A FIDUCIARY DUTY FOR ALL?

Transcription

1 A FIDUCIARY DUTY FOR ALL? Kristina A. Fausti INTRODUCTION Two Regimes: The Investment Adviser Standard versus the Broker-Dealer Standard A. Separate Regulatory Structures B. The Standards of Conduct Addressing Investor Confusion Defining Fiduciary Fiduciary in New Legislation and Regulation A. The State of Legislation B. The Role of Regulation Regulatory Application of Fiduciary Measures A. Balancing Principles and Rules B. Fiduciary-like Measures The Practical Reality A. Effect on Investors B. Effect on Professionals CONCLUSION INTRODUCTION For years, the investment adviser community has called for all financial professionals who provide investment advice to be subject to the fiduciary standard. On June 17, 2009, it seemed their calls would be answered when the Obama Administration issued its framework for financial regulatory reform, which declared that standards of care for all broker-dealers when providing investment advice about securities Kristina Fausti, Esq., is the Director of Legal and Regulatory Affairs for Fiduciary360 (J.D., Georgetown University Law Center, 2002; M.B.A., Georgetown University McDonough School of Business, 2002; B.S.B.A., Accounting and Computer & Information Systems, Robert Morris University, 1997). The author previously served as a Special Counsel in the Office of Chief Counsel of the Division of Trading and Markets at the U.S. Securities and Exchange Commission and specialized in broker-dealer regulation. Fiduciary360 focuses on promoting a culture of fiduciary responsibility and offers training, web-based tools and other resources for investment fiduciaries. 183

2 184 Duquesne Business Law Journal [Vol. 12:183 to retail investors should be raised to the fiduciary standard to align the legal framework with investment advisers. 1 The Administration s recommendation created much needed momentum for reform that would create important protections for investors. As a result, greater clarity on the fiduciary standard and how it applies to financial professionals could be achieved through legislative or regulatory guidance in the near future. 2 Indeed, the U.S. House of Representatives passed a financial regulatory reform bill that would call on the U.S. Securities & Exchange Commission ( SEC or Commission ) to adopt rules for broker-dealers who provide investment advice to retail investors. It still remains to be seen whether the U.S. Senate will also embrace this or a similar approach. Yet, despite any legislative uncertainty, awareness of the fiduciary issue in the public arena appears to have prompted regulators to seek out ways to advance fiduciary measures with or without legislation. This article will explore the recent movement to expand the reach of the fiduciary standard and its potential impact on the financial services industry and investors. First, I will examine the fiduciary standard that applies to investment advisers under the federal securities laws and how it compares to the commercial standard of conduct for broker-dealers (a comparison that looks beyond suitability requirements). I will then discuss legislative and regulatory proposals for extending the fiduciary duty to broker-dealers who provide investment advice and where those proposals will likely end up. I will also address the practical ramifications of legislative and regulatory changes on both financial professionals and investors, and how these consequences should shape any ultimate recommendations for reform. 1. Two Regimes: The Investment Adviser Standard versus the Broker-Dealer Standard Since the release of the Obama Administration s recommendation to extend the fiduciary duty, main stream media journalists, professionals, and academics alike have all highlighted differences between 1. U.S. DEPARTMENT OF THE TREASURY, FINANCIAL REGULATORY REFORM: A NEW FOUNDATION: REBUILDING FINANCIAL SUPERVISION AND REGULATION at 72 (June 30, 2009), 2. For purposes of this article, the financial professionals that will be discussed include broker-dealers and investment advisers as defined and regulated under the federal securities laws.

3 2010] A Fiduciary Duty For All? 185 investment advisers and broker-dealers by comparing the fiduciary standard to the suitability standard. 3 Suitability, however, is not necessarily a standard of conduct, but rather a regulatory requirement for most financial professionals under the federal securities laws. In fact, as discussed further herein, investment advisers have as much of an obligation to meet suitability requirements as broker-dealers. 4 Consequently, framing suitability and fiduciary as either/or options is an improper comparison given that all financial professionals are subject to suitability obligations in some manner despite their roles as investment advisers or broker-dealers, or fiduciaries or non-fiduciaries. A. Separate Regulatory Structures The correct point of comparison between investment advisers and broker-dealers is drawn from the two different statutory and regulatory frameworks governing these professionals roles, conduct, and practices. Under the federal securities laws, investment advisers have long been regulated as trusted advisors while broker-dealers have been regulated as salespeople. In particular, brokers and dealers (collectively referred to herein as broker-dealers ) are regulated under the Securities Exchange Act of Both are generally defined as persons engaged in the business of buying and selling securities. 5 Brokers typically buy and sell securities for the account of others, while dealers buy and sell for their own account. 6 Broker-dealers normally are regulated at the federal 3. See, e.g., Terry Savage, Why Your Stockbroker Doesn t Really Work for You, CHICAGO SUN-TIMES, Mar. 30, 2010, Tara Siegel Bernard, Trusted Advisor or Stock Pusher? Finance Bill May Not Settle It, N.Y. TIMES, March 4, 2010, at B1, available at Steven D. Irwin, Scott A. Lane & Carolyn W. Mendelson, Wasn t My Broker Always Looking Out for My Best Interests? The Road to Become a Fiduciary, 12 DUQ. BUS. L.J. 13, (2009). 4. See ROBERT E. PLAZE, DIVISION OF INVESTMENT MANAGEMENT, U.S. SECURITIES & EXCHANGE COMMISSION, THE REGULATION OF INVESTMENT ADVISERS BY THE SECURITIES AND EXCHANGE COMMISSION 4 (Nov. 22, 2006), see also Suitability of Investment Advice Provided by Investment Advisers, Investment Advisers Act Release No. 1406, 59 Fed. Reg. 13,464 (Mar. 16, 1994). 5. Securities Exchange Act of (a)(4), 15 U.S.C. 78c(a)(4) (2006). 6. Securities Exchange Act of (a)(5), 15 U.S.C. 78c(a)(5) (2006).

