Securities and Exchange Commission.
Proposed interpretation; request for comment.
The Securities and Exchange Commission (the “SEC” or the “Commission”) is publishing for comment a proposed interpretation of the standard of conduct for investment Start Printed Page 21204advisers under the Investment Advisers Act of 1940 (the “Advisers Act” or the “Act”). The Commission also is requesting comment on: Licensing and continuing education requirements for personnel of SEC-registered investment advisers; delivery of account statements to clients with investment advisory accounts; and financial responsibility requirements for SEC-registered investment advisers, including fidelity bonds.
Comments should be received on or before August 7, 2018.
Comments may be submitted by any of the following methods:
- Send paper comments to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-09-18. This file number should be included on the subject line if email is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's internet website (http://www.sec.gov/rules/interp.shtml). Comments also are available for website viewing and printing in the Commission's Public Reference Room, 100 F Street NE, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that we do not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available.
Studies, memoranda or other substantive items may be added by the Commission or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the Commission's website. To ensure direct electronic receipt of such notifications, sign up through the “Stay Connected” option at www.sec.gov to receive notifications by email.
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FOR FURTHER INFORMATION CONTACT:
Jennifer Songer, Senior Counsel, or Sara Cortes, Assistant Director, at (202) 551-6787 or IArules@sec.gov, Investment Adviser Regulation Office, Division of Investment Management, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.
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Start Supplemental Information
The Commission is publishing for comment a proposed interpretation of the standard of conduct for investment advisers under the Advisers Act [15 U.S.C. 80b].
Table of Contents
II. Investment Advisers' Fiduciary Duty
A. Duty of Care
i. Duty To Provide Advice That Is in the Client's Best Interest
ii. Duty To Seek Best Execution
iii. Duty To Act and To Provide Advice and Monitoring Over the Course of the Relationship
B. Duty of Loyalty
C. Request for Comment
III. Economic Considerations
B. Economic Impacts
IV. Request for Comment Regarding Areas of Enhanced Investment Adviser Regulation
A. Federal Licensing and Continuing Education
B. Provision of Account Statements
C. Financial Responsibility
An investment adviser is a fiduciary, and as such is held to the highest standard of conduct and must act in the best interest of its client.
Its fiduciary obligation, which includes an affirmative duty of utmost good faith and full and fair disclosure of all material facts, is established under federal law and is important to the Commission's investor protection efforts.
The Commission also regulates broker-dealers, including the obligations that broker-dealers owe to their customers. Investment advisers and broker-dealers provide advice and services to retail investors and are important to our capital markets and our economy more broadly. Broker-dealers and investment advisers have different types of relationships with their customers and clients and have different models for providing advice, which provide investors with choice about the levels and types of advice they receive and how they pay for the services that they receive.
Today, the Commission is proposing a rule that would require all broker-dealers and natural persons who are associated persons of broker-dealers to act in the best interest of retail customers 
when making a recommendation of any securities transaction or investment strategy involving securities to retail customers (“Regulation Best Interest”).
We are also proposing to require registered investment advisers and registered broker-dealers to deliver to retail investors a relationship summary, which would provide these investors with information about the relationships and services the firm offers, the standard of conduct and the fees and costs associated with those services, specified conflicts of interest, and whether the firm and its financial professionals currently have reportable legal or disciplinary events.
In light of the comprehensive nature of our proposed set of rulemakings, we believe it would be appropriate and beneficial to address in one release 
and reaffirm—and in some cases clarify—certain aspects of the fiduciary duty that an investment adviser owes to its clients under section 206 of the Advisers Act.
An investment adviser's fiduciary duty is similar to, but not the same as, the proposed obligations of broker-Start Printed Page 21205dealers under Regulation Best Interest.
While we are not proposing a uniform standard of conduct for broker-dealers and investment advisers in light of their different relationship types and models for providing advice, we continue to consider whether we can improve protection of investors through potential enhancements to the legal obligations of investment advisers. Below, in addition to our interpretation of advisers' existing fiduciary obligations, we request comment on three potential enhancements to their legal obligations by considering areas where the current broker-dealer framework provides investor protections that may not have counterparts in the investment adviser context.
II. Investment Advisers' Fiduciary Duty
The Advisers Act establishes a federal fiduciary standard for investment advisers.
This fiduciary standard is based on equitable common law principles and is fundamental to advisers' relationships with their clients under the Advisers Act.
