g., James A. Brickley, Clifford W. Smith, Jr., 
Jerold L. Zimmerman, Managerial Economics and Organizational 
Architecture (2004), at 265 (``An agency relationship consists of an 
agreement under which one party, the principal, engages another 
party, the agent, to perform some service on the principal's 
behalf.''). See also Michael C. Jensen and William H. Meckling, 
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership 
Structure, Journal of Financial Economics, Vol. 3, 305-360 (1976).
    \56\ See, e.g., Jensen and Meckling, supra note 55. See also the 
discussion on agency problems in the market for investment advice in 
Section IV.B. of the Regulation Best Interest Proposal, supra note 
5.
    \57\ See, e.g., Frank H. Easterbrook and Daniel R. Fischel, 
Contract and Fiduciary Duty, Journal of Law & Economics, Vol. 36, 
425-46 (1993).
---------------------------------------------------------------------------

    To the extent the Commission's interpretation of investment adviser 
fiduciary duty would cause a change in behavior of those investment 
advisers, if any, who currently interpret their fiduciary duty to 
require something different from the Commission's interpretation, we 
expect a potential reduction in agency problems and, consequently, a 
reduction of agency costs to the client. The extent to which agency 
costs would be reduced is difficult to assess given that we are unable 
to ascertain whether any investment advisers currently interpret their 
fiduciary duty to be something different from the Commission's 
interpretation, and consequently we are not able to estimate the agency 
costs these advisers, if any, currently impose on investors. However, 
we believe that there may be potential benefits for clients of those 
investment advisers, if any, to the extent the Commission's 
interpretation is effective at strengthening investment advisers' 
understanding of their obligations to their clients. For example, to 
the extent that the Commission's interpretation enhances the 
understanding of any investment advisers of their duty of care, it may 
potentially raise the quality of investment advice given and that 
advice's fit with a client's individual profile and preferences or lead 
to increased compliance with the duty to provide advice and monitoring 
over the course of the relationship.
    Additionally, to the extent the Commission's interpretation 
enhances the understanding of any investment advisers of their duty of 
loyalty it may potentially benefit the clients of those investment 
advisers. Specifically, to the extent this leads to a higher quality of 
disclosures about conflicts for clients of some investment advisers, 
the nature and extent of such conflict disclosures would help investors 
better assess the quality of the investment advice they receive, 
therefore providing an important benefit to investors.
    Further, to the extent that the interpretation causes some 
investment advisers to properly identify circumstances in which 
disclosure alone cannot cure a conflict of interest, the proposed 
interpretation may lead those investment advisers to take additional 
steps to mitigate or eliminate the conflict. The interpretation may 
also cause some investment advisers to conclude in some circumstances 
that even if disclosure would be enough to meet their fiduciary duty, 
such disclosure would have to be so expansive or complex that they 
instead voluntarily mitigate or eliminate the conflicts of interest. 
Thus, to the extent the Commission's interpretation would cause 
investment advisers to better understand their obligations as part of 
their fiduciary duty and therefore to make changes to their business 
practices in ways that reduce the likelihood of conflicted advice or 
the magnitude of the conflicts, it may ameliorate the agency conflict 
between investment advisers and their clients and, in turn, may improve 
the quality of advice that the clients receive. This less-conflicted 
advice may therefore produce higher overall returns for clients and 
increase the efficiency of portfolio allocation. However, as discussed 
above, we would generally expect these effects to be minimal. Finally, 
this interpretation would also benefit clients of investment advisers 
to the extent it assists the Commission in its oversight of investment 
advisers' compliance with their regulatory obligations.
Investment Advisers and the Market for Investment Advice
    In general, we expect the Commission's interpretation of an 
investment adviser's fiduciary duty would affirm investment advisers' 
understanding of the obligations they owe their clients, reduce 
uncertainty for advisers, and facilitate their compliance. Furthermore, 
by addressing in one release certain aspects of the fiduciary duty that 
an investment adviser owes to its clients, the Commission's 
interpretation could reduce the costs associated with comprehensively 
assessing their compliance obligations. We acknowledge that, as with 
other