4 186 Duquesne Business Law Journal [Vol. 12:183 level by the SEC and a self-regulatory organization ( SRO ), usually the Financial Industry Regulatory Authority ( FINRA ). 7 Brokerdealers may also be subject to state regulation. 8 Individuals who work for a broker-dealer, known as registered representatives, also must be registered with FINRA or the relevant self-regulatory organization. 9 Investment advisers are regulated separately under the Investment Advisers Act of 1940 ( Advisers Act ). An investment adviser is generally defined as a person 10 that is engaged in the business of providing advice to others regarding securities. 11 Most investment advisers are regulated at the federal level by the SEC or at the state level depending on their size. 12 Individuals who work for a registered investment adviser, known as investment adviser representatives, also must be registered at the state level. In most cases, anyone that meets the definition of a broker, dealer, or investment adviser would be required to register as such with the SEC, states, and/or an SRO, where applicable. There is, however, a so-called broker exemption in the Advisers Act for broker-dealers who provide advice that is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor It should be noted that this exemption includes two key components: (1) advice must be solely incidental to brokerdealers business; and (2) broker-dealers can receive no special compensation, meaning they must earn only brokerage commissions for 7. In 2007, the National Association of Securities Dealers was consolidated with the member regulation, enforcement, and arbitration functions of the New York Stock Exchange to create FINRA. See Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change to Amend the By-Laws of NASD to Implement Governance and Related Changes to Accommodate the Consolidation of the Member Firm Regulatory Functions of NASD and NYSE Regulation, Inc., Exchange Act Release No , 2007 SEC LEXIS 1641 (July 26, 2007). 8. See DIVISION OF TRADING AND MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION, GUIDE TO BROKER-DEALER REGULATION (Apr. 2008), 9. Id. 10. Person under the federal securities laws generally refers to both natural persons and companies. See Investment Advisers Act of (a)(16), 15 U.S.C. 80b-2(a)(16); Securities Exchange Act of (a)(9), 15 U.S.C. 78c(a)(9). 11. Investment Advisers Act of (a)(11), 15 U.S.C. 80b-2(a)(11). 12. See PLAZE, supra note 4, at Investment Advisers Act of (a)(11), 15 U.S.C. 80b-2(a)(11).

5 2010] A Fiduciary Duty For All? 187 their services. 14 While arguments have been advanced regarding the archaic nature of this exemption, 15 it still applies today. It also shields many broker-dealers who provide advice from registering as investment advisers and being subject to the fiduciary standard of care as further explained below. B. The Standards of Conduct Conduct of investment advisers and broker-dealers is regulated under the respective statutory and regulatory regimes for each group of professionals. Specifically, broker-dealer conduct is governed both under the laws and regulations of the Exchange Act and FINRA rules. The SEC has long applied the so-called shingle theory to brokerdealers, which holds that by presenting itself as ready to do business with the public (i.e., hanging its shingle ), the broker-dealer represents that it will deal fairly with its customers. 16 Thus, under the anti-fraud provisions of the Exchange Act, 17 a broker-dealer is deemed to owe its customer a duty of fair dealing. Similarly, FINRA Conduct Rule 2010 lays the basis for brokerdealer conduct requiring high standards of commercial honor and just and equitable principles of trade to be observed. 18 Both the SEC and FINRA standards of care have long been viewed as commercial standards that reflect the role of broker-dealers as salespeople in the investment marketplace. In fact, throughout the Exchange Act and FINRA rules, investors who deal with broker-dealers are referred to as customers further reflecting the commercial nature of their relationship with broker-dealers. 19 Specific regulatory requirements that flow from the duty of fair dealing under the Exchange Act and FINRA 14. Arthur B. Laby, Reforming the Regulation of Broker-Dealers and Investment Advisers, 65 BUS. LAW. 395 (Feb. 2010) (citing H.R. REP. NO. 1775, at 22 (1940)). 15. Id. 16. DIVISION OF TRADING AND MARKETS, supra note 8. In particular, the brokerdealer represents it will deal fairly with customers, consistent with the standards of the profession. Id. 17. Securities Exchange Act of (a), 10(b), 15(c)(1)-(2), 15 U.S.C. 78i(a), 78j(b), 78o(c)(1)-(2). 18. FINRA Manual, FINRA Rule 2010, available at /en/display/display_main.html?rbid=2403&element_id= See, e.g., Securities Exchange Act of (b)(5), 7(c), 15 U.S.C. 78f(b)(5), 78g(c); FINRA Manual, FINRA Rule 2114, available at =8228&record_id=11290.