The fiduciary duty to which advisers are subject is not specifically defined in the Advisers Act or in Commission rules, but reflects a Congressional recognition “of the delicate fiduciary nature of an investment advisory relationship” as well as a Congressional intent to “eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.” 
An adviser's fiduciary duty is imposed under the Advisers Act in recognition of the nature of the relationship between an investment adviser and a client and the desire “so far as is presently practicable to eliminate the abuses” that led to the enactment of the Advisers Act.
It is made enforceable by the antifraud provisions of the Advisers Act.
An investment adviser's fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. Several commenters responding to Chairman Clayton's June 2017 request for public input 
on the standards of conduct for investment advisers and broker-dealers acknowledged these duties.
This fiduciary duty requires an adviser “to adopt the principal's goals, objectives, or ends.” 
This means the adviser must, at all times, serve the best interest of its clients and not subordinate its clients' interest to its own.
The federal fiduciary duty is imposed through the antifraud provisions of the Advisers Act.
The duty follows the contours of the relationship between the adviser and its client, and the adviser and its client may shape that relationship through contract when the client receives full and fair disclosure and provides informed consent.
Although the ability to tailor the terms means that the application of the fiduciary duty will vary with the terms of the relationship, the relationship in all cases remains that of a fiduciary to a client. In other words, the investment adviser cannot disclose or negotiate away, and the investor cannot waive, the federal fiduciary Start Printed Page 21206duty.
We discuss our views 
on an investment adviser's fiduciary duty in more detail below.
A. Duty of Care
As fiduciaries, investment advisers owe their clients a duty of care.
The Commission has discussed the duty of care and its components in a number of contexts.
The duty of care includes, among other things: (i) The duty to act and to provide advice that is in the best interest of the client, (ii) the duty to seek best execution of a client's transactions where the adviser has the responsibility to select broker-dealers to execute client trades, and (iii) the duty to provide advice and monitoring over the course of the relationship.
i. Duty To Provide Advice That Is in the Client's Best Interest
We have addressed an adviser's duty of care in the context of the provision of personalized investment advice. In this context, the duty of care includes a duty to make a reasonable inquiry into a client's financial situation, level of financial sophistication, investment experience, and investment objectives (which we refer to collectively as the client's “investment profile”) and a duty to provide personalized advice that is suitable for and in the best interest of the client based on the client's investment profile.
An adviser must, before providing any personalized investment advice and as appropriate thereafter, make a reasonable inquiry into the client's investment profile. The nature and extent of the inquiry turn on what is reasonable under the circumstances, including the nature and extent of the agreed-upon advisory services, the nature and complexity of the anticipated investment advice, and the investment profile of the client. For example, to formulate a comprehensive financial plan for a client, an adviser might obtain a range of personal and financial information about the client, including current income, investments, assets and debts, marital status, insurance policies, and financial goals.
An adviser must update a client's investment profile in order to adjust its advice to reflect any changed circumstances.
The frequency with which the adviser must update the information in order to consider changes to any advice the adviser provides would turn on many factors, including whether the adviser is aware of events that have occurred that could render inaccurate or incomplete the investment profile on which it currently bases its advice. For example, a change in the relevant tax law or knowledge that the client has retired or experienced a change in marital status might trigger an obligation to make a new inquiry.
An investment adviser must also have a reasonable belief that the personalized advice is suitable for and in the best interest of the client based on the client's investment profile. A reasonable belief would involve considering, for example, whether investments are recommended only to those clients who can and are willing to tolerate the risks of those investments and for whom the potential benefits may justify the risks.29
Start Printed Page 21207Whether the advice is in a client's best interest must be evaluated in the context of the portfolio that the adviser manages for the client and the client's investment profile. For example, when an adviser is advising a client with a conservative investment objective, investing in certain derivatives may be in the client's best interest when they are used to hedge interest rate risk in the client's portfolio, whereas investing in certain directionally speculative derivatives on their own may not. For that same client, investing in a particular security on margin may not be in the client's best interest, even if investing in that same security may be in the client's best interest. When advising a financially sophisticated investor with a high risk tolerance, however, it may be consistent with the adviser's duties to recommend investing in such directionally speculative derivatives or investing in securities on margin.