[[Page 21211]]

circumstances in which the Commission speaks to the legal obligations 
of regulated entities, affected firms, including those whose practices 
are consistent with the Commission's interpretation, incur costs to 
evaluate the Commission's interpretation and assess its applicability 
to them. Moreover, as discussed above, there may be certain investment 
advisers who currently understand the practices necessary to comply 
with their fiduciary duty to be different from the standard of conduct 
in the Commission's interpretation. Those investment advisers if any, 
would experience an increase in their compliance costs as they change 
their systems, processes and behavior, and train their supervised 
persons, to align with the Commission's interpretation.
    Moreover, to the extent any investment advisers that understood 
their fiduciary obligation to be different from the Commission's 
interpretation change their behavior to align with this interpretation, 
there could potentially also be some economic effects on the market for 
investment advice. For example, any improved compliance may not only 
reduce agency costs in current investment advisory relationships and 
increase the value of those relationships to current clients, it may 
also increase trust in the market for investment advice among all 
investors, which may result in more investors seeking advice from 
investment advisers. This may, in turn, benefit investors by improving 
the efficiency of their portfolio allocation. To the extent it is 
costly or difficult, at least in the short term, to expand the supply 
of investment advisory services to meet an increase in demand, any such 
new demand for investment adviser services could potentially put some 
upward price pressure on fees. At the same time, however, if any such 
new demand increases the overall profitability of investment advisory 
services, then we expect it would encourage entry by new investment 
advisers--or hiring of new representatives, by current investment 
advisers--such that competition would increase over time. Indeed, we 
recognize that the recent growth in the investment adviser segment of 
the market, both in terms of firms and number of representatives,\58\ 
may suggest that the costs of expanding the supply of investment 
advisory services are currently relatively low.
---------------------------------------------------------------------------

    \58\ See Form CRS Proposal, supra note 6, at Section IV.A.1.d.
---------------------------------------------------------------------------

    Additionally, we acknowledge that to the extent certain investment 
advisers recognize, due to the Commission's interpretation, that their 
obligations to clients are stricter than how they currently interpret 
their fiduciary duty, it could potentially affect competition. 
Specifically, the Commission's interpretation of certain aspects of the 
standard of conduct for investment advisers may result in additional 
compliance costs to meet their fiduciary obligation under the 
Commission's interpretation. This increase in compliance costs, in 
turn, may discourage competition for client segments that generate 
lower revenues, such as clients with relatively low levels of financial 
assets, which could reduce the supply of investment adviser services 
and raise fees for these client segments. However, the investment 
advisers who already are complying with the understanding of their 
fiduciary duty reflected in the Commission's interpretation, and may 
therefore currently have a comparative cost disadvantage, could 
potentially find it more profitable to compete for the customers of 
those investment advisers who would face higher compliance costs as a 
result of the proposed interpretation, which would mitigate negative 
effects on the supply of investment adviser services. Furthermore, as 
noted above, there has been a recent growth trend in the supply of 
investment advisory services, which is likely to mitigate any potential 
negative supply effects from the Commission's interpretation.\59\
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    \59\ Beyond having an effect on competition in the market for 
investment adviser services, it is possible that the Commission's 
interpretation could affect competition between investment advisers 
and other providers of financial advice, such as broker-dealers, 
banks, and insurance companies. This may be the case if certain 
investors base their choice between an investment adviser and 
another provider of financial advice, at least in part, on their 
perception of the standards of conduct each owes to their customers. 
To the extent that the Commission's interpretation increases 
investors' trust in investment advisers' overall compliance with 
their standard of conduct, certain of these investors may become 
more willing, to hire an investment adviser rather than one of their 
non-investment adviser competitors. As a result, investment advisers 
as a group may increase their competitive situation compared to that 
of other types of providers of financial advice. On the other hand, 
if the Commission's interpretation raises costs for investment 
advisers, they could become less competitive with other financial 
services providers.
---------------------------------------------------------------------------