6 188 Duquesne Business Law Journal [Vol. 12:183 rules include suitability, 20 best execution, 21 disclosure of material information, 22 and charging fair and reasonable rates. 23 Investment adviser conduct is governed under the Advisers Act, and a fundamental concept underlying the Act is that an adviser is a fiduciary. 24 As explained in a landmark case defining fiduciary duties, Justice Benjamin Cardozo explained: A fiduciary is held to something stricter than the morals of the marketplace. 25 Courts and regulators have gone further to explain that the fiduciary duty goes beyond basic concepts of honesty, good faith, and fair dealing, and prohibits any professional from taking unfair advantage of an investor s trust. 26 To reflect the fact that the relationship goes beyond a commercial interaction, investors who are served by investment advisers are referred to throughout the Advisers Act as clients. 27 Similar to broker-dealers under the duty of fair dealing, investment 20. FINRA Manual, NASD Rule 2310, available at /en/display/display_main.html?rbid=2403&element_id=3638. Suitability is also enforced by the SEC under the antifraud provisions of the federal securities laws. Suitability obligations apply to recommendations made by a broker-dealer regarding a specific security or investment strategy. A broker must determine both reasonable basis suitability which relates to a particular security or strategy, and customer-specific suitability which relates to the customer s financial situation and needs. See DIVISION OF TRADING AND MARKETS, supra note FINRA Manual, NASD Rule 2320, available at en/display/display_main.html?rbid=2403&element_id= Securities Exchange Act of (b), 15 U.S.C. 78j(b); Securities Exchange Act of 1934 Rules 10b-5, 10b-10, 17 C.F.R b-5, b-10 (2010); see also DIVISION OF TRADING AND MARKETS, supra note FINRA Manual, NASD Rule 2440, available at Broker-dealers are also subject to several other substantive requirements related to, inter alia, trading securities, extending credit, and customer privacy. See DIVISION OF TRADING AND MARKETS, supra note The fiduciary duty is not specifically set forth in the Advisers Act, but is imposed by operation of law because of the nature of the relationship between the adviser and client. In 1963, the Supreme Court confirmed that investment advisers have a fiduciary duty under the Advisers Act. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963); see also PLAZE, supra note 4, at Meinhard v. Salmon, 164 N.E. 545, 546 (N.Y. 1928). 26. Meinhard, 164 N.E. at 546; see PLAZE, supra note 4, at 13; see also SEC Chairman Mary L. Schapiro, Address at the New York Financial Writers Association Annual Awards Dinner (June 18, 2009), available at See, e.g., Investment Advisers Act of (b), 206, 15 U.S.C. 80b- 3, 80b-6.

7 2010] A Fiduciary Duty For All? 189 advisers have obligations under the fiduciary duty to provide suitable investment advice, 28 seek best execution, 29 and disclose material facts. 30 The fiduciary duty goes further than the duty of fair dealing, though, by requiring the professional to avoid and disclose conflicts of interest. It is the treatment of conflicts of interest that largely separates investment advisers and broker-dealers under the fiduciary and fair dealing standards. An investment adviser must always seek to avoid conflicts of interest with clients and may not overreach or take unfair advantage of a client s trust. 31 In this regard, the fiduciary must be sensitive to both the conscious and unconscious potential for conflicts to arise with respect to the client s interest. 32 Broker-dealers on the other hand often have competing interests with their customers that they neither must avoid nor disclose in most cases. For example, as Professor Mercer Bullard 33 noted, an investment adviser would be re- 28. The SEC does not have a suitability rule for investment advisers, but enforces suitability violations through the anti-fraud rules contained in the federal securities laws. Investment advisers must have a reasonable basis for making recommendations and must also provide advice that is suitable in light of a client s financial situation and objectives. See George Sein Lin, Investment Advisers Act Release No. 1391, 1989 SEC LEXIS 1096 (Nov. 9, 1993) (finding investment adviser made highly risky investments that were unsuitable in light of his clients' investment objectives, assets, income and degree of sophistication concerning securities); Alfred C. Rizzo, Investment Advisers Act Release No. 897, 1984 SEC LEXIS 2429 (Jan. 11, 1984) (finding investment adviser did not have a reasonable basis for investment advice and failed to corroborate issuer s claims); see also PLAZE, supra note 4, at 14; Suitability of Investment Advice Provided by Investment Advisers, Investment Advisers Act Release No. 1406, 59 Fed. Reg (Mar. 16, 1994). 29. See In the Matter of Kidder Peabody & Co., Inc., Investment Advisers Act Release No. 232, 43 SEC 911 (Oct. 16, 1968) ( One of the basic duties of a fiduciary is the duty to execute securities transactions for clients in such a manner that the client's total cost or proceeds in each transaction is the most favorable under the circumstances ). 30. See In the Matter of Arlene W. Hughes, 27 SEC 629 (1948), aff'd sub nom., Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1940) ( [T]he duty of loyalty to his principal requires a fiduciary to disclose all material circumstances fully and completely ). Investment advisers also are subject to substantive requirements related to, inter alia, principal trades, custody of assets, and proxy voting. See PLAZE, supra note 4, at See PLAZE, supra note 4, at See Capital Gains Research, 375 U.S. at See Capital Markets Regulatory Reform: Strengthening Investor Protection, Enhancing Oversight of Private Pools of Capital, and Creating a National Insur-

