SEC STUDY ON INVESTMENT ADVISERS AND BROKER-DEALERS
The Dodd-Frank Act of 2010 required the SEC to conduct a study on the differences between the regulatory regimes of investment advisers ("IAs") and broker-dealers ("BDs"). The star of the resulting report was a recommendation to hold BDs to a fiduciary duty standard of care when providing personalized investment advice about securities to retail customers. To jump to Vista360’s Perspective on this study, click here.
The study also examined the differences in the regulations governing each entity and recommended that, when BDs and IAs are performing similar functions, the regulatory protections afforded to investors should also be similar. Specifically, the report stated, “harmonization should take into account the best elements of each regime” to protect retail investors. The devil may be in the details, however, as several key recommendations seem to bring IA governance more in line with the rules-based BD regime:
Advertising and Other Communications: The report emphasized the major difference between BD and IA marketing regulations: the pre-use review required of BDs. Report Recommendation: Require IAs, as already required of BDs, to designate an employee to review and approve all communications before they are distributed to the public.
Licensing and Registration of Firms: The study pointed out that IAs, unlike BDs, are not subject to any pre-registration review by a regulatory authority. Report Recommendation: Subject investment advisers to a substantive review prior to licensing.
Licensing and Continuing Education: Report Recommendation: Impose continuing education and licensing requirements on investment adviser representatives similar to those required of registered representative of BDs.
Books and Records: The study identified a “catch-all” provision requiring BDs to keep all records relating to a firm’s “business as such.” Report Recommendation: Consider whether to modify the Advisers Act books and records requirements "to be consistent with those applicable to BDs."
Supervision: The study pointed out that BDs are generally subject to more specific supervisory requirements than IAs and outlined the SRO rules regarding BD supervision. Report Recommendation: Nothing specific, other than to consider the size of the firm when reviewing the gaps in regulation of IAs and BDs. However, SEC staff has stated the agency is considering an expanded supervisory model for IAs, potentially incorporating a BD-like SRO.
Considering the report took into account "the best elements of each regime," many recommendations imply a preference for the rules-based BD model. Unfortunately, a rules-based regulatory model and the fiduciary duty standard of care are somewhat contradictory. Unlike a suitability standard of care, the fiduciary duty does not fit into a neat, square box. Instead, it allows for regulators to review all the facts and circumstances to determine whether there was a breach. A suitability requirement, however, can be reviewed using quantifiable information about the investor. In effect, it is possible for a broker to adhere to a suitability standard yet, at the same time, violate a fiduciary duty. Determining whether a breach of a fiduciary duty occurred may require more information that, often, cannot be quantified.
In the end, the recommendations do not amount to a seismic shift away from a principles-based regime toward a rules-based regime. However, the implication is noticeable… and troubling.