    Finally, to the extent the proposed interpretation would cause some 
investment advisers to reassess their compliance with their disclosure 
obligations, it could lead to a reduction in the expected profitability 
of certain products associated with particularly conflicted advice for 
which compliance costs would increase following the reassessment.\60\ 
As a result, the number of investment advisers willing to advise a 
client to make these investments may be reduced. A decline in the 
supply of investment adviser advice on these investments could 
potentially reduce the efficiency of portfolio allocation of those 
investors who might otherwise benefit from investment adviser advice on 
these investments.
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    \60\ For example, such products could include highly complex, 
high cost products with risk and return characteristics that are 
hard to fully understand for retail investors or mutual funds or 
fund share classes that may pay higher compensation to investment 
advisers that are dual registrants, or that the investment adviser 
and its representatives may receive through payments to an 
affiliated broker-dealer or third party broker-dealer with which 
representatives of the investment adviser are associated.
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IV. Request for Comment Regarding Areas of Enhanced Investment Adviser 
Regulation

    In 2011, the Commission issued the staff's 913 Study, pursuant to 
section 913 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010, in which the staff recognized several areas for 
potential harmonization of broker-dealer and investment adviser 
regulation.\61\ We have identified a few discrete areas where the 
current broker-dealer framework provides investor protections that may 
not have counterparts in the investment adviser context, and request 
comment on those areas. The Commission intends to consider these 
comments in connection with any future proposed rules or other proposed 
regulatory actions with respect to these matters.
---------------------------------------------------------------------------

    \61\ The staff made two primary recommendations in the 913 
Study. The first recommendation was that we engage in rulemaking to 
implement a uniform fiduciary standard of conduct for broker-dealers 
and investment advisers when providing personalized investment 
advice about securities to retail customers. The second 
recommendation was that we consider harmonizing certain regulatory 
requirements of broker-dealers and investment advisers where such 
harmonization appears likely to enhance meaningful investor 
protection, taking into account the best elements of each regime. In 
the 913 Study, the areas the staff suggested the Commission consider 
for harmonization included, among others, licensing and continuing 
education requirements for persons associated with firms. The staff 
stated that the areas identified were not intended to be a 
comprehensive or exclusive listing of potential areas of 
harmonization. See 913 Study supra note 38.
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A. Federal Licensing and Continuing Education

    Associated persons of broker-dealers that effect securities 
transactions are required to be registered with the Financial Industry 
Regulatory Authority (``FINRA''),\62\ and must meet

[[Page 21212]]