8 190 Duquesne Business Law Journal [Vol. 12:183 quired under the fiduciary standard to disclose any differential compensation it receives as the result of recommending different products to its client because of the conflict of interest such differential compensation creates. Broker-dealers, however, generally have no such obligation to disclose differential compensation to their clients. 34 Such a difference in treatment creates an environment of caveat emptor for investors who deal with broker-dealers that is not present in interactions with investment advisers because of the burden placed on the professionals to serve investors best interest. Thus, this difference in regulatory standards for broker-dealers and investment advisers, coupled with the broker exemption, has created a severe gap in regulation and investor protection. 2. Addressing Investor Confusion As mentioned above, the Obama Administration s plan for financial regulatory reform set forth a specific initiative to empower the SEC to establish a fiduciary duty for broker-dealers offering investment advice. In addition to extending the fiduciary standard, the Administration s plan called for legislators and regulators to harmonize the investment adviser and broker-dealer regulatory regimes. 35 The Administration s plan also sought to further protect investors by calling for legislation that would require simple and clear disclosures to investors regarding the scope of their relationships with investment ance Office: Hearing Before the House Committee on Financial Services, 111th Cong. (Oct. 8, 2009), archived webcast available at apps/list/hearing/financialsvcs_dem/hr_ shtml; Meeting of the SEC Investor Advisory Committee (Oct. 5, 2009), archived webcast available at secadvisory100509/. Mercer Bullard, an Associate Professor of Law at the University of Mississippi School of Law, teaches courses on securities, banking, corporations, corporate finance, and law and economics, and is also the Founder and President of Fund Democracy, an advocacy group for mutual fund shareholders. 34. See, e.g., In re Morgan Stanley and Van Kampen Mutual Fund Sec. Litigation, 2006 U.S. Dist. LEXIS (S.D.N.Y. Apr. 14, 2006); United States v. Alvarado, 2001 U.S. Dist LEXIS (S.D.N.Y. December 17, 2001); Castillo v. Dean Witter Discover & Co., 1998 U.S. Dist. LEXIS 9489 (S.D.N.Y. June 25, 1998). 35. U.S. Department of the Treasury, supra note 1, at 71. The plan also notes that the SEC should be permitted to align duties for financial professionals across financial products. Id.

9 2010] A Fiduciary Duty For All? 191 professionals, and that would prohibit certain conflicts of interest and sales practices that are contrary to the interests of investors. 36 The Administration s recommendations were based on the widespread recognition that retail investors are often confused about the differences between investment advisers and broker-dealers. 37 Such investor confusion was studied and highlighted in the so-called RAND Report issued by the SEC in January The RAND Report concluded that investors did not understand key distinctions between investment advisers and broker-dealers, including their duties, the titles they use, and the services they offer. 39 Also contributing to investor confusion is the ambiguity and inconsistency in titles used across the financial services industry. Although brokers, dealers, and investment advisers are clearly identified and regulated under the federal securities laws, in practice many financial professionals use varying titles to describe themselves including: financial advisor, financial consultant, advisor, financial planner, and stockbroker. 40 The RAND report also showed that investors struggled to understand the different legal standards of care to which investment advisers and broker-dealers are held. 41 The report actually questioned whether the fiduciary duty is a higher standard of care in practice. 42 In fact, the report seems to support a conclusion that most investors are under the impression that all financial professionals have an obligation to put investors interest first. 43 As a result of investor misconception highlighted in the RAND Report, policy and lawmakers began considering proposals for improving investor protections, including 36. Id. at Id. at ANGELA A. HUNG, NOREEN CLANCY, JEFF DOMINITZ, ERIC TALLEY, CLAUDE BERREBI & FARRUKH SUVANKULOV, RAND CORP. TECHNICAL REPORT: INVESTOR AND INDUSTRY PERSPECTIVES ON INVESTMENT ADVISERS AND BROKER-DEALERS 89 (2008), The RAND Report was the result of a study commissioned by the SEC. The Study specifically addressed two questions: (1) What are the current business practices of broker-dealers and investment advisers; and (2) do investors understand the differences between the relationships among broker-dealers and investment advisers. Id. at xiv. 39. Id. at Id. at Id. at 113. The RAND study used fiduciary and suitability requirements as their point of comparison for investors. Id. 42. Id. at HUNG, supra note 38.

10 192 Duquesne Business Law Journal [Vol. 12:183 broadening the scope of the fiduciary standard. As will be explored further below, these proposed solutions have ignited much controversy and debate. 3. Defining Fiduciary With the Administration calling for the broader application of the fiduciary standard to respond to investor confusion, members of the brokerage industry quickly moved to question the need for the policy change. In many cases, brokerage industry groups argued that a new universal standard of care or a newly crafted fiduciary standard should be created, rather than relying on the existing fiduciary standard. 44 These groups supported their arguments in large part by questioning the definition of fiduciary. For example, the Financial Services Institute ( FSI ) and Securities Industry and Financial Markets Association ( SIFMA ) have claimed that the fiduciary is defined differently in various federal and state laws and, therefore, has a limited usefulness. 45 While arguments to create a new universal standard of care for investment advisers and broker-dealers may be appealing to many, several issues arise with the use of a new standard. First and foremost, it does not address the fundamental investor protection issues that 44. Robert F. Keane, FSI Supports a Universal Standard of Care for Financial Advice, INVESTMENT ADVISOR, Oct. 7, 2009, News/2009/10/Pages/FSI-Supports-a-Universal-Standard-of-Care-for-Financial- Advice.aspx; Thomas P. Lemke & Steven W. Stone, The Madoff Opportunity : Harmonizing the Overarching Standard of Care for Financial Professionals Who Give Investment Advice, WALL STREET LAWYER (June 2009); Enhancing Investor Protection and the Regulation of Securities Markets, Hearing Before the U.S. Senate Committee on Banking, Housing and Urban Affairs 111th Cong. (Mar. 10, 2009) (statement of T. Timothy Ryan, Jr., President and Chief Executive Officer, Securities Industry and Financial Markets Association), available at ng_id=faf91bea-ca58-4bc1-873d-33739dbb4f76&witness_id=f2cf02f4-d63e- 4bd0-a16c-3786fbc08c19). 45. See Industry Perspectives on the Obama Administration s Financial Regulatory Reform Proposals, Hearing Before the House Committee on Financial Services, 111th Cong. (July 17, 2009) (statement of Randolph C. Snook, Executive Vice President of the Securities Industry and Financial Markets Association), available at see also Industry Groups Differ on Fiduciary Standard, FINANCIAL ADVISOR, Oct. 6, 2009,

