Fiduciary duty is a legal obligation to act in another's interest when acting on their behalf. For an investment adviser, the SEC describes the federal fiduciary duty under the Investment Advisers Act of 1940 as a duty of care and a duty of loyalty: the adviser must, at all times, "serve the best interest of its client and not subordinate its client's interest to its own". Other roles carry other standards, including Regulation Best Interest for broker-dealers' recommendations and ERISA for fiduciaries of employee benefit plans.
Why It Matters
Which standard applies, and to which part of a relationship, decides how a firm's recommendations, compensation and conflicts of interest are judged. An adviser's fiduciary duty applies to the entire relationship with the client and cannot be waived, though adviser and client may shape the scope of the relationship by agreement with full and fair disclosure and informed consent; a broker-dealer's obligation under Regulation Best Interest attaches to each recommendation it makes to a retail customer.
How It Works in Practice
- 1Investment advisers: the SEC's Commission Interpretation Regarding Standard of Conduct for Investment Advisers (Release IA-5248, June 5, 2019) says the duty under the Advisers Act "is broad and applies to the entire adviser-client relationship" and comprises a duty of care and a duty of loyalty.
- 2Duty of loyalty: an adviser "must eliminate or at least expose through full and fair disclosure all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested", and disclosure and consent do not by themselves satisfy the duty to act in the client's best interest.
- 3Broker-dealers: Regulation Best Interest (17 CFR 240.15l-1), adopted by the SEC in June 2019 under the Securities Exchange Act of 1934, requires a broker-dealer making a recommendation to a retail customer to "act in the best interest of the retail customer at the time the recommendation is made", through disclosure, care, conflict of interest and compliance obligations. It is a separate rule from the Advisers Act fiduciary duty.
- 4Retirement plans: ERISA section 404(a) requires a plan fiduciary to discharge its duties "solely in the interest of the participants and beneficiaries", for the exclusive purpose of providing benefits and defraying reasonable plan expenses, and with the care, skill, prudence and diligence of the statute's prudent man standard.
Common Pitfalls
Describing the adviser standard as acting "solely" in the client's interest. That is ERISA's statutory wording for plan fiduciaries; the SEC's adviser interpretation instead speaks of serving the client's best interest and not subordinating it to the adviser's own, with conflicts eliminated or disclosed so the client can give informed consent.
Treating Regulation Best Interest as the old suitability standard, or as the adviser fiduciary duty. For a dual registrant the standard depends on the capacity in which it acts: Regulation Best Interest requires disclosure that the firm is acting as a broker-dealer with respect to a recommendation, and the SEC's adviser interpretation expects dual registrants to disclose when they will act in an advisory capacity.
Relying on disclosure alone. Under the SEC's interpretation, disclosure and informed consent can address a conflict, but they do not themselves satisfy the adviser's duty to act in the client's best interest, and a contract provision cannot waive the federal fiduciary duty.
Sources
- Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-5248 (June 5, 2019) — U.S. Securities and Exchange Commission
- 17 CFR 240.15l-1, Regulation best interest — eCFR
- 29 U.S. Code § 1104, Fiduciary duties (ERISA section 404) — Legal Information Institute, Cornell Law School
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