qualification requirements, which include passing a securities 
qualification exam and fulfilling continuing education 
requirements.\63\ The federal securities laws do not require investment 
adviser representatives to become licensed or to meet qualification 
requirements, but most states impose registration, licensing, or 
qualification requirements on investment adviser representatives who 
have a place of business in the state, regardless of whether the 
investment adviser is registered with the Commission or the state.\64\ 
These qualification requirements typically mandate that investment 
adviser representatives register and pass certain securities exams or 
hold certain designations (such as Chartered Financial Analyst 
credential).\65\ The staff recommended in the 913 Study that the 
Commission consider requiring investment adviser representatives to be 
subject to federal continuing education and licensing requirements.\66\
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    \62\ Generally, all registered broker-dealers that deal with the 
public must become members of FINRA, a registered national 
securities association, and may choose to become exchange members. 
See Exchange Act section 15(b)(8) and Exchange Act rule 15b9-1. 
FINRA is the sole national securities association registered with 
the SEC under section 15A of the Exchange Act.
    \63\ See NASD Rule 1021 (``Registration Requirements''); NASD 
Rule 1031 (``Registration Requirements''); NASD Rule 1041 
(``Registration Requirements for Assistant Representatives''); FINRA 
Rule 1250 (``Continuing Education Requirements'').
    \64\ See 913 Study, supra note 38, at 86. See also Advisers Act 
rule 203A-3(a) (definition of ``investment adviser 
representative'').
    \65\ See 913 Study, supra note 38, at 86-87, 138. The North 
American Securities Administrators Association (``NASAA'') is 
considering a potential model rule that would require that 
investment adviser representatives meet a continuing education 
requirement in order to maintain their state registrations. An 
internal survey of NASAA's membership identified strong support for 
such a requirement along with significant regulatory need. NASAA is 
now conducting a nationwide survey of relevant stakeholders to get 
their input and views on such a requirement. For more information, 
see https://www.nasaa.org/industry-resources/investment-advisers/nasaa-survey-regarding-continuing-education-for-investment-adviser-representatives/.
    \66\ Several commenters, cited in the 913 Study, suggested that 
this was a gap that should be addressed. See 913 Study, supra note 
38, at 138 (citing letters from AALU, Bank of America, FSI, 
Hartford, LPL, UBS, and Woodbury).
---------------------------------------------------------------------------

    We request comment on whether there should be federal licensing and 
continuing education requirements for personnel of SEC-registered 
investment advisers. Such requirements could be designed to address 
minimum and ongoing competency requirements for the personnel of SEC-
registered advisers.\67\
---------------------------------------------------------------------------

    \67\ See 913 Study, supra note 38, at 138.
---------------------------------------------------------------------------

     Should investment adviser representatives be subject to 
federal continuing education and licensing requirements?
     Which advisory personnel should be included in these 
requirements? For example, should persons whose functions are solely 
clerical or ministerial be excluded, similar to the exclusion in the 
FINRA rules regarding broker-dealer registered representatives? Should 
a subset of registered investment adviser personnel (such as supervised 
persons, individuals for whom an adviser must deliver a Form ADV 
brochure supplement, ``investment adviser representatives'' as defined 
in the Advisers Act, or some other group) be required to comply with 
such requirements?
     How should the continuing education requirement be 
structured? How frequent should the certification be? How many hours of 
education should be required? Who should determine what qualifies as an 
authorized continuing education class?
     How could unnecessary duplication of any existing 
continuing education requirement be avoided?
     Should these individuals be required to register with the 
Commission? What information should these individuals be required to 
disclose on any registration form? Should the registration requirements 
mirror the requirements of existing Form U4 or require additional 
information? Should such registration requirements apply to individuals 
who provide advice on behalf of SEC-registered investment advisers but 
fall outside the definition of ``investment adviser representative'' in 
rule 203A-3 (because, for example, they have five or fewer clients who 
are natural persons, they provide impersonal investment advice, or ten 
percent or less of their clients are individuals other than qualified 
clients)? Should these individuals be required to pass examinations, 
such as the Series 65 exam required by most states, or to hold certain 
designations, as part of any registration requirements? Should other 
steps be required as well, such as a background check or 
fingerprinting? Would a competency or other examination be a 
meritorious basis upon which to determine competency and proficiency? 
Would a competency or other examination requirement provide a false 
sense of security to advisory clients of competency or proficiency?
     If continuing education requirements are a part of any 
licensing requirements, should specific topics or types of training be 
required? For example, these individuals could be required to complete 
a certain amount of training dedicated to ethics, regulatory 
requirements or the firm's compliance program.
     What would the expected benefits of continuing education 
and licensing be? Would it be an effective way to increase the quality 
of advice provided to investors? Would it provide better visibility 
into the qualifications and education of personnel of SEC-registered 
investment advisers?
     What would the expected costs of continuing education and 
licensing be? How expensive would it be to obtain the continuing 
education or procure the license? Do those costs scale, or would they 
fall more heavily on smaller advisers? Would these requirements result 
in a barrier to entry that could decrease the number of advisers and 
advisory personnel (and thus potentially increase the cost of advice)?
     What would the effects be of continuing education and 
licensing for investment adviser personnel in the market for investment 
advice (i.e., as compared to broker-dealers)?
     What other types of qualification requirements should be 
considered, such as minimum experience requirements or standards 
regarding an individual's fitness for serving as an investment adviser 
representative?