11 2010] A Fiduciary Duty For All? 193 Congress and regulators seek to address. For example, melding the fair dealing and fiduciary standards together will only serve to dilute fiduciary principles, which currently place the burden on the professional to act in the investor s best interest. Any dilution of fiduciary principles will result in movement toward the fair dealing standard, placing the burden on investors to look out for their own interests under a theory of caveat emptor. Moreover, the creation of a new standard would introduce elements of uncertainty because industry professionals, investors, and regulators would have little experience with how to apply a new standard. With investment advisers already operating under the fiduciary standard of care and over seventy years of regulatory application of the standard under the Advisers Act, it would arguably be more sensible to start with the strong foundation that exists. In analyzing criticisms raised by the brokerage industry, it should also be recognized that there is a key difference between (1) what it means to be a fiduciary and (2) how the fiduciary standard should and will apply. Arguments regarding the latter are being used to cloud the first issue and create reasons for a policy debate to linger while delaying regulatory action. Any claims that the definition of fiduciary is unclear ignore key points about the framework of fiduciary obligations. In its most basic form, to act as a fiduciary is to serve under an already defined standard based on a relationship of trust that carries with it duties of loyalty, due care, and utmost good faith. 46 Indeed, what it means to be a fiduciary is a standard that is common among all fiduciary relationships across the financial services profession as well as other professions, such as the legal and medical fields. Where differences in laws exist is not necessarily based on what it means to be a fiduciary, but rather on the roles that the fiduciaries play depending on the nature of their relationships with their clients. It is from these differing roles that differing requirements and prohibitions flow under the laws. 47 What is more, it is well-established that a federal fiduciary 46. See Ron A. Rhoades, I Am a Fiduciary Financial Advisor, ADVISOR PERSPECTIVES, Nov. 3, 2009, pdfs/i_am_a_fiduciary_financial_advisor.pdf. 47. For example, laws like Employee Retirement Income Security Act (ERISA) sets requirements and prohibitions based on the role of a fiduciary for a qualified retirement plan, and the Uniform Prudent Investor Act (UPIA) addresses the role of fiduciaries serving private trusts. See Employee Retirement Income Security Act, 29 U.S.C et seq.; NATIONAL CONFERENCE OF COMMISSIONERS ON

12 194 Duquesne Business Law Journal [Vol. 12:183 standard exists under the Advisers Act and that uniformity is promoted under this standard. 48 Accordingly, legislators and regulators should focus on preserving and strengthening this federally established standard through financial reform. 4. Fiduciary in New Legislation and Regulation The industry debate over how to define fiduciary and whether and how to apply the existing fiduciary standard to broker-dealers has had an impact on legislative action and is expected to affect regulatory initiatives as well. As of the drafting of this article, the future of the fiduciary standard is still in the hands of legislators on Capitol Hill, but regulators are keenly aware of the issue and are preparing to propose and implement changes. A. The State of Legislation Soon after the Obama plan was released in 2009, U.S. Department of Treasury staff began drafting key pieces of legislation aimed at advancing the Administration s plan. A key piece of that legislation included the Investor Protection Act ( IPA ), which the House Committee on Financial Services quickly took up for consideration and voted out of committee in October The IPA would give the SEC the authority to adopt a fiduciary standard consistent with the Advisers Act for broker-dealers, as well as prohibit certain compensation structures and sales practices that harm investor interests because of the conflicts they create. The SEC would also have the authority to mandate simple and clear disclosures to investors regarding the terms of their relationships with investment professionals. Such disclosures could further bolster an investor-oriented standard of care and greatly reduce investor confusion related to the nature of the services various financial service professionals provide. In December 2009, the U.S. House of Representatives passed a comprehensive financial reform UNIFORM STATE LAWS, UNIFORM PRUDENT INVESTOR ACT (Apr. 18, 1995), available at PLAZE, supra note 4, at 14 n.80; Memorandum from the Investor as Purchaser Subcommittee, to the SEC Investor Advisory Committee (Feb. 15, 2010), Investor Protection Act of 2009, H.R. 3817, 111th Cong. (2009).