The cost (including fees and compensation) associated with investment advice would generally be one of many important factors—such as the investment product's or strategy's investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions—to consider when determining whether a security or investment strategy involving a security or securities is in the best interest of the client. Accordingly, the fiduciary duty does not necessarily require an adviser to recommend the lowest cost investment product or strategy. We believe that an adviser could not reasonably believe that a recommended security is in the best interest of a client if it is higher cost than a security that is otherwise identical, including any special or unusual features, liquidity, risks and potential benefits, volatility and likely performance. For example, if an adviser advises its clients to invest in a mutual fund share class that is more expensive than other available options when the adviser is receiving compensation that creates a potential conflict and that may reduce the client's return, the adviser may violate its fiduciary duty and the antifraud provisions of the Advisers Act if it does not, at a minimum, provide full and fair disclosure of the conflict and its impact on the client and obtain informed client consent to the conflict.
Furthermore, an adviser would not satisfy its fiduciary duty to provide advice that is in the client's best interest by simply advising its client to invest in the least expensive or least remunerative investment product or strategy without any further analysis of other factors in the context of the portfolio that the adviser manages for the client and the client's investment profile. For example, it might be consistent with an adviser's fiduciary duty to advise a client with a high risk tolerance and significant investment experience to invest in a private equity fund with relatively high fees if other factors about the fund, such as its diversification and potential performance benefits, cause it to be in the client's best interest. We believe that a reasonable belief that investment advice is in the best interest of a client also requires that an adviser conduct a reasonable investigation into the investment sufficient to not base its advice on materially inaccurate or incomplete information.
We have brought enforcement actions where an investment adviser did not independently or reasonably investigate securities before recommending them to clients.
This obligation to provide advice that is suitable and in the best interest applies not just to potential investments, but to all advice the investment adviser provides to clients, including advice about an investment strategy or engaging a sub-adviser and advice about whether to rollover a retirement account so that the investment adviser manages that account.
ii. Duty To Seek Best Execution
We have addressed an investment adviser's duty of care in the context of trade execution where the adviser has the responsibility to select broker-dealers to execute client trades (typically in the case of discretionary accounts). We have said that, in this context, an adviser has the duty to seek best execution of a client's transactions.
In meeting this obligation, an adviser must seek to obtain the execution of transactions for each of its clients such that the client's total cost or proceeds in each transaction are the most favorable under the circumstances. An adviser fulfills this duty by executing securities transactions on behalf of a client with the goal of maximizing value for the client under the particular circumstances occurring at the time of the transaction. As noted below, maximizing value can encompass more than just minimizing cost. When seeking best execution, an adviser should consider “the full range and quality of a broker's services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness” to the adviser.
In other words, the determinative factor is not the lowest possible commission cost but whether the transaction represents the best qualitative execution. Further, an investment adviser should “periodically and systematically” evaluate the execution it is receiving for clients.
iii. Duty To Act and To Provide Advice and Monitoring Over the Course of the Relationship
An investment adviser's duty of care also encompasses the duty to provide advice and monitoring over the course of a relationship with a client.
An Start Printed Page 21208adviser is required to provide advice and services to a client over the course of the relationship at a frequency that is both in the best interest of the client and consistent with the scope of advisory services agreed upon between the investment adviser and the client. The duty to provide advice and monitoring is particularly important for an adviser that has an ongoing relationship with a client (for example, a relationship where the adviser is compensated with a periodic asset-based fee or an adviser with discretionary authority over client assets). Conversely, the steps needed to fulfill this duty may be relatively circumscribed for the adviser and client that have agreed to a relationship of limited duration via contract (for example, a financial planning relationship where the adviser is compensated with a fixed, one-time fee commensurate with the discrete, limited-duration nature of the advice provided).
An adviser's duty to monitor extends to all personalized advice it provides the client, including an evaluation of whether a client's account or program type (for example, a wrap account) continues to be in the client's best interest.
B. Duty of Loyalty
The duty of loyalty requires an investment adviser to put its client's interests first. An investment adviser must not favor its own interests over those of a client or unfairly favor one client over another.
In seeking to meet its duty of loyalty, an adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship.
In addition, an adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure of all material conflicts of interest that could affect the advisory relationship. The disclosure should be sufficiently specific so that a client is able to decide whether to provide informed consent to the conflict of interest.
We discuss each of these aspects of the duty of loyalty below.
Because an adviser must serve the best interests of its clients, it has an obligation not to subordinate its clients' interests to its own. For example, an adviser cannot favor its own interests over those of a client, whether by favoring its own accounts or by favoring certain client accounts that pay higher fee rates to the adviser over other client accounts.
Accordingly, the duty of loyalty includes a duty not to treat some clients favorably at the expense of other clients. Thus, we believe that in allocating investment opportunities among eligible clients, an adviser must treat all clients fairly.