B. Provision of Account Statements

    Fees and costs are important to retail investors,\68\ but many 
retail investors are uncertain about the fees they will pay.\69\ The 
relationship summary that we are proposing in a concurrent release 
would discuss certain differences between advisory and brokerage fees 
to provide investors more clarity concerning the key categories of fees 
and expenses they should expect to pay, but would not require more 
complete, specific or personalized disclosures or disclosures about the 
amount of fees and expenses.\70\ We believe that delivery of periodic 
account statements, if they specified the dollar amounts of

[[Page 21213]]

fees and expenses, would allow clients to readily see and understand 
the fees and expenses they pay for an adviser's services. Clients would 
receive account statements close in time to the assessment of periodic 
account fees, which could be an effective way for clients to understand 
and evaluate the cost of the services they are receiving from their 
advisers.
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    \68\ See Staff of the Securities and Exchange Commission, Study 
Regarding Financial Literacy Among Investors as required by Section 
917 of the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(Aug. 2012), at iv, available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf (``With respect to 
financial intermediaries, investors consider information about fees, 
disciplinary history, investment strategy, conflicts of interest to 
be absolutely essential.'').
    \69\ See Angela A. Hung, et al., RAND Institute for Civil 
Justice, Investor and Industry Perspectives on Investment Advisers 
and Broker-Dealers (2008), at xix, available at https://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf (``In fact, focus-group 
participants with investments acknowledged uncertainty about the 
fees they pay for their investments, and survey responses also 
indicate confusion about the fees.'').
    \70\ See Form CRS Proposal, supra note 6, at Section II.B.4.
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    Broker-dealers are required to provide confirmations of 
transactions with detailed information concerning commissions and 
certain other remuneration, as well as account statements containing a 
description of any securities positions, money balances or account 
activity during the period since the last statement was sent to the 
customer.\71\ Broker-dealers generally must provide account statements 
no less than once every calendar quarter. Brokerage customers must 
receive periodic account statements even when not receiving immediate 
trade confirmations.\72\ Although we understand that many advisers do 
provide clients with account statements, advisers are not directly 
required to provide account statements under the federal securities 
laws. Notably, however, the custody rule requires advisers with custody 
of a client's assets to have a reasonable basis for believing that the 
qualified custodian sends an account statement at least quarterly.\73\ 
In addition, in any separately managed account program relying on rule 
3a-4 under the Investment Company Act of 1940, the program sponsor or 
another person designated by the sponsor must provide clients 
statements at least quarterly containing specified information.\74\
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    \71\ See, e.g., NASD Rule 2340; FINRA Rule 2232; MSRB Rule G-15. 
See also Exchange Act rule 15c3-2 (account statements); Exchange Act 
rule 10b-10 (confirmation of transactions).
    \72\ See Confirmation of Transactions, Securities Exchange Act 
Release No. 34962 (November 10, 1994).
    \73\ Advisers Act rule 206(4)-2(a)(3) (custody rule). The 
Commission also has stated that an adviser's policies and 
procedures, at a minimum, should address the accuracy of disclosures 
made to investors, clients, and regulators, including account 
statements.
    \74\ Investment Company Act of 1940 [15 U.S.C. 80a-1 et seq.] 
(``Investment Company Act'') rule 3a-4(a)(4).
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    We request comment on whether we should propose rules to require 
registered investment advisers to provide account statements, either 
directly or via the client's custodian, regardless of whether the 
adviser is deemed to have custody of client assets under Advisers Act 
Rule 206(4)-2 or the adviser is a sponsor (or a designee of a sponsor) 
of a managed account program relying on the safe harbor in Investment 
Company Act rule 3a-4.
     To what extent do retail clients of registered investment 
advisers already receive account statements? To what extent do those 
account statements specify the dollar amounts charged for advisory fees 
and other fees (e.g., brokerage fees) and expenses? Would retail 
clients benefit from a requirement that they receive account statements 
from registered investment advisers? If clients are uncertain about 
what fees and expenses they will pay, would they benefit from a 
requirement that, before receiving advice from a registered investment 
adviser, they enter into a written (including electronic) agreement 
specifying the fees and expenses to be paid?
     What information, in addition to fees and expenses, would 
be most useful for retail clients to receive in account statements? 
Should any requirement to provide account statements have prescriptive 
requirements as to presentation, content, and delivery? Should they 
resemble the account statements required to be provided by broker-
dealers, under NASD Rule 2340 with the addition of fee disclosure?
     How often should clients receive account statements?
     How costly would it be to provide account statements? Does 
that cost depend on how those account statements could be delivered 
(e.g., via U.S. mail, electronic delivery, notice and access)? Are 
there any other factors that would impact cost?