13 2010] A Fiduciary Duty For All? 195 bill called the Wall Street Reform and Consumer Protection Act of 2009, which incorporated the key investor protections of the IPA. 50 Despite this progress within the House on Capitol Hill, the U.S. Senate has been slower to act on financial regulatory reform. And when it comes to the fiduciary standard, the Senate has arguably stepped backwards in terms of identifying a solution to clear up investor confusion and provide strong safeguards for investors. In November 2009, Senator Christopher Dodd, the Chairman of the Senate Committee on Banking, Housing and Urban Affairs ( Senate Banking Committee ) released draft legislation entitled the Restoring American Financial Stability Act of 2009, 51 which included a markedly different approach to the fiduciary issue than that approved by the House. Specifically, Dodd proposed to remove the exemption from the Advisers Act for broker-dealers who provide advice that is solely incidental to their brokerage activities. With the removal of this exemption, any broker-dealer who fits the definition of an investment adviser under the Advisers Act would be required to register as such and thus be subject to the fiduciary standard. Dodd s proposal also included additional investor protections that would require professionals to properly manage conflicts of interests and disclose to clients any limitations on the range of investment products that they offer and recommend. Potentially, this initial Senate proposal would provide a cleaner way to provide consistent protections to investors who receive advice by keeping the established fiduciary standard in place and regulating all financial professionals providing advice under the same statutory and regulatory framework. In contrast, the House approach would keep two separate regimes and sets of rules in place for brokersdealers and investment advisers, which could result in differences in the standard for each group Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. (2009). 51. Discussion Draft, Restoring American Financial Stability Act of 2009, FinancialStabilityActof2009.pdf. 52. Maintaining separate sets of rules also has presented opportunities for legislators to add amendments to the House's proposed bill that could chip away at the fiduciary standard on the broker-dealer side rather than bringing the standard for broker-dealers up to the same stringent level as the standard currently applicable to investment advisers. For example, the final version of the House bill would not require broker-dealers to have an ongoing fiduciary duty after providing investment

14 196 Duquesne Business Law Journal [Vol. 12:183 As a whole, Dodd s proposed financial reform bill drew criticism and failed to gain bipartisan support, forcing Dodd to shift his strategy several times for finalizing a bill and significantly delaying consideration of a bill by the Senate Banking Committee. 53 In March 2010, after breaking off discussions with his Republican counterparts, Dodd issued a revised proposal for financial regulatory reform. 54 For proponents of the fiduciary standard, however, this new proposal brought big disappointment. Dodd s previous proposal to remove the broker exemption and extend the fiduciary standard was replaced by a new provision introduced by Senators Tim Johnson and Mike Crapo to study the effectiveness of the existing standards of conduct for financial professionals providing personalized investment advice and recommendations about securities to retail customers. 55 Much of the lost momentum on the Senate side can be attributed to strong lobbying by Wall Street, including the brokerage and insurance industries, which strongly opposed Dodd s original proposal to remove the broker exemption. As discussed earlier, several groups have questioned the usefulness of the fiduciary standard, and those questions have served as a source of confusion and misinformation for legislators who are unfamiliar with the intricacies of the financial services industry. As a result, legislators have been persuaded to take a more cautious approach to extending the fiduciary standard. It may not seem clear why questioning the status of fiduciary duty would be an issue here. In fact, some could argue that taking the time to further study, debate and consider the issue could lead to a more robust standard. But the real risk lies in legislators and regulators getting lost in a game of semantics and losing sight of the big picture in terms of protecting the basic foundation of the fiduciary standard and ultimately the interests of investors. advice to an investor. Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. 7103(a)(1) (2009). Investment advisers, however, generally are assumed to have an ongoing fiduciary duty as a result of the relationship they form with their clients. Id. 53. See Stephen Labaton, A Study in Contrasts in Financial Overhaul, N.Y. TIMES, Dec. 2, 2009, at B3, available at business/02regulate.html?_r=3&hpw. 54. Discussion Draft, Restoring American Financial Stability Act of 2010, cialreformlegislationbill.pdf. 55. Id. at 913.

15 2010] A Fiduciary Duty For All? 197 At this time, it is unclear just what will be the legislative fate of the Obama Administration s recommendation to extend the fiduciary standard. It is becoming clear that a financial reform bill will likely pass by the summer of 2010, if not sooner. In an unusual move, Senator Dodd s latest proposal was voted out of committee on March 22, 2010, without any significant markup and without the clear bipartisan support needed to get it approved on the Senate floor. 56 Senators Dodd and Richard Shelby, ranking member of the Senate Banking Committee, however, have agreed to continue to negotiate and reach agreement on a final bill to bring to the Senate floor. Once a Senate bill is approved, a Conference Committee will be convened to reconcile the House and Senate versions of a financial regulatory reform bill. Thus, whether the fiduciary standard will be extended through legislation remains a toss-up given the different approaches each side has taken so far. There are many fiduciary advocates that are hoping that Representative Barney Frank, chair of the House Committee on Financial Services, will stick to his resolve to maintain strong consumer and investor protections, allowing for the fiduciary duty to be extended through final legislation. B. The Role of Regulation Ultimately, with or without legislation, the responsibility for extending the fiduciary standard will lie with the SEC. And it has become clearer over time that there is great support and drive within the agency to implement fiduciary measures for broker-dealers even if the fiduciary standard itself is not extended to those professionals. In fact, the recommendation put forth by the Obama Administration to harmonize investment adviser and broker-dealer regulatory schemes and extend the fiduciary duty to all investment advice providers likely originated within the walls of the SEC. The Commission s support for fiduciary measures can be traced to the publication of the RAND Report, which made clear that investors are confused about the difference between broker-dealers and in- 56. Executive Session to Mark-up an Original Bill Entitled: Restoring American Financial Stability Act of 2010, Senate Committee on Banking, Housing, and Urban Affairs, 111th Cong. (Mar. 22, 2009), FuseAction=Hearings.Hearing&Hearing_ID=b8c4a3bd-db46-4b8d-a b72204cd. As of April 14, 2010, a number had not been assigned to the Senate bill yet.

