Key Takeaways
- Investment advisers owe a fiduciary duty comprised of duty of care AND duty of loyalty.
- Fiduciary duty requires acting in the client's BEST interest, not just a suitable option.
- The duty of care includes providing advice, seeking best execution, and ongoing monitoring.
- The duty of loyalty requires putting client interests first and avoiding self-dealing.
- Fiduciary duty CANNOT be waived, though specific terms can be shaped by contract.
- All conflicts of interest must be disclosed and managed or eliminated.
- Broker-dealers are subject to Regulation Best Interest (Reg BI), not full fiduciary duty.
- Reg BI has four components: Disclosure, Care, Conflict of Interest, and Compliance.
Fiduciary Duty
Investment advisers owe a fiduciary duty to their clients - the highest standard of care in the financial services industry.
The SEC's Fiduciary Interpretation
In 2019, the SEC issued a formal interpretation clarifying that an investment adviser's fiduciary duty under the Investment Advisers Act of 1940 has two main components:
Duty of Care
The duty of care requires advisers to provide advice with diligence and skill, always in the client's best interest.
| Component | Description |
|---|---|
| Provide suitable advice | Based on client's goals, risk tolerance, and financial situation |
| Seek best execution | Obtain the most favorable terms reasonably available |
| Provide advice and monitoring | Ongoing guidance throughout the relationship |
| Make reasonable inquiry | Understand client's circumstances before advising |
Duty of Loyalty
The duty of loyalty requires placing the client's interests ahead of the adviser's.
| Component | Description |
|---|---|
| Put client first | Never subordinate client interests to your own |
| Avoid self-dealing | Don't benefit at the client's expense |
| Disclose conflicts | Full and fair disclosure of all material conflicts |
| Obtain informed consent | Client must understand and agree to any conflicts |
Key Principles
Cannot Waive Fiduciary Duty
The SEC expressly stated that the federal fiduciary duty cannot be waived entirely. However:
- Advisers and clients can shape the relationship by contract
- Specific scope of services can be limited
- Full and fair disclosure is always required
- Informed consent must be obtained
Best Interest Standard
The "best interest" obligation is an overarching principle that encompasses both duties:
- Not just suitable - the BEST option for the client
- Considered at the time advice is given
- Must continue throughout the relationship
Fiduciary vs. Suitability vs. Reg BI
| Standard | Applies To | Key Requirement |
|---|---|---|
| Fiduciary Duty | Investment Advisers | Act in client's BEST interest always |
| Reg BI | Broker-Dealers | Best interest at time of recommendation |
| Suitability | Historical BD standard | Recommendation must be suitable |
Important Distinctions
| Factor | Fiduciary (IA) | Reg BI (BD) |
|---|---|---|
| Scope | Entire relationship | Point of recommendation |
| Ongoing duty | Yes, continuous | At recommendation only |
| Monitoring | Required | Not required |
| Standard | Highest standard | Elevated suitability |
Regulation Best Interest (Reg BI)
Effective June 30, 2020, Reg BI requires broker-dealers to act in the retail customer's best interest at the time of a recommendation.
Four Component Obligations
| Obligation | Requirement |
|---|---|
| Disclosure | Provide Form CRS; disclose material facts |
| Care | Exercise reasonable diligence and skill |
| Conflict of Interest | Establish policies to identify and mitigate conflicts |
| Compliance | Written policies and procedures for supervision |
Form CRS (Client Relationship Summary)
Both investment advisers and broker-dealers must provide Form CRS to retail investors:
- Maximum 2 pages (4 pages for dual registrants)
- Plain language format
- Key questions to consider
- Comparison of services (for dual registrants)
Conflicts of Interest
Common Conflicts for Investment Advisers
| Conflict Type | Example |
|---|---|
| Compensation conflicts | Higher fees for recommending certain products |
| Principal trading | Selling securities from own inventory |
| Soft dollars | Using client commissions for research |
| Referral fees | Compensation for sending business |
| Outside activities | Board seats, side businesses |
| Personal trading | Trading same securities as clients |
Managing Conflicts
| Strategy | Description |
|---|---|
| Eliminate | Remove the conflict entirely if possible |
| Disclose | Full and fair disclosure in ADV Part 2A |
| Mitigate | Implement policies to reduce harm |
| Obtain consent | Client's informed agreement |
Disclosure Requirements
Advisers must disclose in Form ADV Part 2A:
- All fees and compensation arrangements
- Conflicts of interest
- Disciplinary history
- Material facts about business practices
- Code of ethics summary
Exam Tip: Fiduciary duty CANNOT be waived entirely. It has TWO components: duty of CARE and duty of LOYALTY. Reg BI applies to broker-dealers, not investment advisers. Conflicts must be DISCLOSED, not just avoided.
Under the SEC's fiduciary interpretation, an investment adviser's fiduciary duty consists of:
Which statement about an investment adviser's fiduciary duty is TRUE?
Regulation Best Interest (Reg BI) applies to:
The four component obligations of Regulation Best Interest are:
13.2 Prohibited and Unethical Practices
Continue learning