C. Financial Responsibility

    Broker-dealers are subject to a comprehensive financial 
responsibility program. Pursuant to Exchange Act rule 15c3-1 (the net 
capital rule), broker-dealers are required to maintain minimum levels 
of net capital designed to ensure that a broker-dealer under financial 
stress has sufficient liquid assets to satisfy all non-subordinated 
liabilities without the need for a formal liquidation proceeding.\75\ 
Exchange Act rule 15c3-3 (the customer protection rule) requires 
broker-dealers to segregate customer assets and maintain them in a 
manner designed to ensure that should the broker-dealer fail, those 
assets are readily available to be returned to customers.\76\ Broker-
dealers are also subject to extensive recordkeeping and reporting 
requirements, including an annual audit requirement as well as a 
requirement to make their audited balance sheets available to 
customers.\77\ Broker-dealers are required to be members of the 
Securities Investor Protection Corporation (``SIPC''), which is 
responsible for overseeing the liquidation of member broker-dealers 
that close due to bankruptcy or financial trouble and customer assets 
are missing. When a brokerage firm is closed and customer assets are 
missing, SIPC, within certain limits, works to return customers' cash, 
stock, and other securities held by the firm. If a firm closes, SIPC 
protects the securities and cash in a customer's brokerage account up 
to $500,000, including up to $250,000 protection for cash in the 
account.\78\ Finally, FINRA rules require that broker-dealers obtain 
fidelity bond coverage from an insurance company.\79\
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    \75\ See Exchange Act rule 15c3-1.
    \76\ See Exchange Act rule 15c3-3.
    \77\ See Exchange Act rules 17a-3, 17a-4, and 17a-5.
    \78\ See Securities Investor Protection Act of 1970, Public Law 
91-598, 84 Stat. 1636 (Dec. 30, 1970), 15 U.S.C. 78aaa through 15 
U.S.C. 78lll.
    \79\ See FINRA Rule 4360, (``Fidelity Bonds'').
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    Under Advisers Act rule 206(4)-2, investment advisers with custody 
must generally maintain client assets with a ``qualified custodian,'' 
which includes banks and registered broker-dealers, and must comply 
with certain other requirements.\80\ In 2009 the Commission adopted 
amendments to the custody requirements for investment advisers that, 
among other enhancements, required all registered investment advisers 
with custody of client assets to undergo an annual surprise examination 
by an independent public accountant. SEC-registered investment 
advisers, however, are not subject to any net capital requirements 
comparable to those applicable to broker-dealers, although they must 
disclose any material financial condition that impairs their ability to 
provide services to their clients.\81\ Many investment advisers have 
relatively small amounts of capital, particularly compared to the 
amount of assets that they have under management.\82\ When we discover 
a serious fraud by an adviser, often the assets of the adviser are 
insufficient to compensate clients for their loss. In addition, 
investment advisers are not required to obtain fidelity bonds, unlike