16 198 Duquesne Business Law Journal [Vol. 12:183 vestment advisers. Even with the results of the RAND Report, many doubted the ability, and more importantly, willingness of the SEC to take on the fiduciary issue as a result of Chairman Mary Schapiro s and Commissioner Elisse Walter s ties to FINRA and assumed sympathy to the lobbying efforts of the brokerage industry. 57 Indeed, investor and advisory groups expressed concern early on that the SEC would lower the fiduciary standard in order to accommodate brokerdealer business practices. 58 Despite these concerns, public statements from several SEC commissioners, including Chairman Schapiro and Commissioner Walter have championed the fiduciary issue and highlighted the SEC s commitment to protecting investors, a key value embedded in the agency s mission. But perhaps the strongest supporter for the fiduciary standard has been SEC Commissioner Luis Aguilar. In May 2009, while delivering a speech, Commissioner Aguilar argued that as broker-dealers increasingly provide advice to investors, the SEC should consider whether higher standards and fiduciary duties should be applied to these professionals. And in response to calls for a uniform standard of care for financial professionals, Commissioner Aguilar passionately emphasized: there is only one fiduciary standard and it means that a fiduciary has an affirmative obligation to put a client s interests above his or her own. 59 Commissioner Aguilar repeated his support for the fiduciary standard in remarks in March 2010, emphasizing that [t]he fiduciary standard has served advisory clients well for many years and it should be the governing standard whenever investment advice is provided See Dan Jamieson, RIAs Fretful about Finra Grabbing Regulatory Oversight, INVESTMENT NEWS, Jan. 4, 2009, /REG/ Prior to joining the SEC, Mary Schapiro served as the CEO of FINRA, and Elisse Walter was a Senior Executive Vice President for FINRA. Id. 58. See Jeff Plungis & Alexis Leondis, Financial Planners Say Fiduciary Debate May Favor Brokers, BLOOMBERG, Aug. 7, 2009, apps/news?pid= &sid=adrjvkh6iqgk. 59. Luis A. Aguilar, SEC Comm r, SEC s Oversight of the Adviser Industry Bolsters Investor Protection, Address at the Investment Advisers Association Annual Conference (May 7, 2009), available at /spch050709laa.htm. 60. Luis A. Aguilar, SEC Comm r, A Shared Responsibility: Preserving the Fiduciary Standard, Address at the IA Compliance Best Practices Summit 2010 (Mar. 26, 2010), available at spch032610laa.htm.

17 2010] A Fiduciary Duty For All? 199 For her part, Commissioner Walter has spoken several times about harmonizing the regimes for financial professionals on a more comprehensive scale, but has also publicly supported the extension of the fiduciary standard. Accordingly, she said in February of 2010, I believe strongly that this [fiduciary] duty, with its underlying concepts of loyalty and care, is critical to comprehensive investor protection. 61 Chairman Schapiro has also stated her support for extending the fiduciary duty in her public remarks and testimony before Congress. 62 In June 2009, she provided extensive remarks on the regulation of financial professionals, noting that If broker-dealers and investment advisers are providing virtually identical services to retail investors, then the regulatory regimes that govern those activities should be virtually identical as well. 63 In December 2009, she stated she believes that all securities professionals should be subject to the same fiduciary duty and that all investors receiving advice should rest assured that the advice they get is being given with their interest at heart. 64 To further demonstrate her commitment to the fiduciary standard, the Chairman reportedly sent a letter to the Senate Banking Committee in March 2010 requesting the extension of the fiduciary standard be included in the financial regulatory reform legislation Elisse B. Walter, SEC Comm r, Remarks at 2010 Investment Adviser Compliance Forum (Feb. 25, 2010), available at /spch022510ebw.htm. 62. See, e.g., Mary L. Schapiro, SEC Chairman, Address to Financial Services Roundtable 2009 Fall Conference (Sept. 24, 2009), available at SEC Oversight:Current State and Agenda, Hearing Before the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, 111th Cong. (July 14, 2009) (statement of the Honorable Chairman Mary L. Schapiro, Chairman, U.S. Securities and Exchange Commission), available at hearing/financialsvcs_dem/sec_testimony.pdf. 63. Schapiro, supra note Mary L. Schapiro, SEC Chairman, The Consumer in the Financial Services Roundtable, Address at the Consumer Federation of America 21st Annual Financial Services Conference (Dec. 3, 2009), available at /spch120309mls.htm. 65. Fawn Johnson, SEC Asked Senate for Tougher Dealer Standards in Financial Bill, DOW JONES, Mar. 19, 2010, available at stock-market-news-story.aspx?storyid= dowjonesdjonline &title=sec-asked-senate-for-tougher-dealer-standards-in-financial-billCite article.

