Thursday, April 29, 2010

Menendez Amendment Would Require SEC to Adopt Uniform Fiduciary Standard for Brokers and Advisers, Conforming to House Bill

Senator Robert Menendez plans to introduce an amendment to the Senate financial reform bill, S. 3217, that would mandate a harmonized federal fiduciary standard for brokers and investment advisers in their dealings with retail customers. Thus, every financial intermediary, such as brokers and investment advisers, that provides personalized investment advice to retail customers would have a fiduciary duty to the investor. The Menendez Amendment essentially mirrors Section 7103 of the House-passed reform measure, HR 4173, in directing the SEC to adopt rules providing that the standard of conduct for all brokers and investment advisers is to act in the best interest of their customers without regard to their own financial or other interest.

Any material conflicts of interest must be disclosed to the customer, who must consent. However, brokers or dealers are not subject to a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities. Under this harmonized standard, broker-dealers and investment advisers will have to put customers’ interests first. The receipt of compensation based on commissions or fees will not, in and of itself, be considered a violation of the standard applied to a broker or dealer or investment adviser. The legislation defines retail customers as those receiving personalized investment advice from a broker, dealer, or investment adviser for use primarily for personal, family, or household purposes.

Both the House legislation and the Menendez Amendment clarify that the SEC must not define “customer” to include investors in a private fund managed by an investment adviser when that private fund has also entered into an advisory contract with the same adviser. This is designed to prevent advisers from being subjected to an irresolvable conflict of interest when they manage a pooled investment with the interest of each individual investor in mind.

Instead of mandating a new uniform federal fiduciary standard for brokers and investment advisers, the Senate bill currently directs the SEC to conduct an exhaustive study of the effectiveness of existing legal and regulatory standards of care for brokers and investment advisers and whether there are any legal or regulatory gaps or overlap in the protection of retail customers, defined as individual customers, of the broker or adviser relating to the standards of care. If such gaps are found, the SEC must commence rulemaking within two years to address them and protect the interests of the retail customers of brokers and investment advisers.

The SEC supports a harmonized standard requiring broker-dealers and investment advisers to act solely in the interests of their customers when providing investment advice. The SEC believes that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients and be subject to equivalent regulation.

Many investors do not recognize the differences in standards of conduct or the regulatory protections applicable to broker-dealers and investment advisers. Thus, the SEC believes it essential that when investors receive similar services from similar financial service providers, the service providers should be subject to the same standard of conduct and regulatory requirements, regardless of the label attached to the providers.

Currently, the fiduciary duty imposed by the Investment Advisers Act requires advisers to act solely with the client’s investment goals and interests in mind, free from any conflicts of interest that would tempt them to make recommendations that would also benefit them. Unlike investment advisers, brokers are not categorically bound by statute, regulation, or precedent to a per se rule imposing fiduciary obligations toward clients.


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