[[Page 21214]]

many other financial service providers that have access to client 
assets.\83\
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    \80\ See Advisers Act rule 206(4)-2.
    \81\ See Form ADV. Many states have imposed fidelity bonding 
and/or net capital requirements on state-registered investment 
advisers. Rule 17g-1 under the Investment Company Act of 1940 
requires registered investment companies to obtain fidelity bonds 
covering their officers and employees who may have access to the 
investment companies' assets.
    \82\ See Custody of Funds or Securities of Clients by Investment 
Advisers, Investment Advisers Act Release No. 2968 (Dec. 30, 2009).
    \83\ Fidelity bonds are required to be obtained by broker-
dealers (FINRA Rule 4360; New York Stock Exchange Rule 319; American 
Stock Exchange Rule 330); transfer agents (New York Stock Exchange 
Rule Listed Company Manual Sec.  906); investment companies (17 CFR 
270.17g-1); national banks (12 CFR 7.2013); federal savings 
associations (12 CFR 563.190).
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    In light of these disparities, we request comment on whether SEC-
registered investment advisers should be subject to financial 
responsibility requirements along the lines of those that apply to 
broker-dealers.
     What is the frequency and severity of client losses due to 
investment advisers' inability to satisfy a judgment or otherwise 
compensate a client for losses due to the investment adviser's 
wrongdoing?
     Should investment advisers be subject to net capital or 
other financial responsibility requirements in order to ensure they can 
meet their obligations, including compensation for clients if the 
adviser becomes insolvent or advisory personnel misappropriate clients' 
assets? \84\ Do the custody rule and other rules \85\ under the 
Advisers Act adequately address the potential for misappropriation of 
client assets and other financial responsibility concerns for advisers? 
Should investment advisers be subject to an annual audit requirement?
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    \84\ We note that Congress and the Commission have considered 
such requirements in the past. In 1973, a Commission advisory 
committee recommended that Congress authorize the Commission to 
adopt minimum financial responsibility requirements for investment 
advisers, including minimum capital requirements. See Report of the 
Advisory Committee on Investment Management Services for Individual 
Investors, Small Account Investment Management Services, Fed. Sec. 
L. Rep. (CCH) No. 465, Pt. III, 64-66 (Jan. 1973) (``Investment 
Management Services Report''). Three years later, in 1976, the 
Senate Committee on Banking, Housing and Urban Affairs considered a 
bill that, among other things, would have authorized the Commission 
to adopt rules requiring investment advisers (i) with discretionary 
authority over client assets, or (ii) that advise registered 
investment companies, to meet financial responsibility standards. S. 
Rep. No. 94-910, 94th Cong. 2d Sess. (May 20, 1976) (reporting 
favorably S. 2849). S. 2849 was never enacted. In 1992, both the 
Senate and House of Representatives passed bills that would have 
given the Commission the explicit authority to require investment 
advisers with custody of client assets to obtain fidelity bonds. S. 
226, 102d Cong., 2d Sess. (Aug. 12, 1992) and H.R. 5726, 102d Cong. 
Ed (Sept. 23, 1992). Differences in these two bills were never 
reconciled and thus neither became law. In 2003, the Commission 
requested comment on whether to require a fidelity bonding 
requirement for advisers as a way to increase private sector 
oversight of the compliance by funds and advisers with the federal 
securities laws. The Commission decided not to adopt a fidelity 
bonding requirement at that time, but noted that it regarded such a 
requirement as a viable option should the Commission wish to further 
strengthen compliance programs of funds and advisers. Compliance 
Programs of Investment Companies and Investment Advisers, Investment 
Company Act Release No. 25925 (Feb. 5, 2003).
    \85\ See, e.g., Advisers Act rule 206(4)-7 (requires each 
investment adviser registered or required to be registered with the 
Commission to adopt and implement written policies and procedures 
reasonably designed to prevent violations of the Advisers Act and 
Advisers Act rules, review those policies and procedures annually, 
and designate an individual to serve as a chief compliance officer).