18 200 Duquesne Business Law Journal [Vol. 12:183 In addition to these SEC Commissioners, another key regulator has stepped forward to show support for the extension of the fiduciary standard. In 2009, FINRA CEO Richard Ketchum stated that he believes a single standard should apply to financial professionals and it should be the fiduciary standard. 66 In fact, in recent remarks, Ketchum told the brokerage industry it should prepare for the fiduciary duty, stating, [t]his common fiduciary standard is neither impossible, illogical or even that scary. 67 Ketchum s remarks and support for the fiduciary standard are significant given the key role FINRA plays in broker-dealer regulation and oversight. With such strong support from key officials within both the SEC and FINRA, the hope would be that legislators would act to strengthen the fiduciary standard. Absent such action, however, it is clear that regulators are ready to take steps to promote fiduciary principles in an effort to better protect investors. 5. Regulatory Application of Fiduciary Measures While the SEC is ready to act with or without legislation, what measures the SEC can adopt will be greatly affected by whether legislation passes. Chairman Schapiro has acknowledged that the SEC lacks statutory authority to extend the fiduciary standard to brokerdealers. 68 Thus, regulatory action will take different forms and have different effects on financial professionals depending on how Congress acts. A. Balancing Principles and Rules As noted earlier, much of the debate over defining what a fiduciary is has centered on how the standard will ultimately be applied by 66. Rick Ketchum, Chairman & CEO, FINRA, Capital Markets Regulatory Reform: Strengthening Investor Protection, Enhancing Oversight of Private Pools of Capital, and Creating a National Insurance Office, Hearing Before the House Committee on Financial Services, 111th Cong. (Oct. 6, 2009), available at Finra CEO Expects Eventual Move to Fiduciary Standard, DOW JONES, Mar. 16, 2010, available at See Donna Rosato, How Well Is the SEC Protecting You?, MONEY MAGAZINE, Feb. 24, 2010, SEC_Schapiro.moneymag/index.htm.

19 2010] A Fiduciary Duty For All? 201 regulators. Related to this issue is the so-called harmonization of investment adviser and broker-dealer requirements. If legislation is passed, the application of the fiduciary standard will take center stage in SEC rulemaking. While Chairman Schapiro has recognized that the fiduciary standard is not a cure-all, she has noted that it is important for broker-dealers and investment advisors to be subject to equivalent regulatory requirements. 69 Thus, what harmonization in this case will likely mean is bringing more rules to the principles-driven world of fiduciary standard. Because the regulation of investment advisers under the fiduciary standard has largely been principles driven, professionals operating in a fiduciary capacity learn to judge their actions against the spirit of the principles versus strictly following regulatory rules. For example, a group of advisory and investor advocates, dubbed the Committee for the Fiduciary Standard, 70 recently articulated a set of five core fiduciary principles: (1) put client s interest first, (2) act with prudence, (3) do not mislead clients, (4) avoid conflicts of interest, and (5) fully disclose and fairly manage unavoidable conflicts. 71 What these principles illustrate is a basic relationship based on trust that demands that loyalty and due care always remain at the foundation of the fiduciary standard. Furthermore, as explained by the Committee for the Fiduciary Standard, while all of these principles do not necessarily capture all that is required of a fiduciary, they do provide a sort of checklist to ensure that an investor s best interests are not compromised. 72 Broker-dealer regulation, on the other hand, is largely driven by FINRA and other SRO rules. As a result, the brokerage industry has often cited issues with a principles-based approach because of a perceived lack of guidance available to practitioners on how to act in specific situations. Such arguments, however, ignore the fact that even rules cannot always provide complete guidance given the fast evolution of the financial services industry and the products and ser- 69. Schapiro, supra note The Committee for the Fiduciary Standard was formed by a group of likeminded financial professionals and industry experts on the fiduciary standard. The Committee for the Fiduciary Standard, index.cfm (last visited Apr. 13, 2010). 71. Blaine F. Aikin, THE COMMITTEE FOR THE FIDUCIARY STANDARD, FIVE FUNDAMENTAL FIDUCIARY PRINCIPLES (July 29, 2009) (on file with the author). 72. Id.

20 202 Duquesne Business Law Journal [Vol. 12:183 vices provided. 73 Given the potential shortcomings of both principlesbased and rules-based regulation, it will be important for regulators to seek a proper balance of each with regard to the application of the fiduciary standard to both investment advisers and broker-dealers. The North American Securities Administrators Association ( NASAA ) has best articulated the need for balancing principles and rules. As explained by NASAA board member, Melanie Lubin, a broadly framed principles-based standard serves as a helpful guide for professionals and can enhance enforcement. 74 Clear and strong rules, meanwhile, help to draw lines and curb abuse. Thus, conduct rules should complement the fiduciary standard and further shape the requirements for investment professionals. 75 Commissioner Walter has also stated she believes a fiduciary standard and business practice rules should work together in a complementary fashion. In this regard, she believes in prohibiting certain conflicted behavior or requiring mitigation or management of the conflicts that exist. 76 Commissioner Walter has also noted that what is required under the fiduciary duty depends on the scope of the engagement as well as the sophistication of the investor. 77 At least implicitly, the sophistication of an investor appears to be a concept that has been adopted by Congress, which has focused on advice provided to a retail investor. 78 Thus, because Congress has failed to address the broker ex- 73. For example, although FINRA has an established suitability rule, it has issued several notices to its members providing additional guidance on suitability issues related to specific products and practices. See, e.g., NASD Notice to Members 05-59, Structured Products (Sept. 2005), available at groups/industry/@ip/@reg/@notice/documents/notices/p pdf; NASD Notice to Members 01-23, Suitability Rule and Online Communications (Apr. 2001), available at NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION, PROCEEDINGS OF THE NASAA FINANCIAL SERVICES REGULATORY REFORM ROUNDTABLE: A MAIN STREET AGENDA FOR WALL STREET REFORM (Dec. 11, 2008), Reform_Roundtable.pdf. 75. Id. 76. Elisse B. Walter, SEC Comm r, Regulating Broker-Dealers and Investment Advisers: Demarcation or Harmonization?, Address at the Mutual Fund Directors Forum Ninth Annual Policy Conference (May 5, 2009), available at Id. 78. See, e.g., Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. (2009).