The Securities and Exchange Commission has issued an interpretation that reaffirms and, in some cases, clarifies the fiduciary duty that an investment adviser owes to its clients under federal law.
The SEC said it was beneficial to address the standard that private equity fund managers and other investment advisers owe their clients under Investment Advisers Act of 1940, after it proposed rules in 2018 to enhance the required standard of conduct for broker-dealers.
The SEC’s interpretation, which took effect in July 2019, will sound familiar to many advisers.
“In general, we expect this Final Interpretation to affirm investment advisers’ understanding of the fiduciary duty they owe their clients under the Advisers Act, reduce uncertainty for advisers, and facilitate their compliance,” the commission wrote.
Waiver Of Duties
The interpretation reaffirms an investment adviser’s fiduciary duty comprises a duty of care, and a duty of loyalty. It makes clear that an adviser’s federal fiduciary duty will apply in a way that reflects the agreed-upon scope of the relationship, but can’t be waived.
Contract provisions purporting to waive the adviser’s fiduciary duty generally – such as a statement that the adviser will not act as a fiduciary or a blanket waiver of all conflicts of interest – “would be inconsistent with the Advisers Act, regardless of the sophistication of the client,” the agency wrote.
Duty of Care
An important part of duty of care is to provide advice that’s in the best interest of the client. This is based on a “reasonable understanding” of the client’s objectives. To this end, an adviser should, at a minimum, make inquiries into a retail client’s financial situation, its level of financial sophistication, investment experience, and financial goals.
The duty of care also includes a duty to seek best execution of a client’s transactions where the adviser has the responsibility to select broker-dealers to execute client trades. Maximizing value is more than just minimizing cost, the SEC said: “the ‘determinative factor’” is “‘whether the transaction represents the best qualitative execution.’” The adviser also has a duty to provide advice and monitoring over the course of the relationship.
Duty of Loyalty
The duty of loyalty requires an investment adviser not place its own interest ahead of the client’s interests. Among other things, advisers must fully disclose to clients all “material facts” related to their arrangement. The disclosures should also be specific. For example, it would be inadequate to simply say the adviser “may” have a particular conflict when a conflict actually exists.
“In all of these cases where an investment adviser cannot fully and fairly disclose a conflict of interest to a client such that the client can provide informed consent, the adviser should either eliminate the conflict or adequately mitigate (i.e., modify practices to reduce) the conflict such that full and fair disclosure and informed consent are possible,” the SEC said.
The full SEC interpretation can be found here.