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     Should advisers be required to obtain a fidelity bond from 
an insurance company? If so, should some advisers be excluded from this 
requirement? \86\ Is there information or data that demonstrates 
fidelity bonding requirements provide defrauded clients with recovery, 
and if so what amount or level of recovery is evidenced?
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    \86\ As noted above, the 1992 legislation would have given us 
the explicit authority to require bonding of advisers that have 
custody of client assets or that have discretionary authority over 
client assets. Section 412 of ERISA [29 U.S.C. 1112] and related 
regulations (29 CFR 2550.412-1 and 29 CFR 2580) generally require 
that every fiduciary of an employee benefit plan and every person 
who handles funds or other property of such a plan shall be bonded. 
Registered investment advisers exercising investment discretion over 
assets of plans covered by title I of ERISA are subject to this 
requirement; it does not apply to advisers who exercise discretion 
with respect to assets in an individual retirement account or other 
non-ERISA retirement account. In 1992, only approximately three 
percent of Commission registered advisers had discretionary 
authority over client assets; as of March 31, 2018, according to 
data collected on Form ADV, 91 percent of Commission registered 
advisers have that authority.
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     Alternatively, should advisers be required to maintain a 
certain amount of capital that could be the source of compensation for 
clients? \87\ What amount of capital would be adequate? \88\
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    \87\ See supra note 84.
    \88\ Section 412 of ERISA provides that the bond required under 
that section must +be at least ten percent of the amount of funds 
handled, with a maximum required amount of $500,000 (increased to 
$1,000,000,000 for plans that hold securities issued by an employer 
of employees covered by the plan).
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     What would be the expected cost of either maintaining some 
form of reserve capital or purchasing a fidelity bond? Specifically, in 
addition to setting aside the initial sum or purchasing the initial 
bond, what would be the ongoing cost and the opportunity cost for 
investment advisers? Would one method or the other be more feasible for 
certain types of investment advisers (particularly, smaller advisers)?
     Would the North American Securities Administrators 
Association Minimum Financial Requirements For Investment Advisers 
Model Rule 202(d)-1 \89\ (which requires, among other things, an 
investment adviser who has custody of client funds or securities to 
maintain at all times a minimum net worth of $35,000 (with some 
exceptions), an adviser who has discretionary authority but not custody 
over client funds or securities to maintain at all times a minimum net 
worth of $10,000, and an adviser who accepts prepayment of more than 
$500 per client and six or more months in advance to maintain at all 
times a positive net worth), provide an appropriate model for a minimum 
capital requirement? Why or why not?
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    \89\ NASAA Minimum Financial Requirements For Investment 
Advisers Model Rule 202(d)-1 (Sept. 11, 2011), available at https://www.nasaa.org/wp-content/uploads/2011/07/IA-Model-Rule-Minimum-Financial-Requirements.pdf.
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     Although investment advisers are required to report 
specific information about the assets that they manage on behalf of 
clients, they are not required to report specific information about 
their own assets.\90\ Should advisers be required to obtain annual 
audits of their own financials and to provide such information on Form 
ADV? Would such a requirement raise privacy concerns for privately held 
advisers?
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    \90\ Form ADV only requires that advisers with significant 
assets (at least $1 billion) report the approximate amount of their 
assets within one of the three ranges ($1 billion to less than $10 
billion, $10 billion to less than $50 billion, and $50 billion or 
more). Item 1.O of Part 1A of Form ADV.

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    By the Commission.

    Dated: April 18, 2018.
Brent J. Fields,
Secretary.
[FR Doc. 2018-08679 Filed 5-8-18; 8:45 am]
 BILLING CODE 8011-01-P

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