This does not mean that an adviser must have a pro rata allocation policy, that the adviser's allocation policies cannot reflect the differences in clients' objectives or investment profiles, or that the adviser cannot exercise judgment in allocating investment opportunities among eligible clients. Rather, it means that an adviser's allocation policies must be fair and, if they present a conflict, the adviser must fully and fairly disclose the conflict such that a client can provide informed consent.
An adviser must seek to avoid conflicts of interest with its clients, and, at a minimum, make full and fair disclosure to its clients of all material conflicts of interest that could affect the advisory relationship.
Disclosure of a conflict alone is not always sufficient to satisfy the adviser's duty of loyalty and section 206 of the Advisers Act.
Any Start Printed Page 21209disclosure must be clear and detailed enough for a client to make a reasonably informed decision to consent to such conflicts and practices or reject them.
An adviser must provide the client with sufficiently specific facts so that the client is able to understand the adviser's conflicts of interest and business practices well enough to make an informed decision.
For example, an adviser disclosing that it “may” have a conflict is not adequate disclosure when the conflict actually exists.
A client's informed consent can be either explicit or, depending on the facts and circumstances, implicit. We believe, however, that it would not be consistent with an adviser's fiduciary duty to infer or accept client consent to a conflict where either (i) the facts and circumstances indicate that the client did not understand the nature and import of the conflict, or (ii) the material facts concerning the conflict could not be fully and fairly disclosed.
For example, in some cases, conflicts may be of a nature and extent that it would be difficult to provide disclosure that adequately conveys the material facts or the nature, magnitude and potential effect of the conflict necessary to obtain informed consent and satisfy an adviser's fiduciary duty. In other cases, disclosure may not be specific enough for clients to understand whether and how the conflict will affect the advice they receive. With some complex or extensive conflicts, it may be difficult to provide disclosure that is sufficiently specific, but also understandable, to the adviser's clients. In all of these cases where full and fair disclosure and informed consent is insufficient, we expect an adviser to eliminate the conflict or adequately mitigate the conflict so that it can be more readily disclosed.
Full and fair disclosure of all material facts that could affect an advisory relationship, including all material conflicts of interest between the adviser and the client, can help clients and prospective clients in evaluating and selecting investment advisers. Accordingly, we require advisers to deliver to their clients a “brochure,” under Part 2A of Form ADV, which sets out minimum disclosure requirements, including disclosure of certain conflicts.
Investment advisers are required to deliver the brochure to a prospective client at or before entering into a contract so that the prospective client can use the information contained in the brochure to decide whether or not to enter into the advisory relationship.
In a concurrent release, we are proposing to require all investment advisers to deliver to retail investors before or at the time the adviser enters into an investment advisory agreement a relationship summary which would include a summary of certain conflicts of interest.
C. Request for Comment
The Commission requests comment on our proposed interpretation regarding certain aspects of the fiduciary duty under section 206 of the Advisers Act.
- Does the Commission's proposed interpretation offer sufficient guidance with respect to the fiduciary duty under section 206 of the Advisers Act?
- Are there any significant issues related to an adviser's fiduciary duty that the proposed interpretation has not addressed?
- Would it be beneficial for investors, advisers or broker-dealers for the Commission to codify any portion of our proposed interpretation of the fiduciary duty under section 206 of the Advisers Act?
III. Economic Considerations
The Commission is sensitive to the potential economic effects of the proposed interpretation provided above.
In this section we discuss how the proposed Commission interpretation may benefit investors and reduce agency problems by reaffirming and clarifying the fiduciary duty an investment adviser owes to its clients. We also discuss some potential broader economic effects on the market for investment advice.
The Commission's interpretation of the standard of conduct for investment advisers under the Advisers Act set forth in this Release would affect investment advisers and their associated persons as well as the clients of those investment advisers, and the market for financial advice more broadly.
There are 12,659 investment advisers registered with the Commission with over $72 trillion in assets under management as well as 17,635 investment advisers registered with states and 3,587 investment advisers who submit Form ADV as exempt reporting advisers.
As of December Start Printed Page 212102017, there are approximately 36 million client accounts advised by SEC-registered investment advisers.
These investment advisers currently incur ongoing costs related to their compliance with their legal and regulatory obligations, including costs related to their understanding of the standard of conduct. We believe, based on the Commission's experience, that the interpretations we are setting forth in this Release are generally consistent with investment advisers' current understanding of the practices necessary to comply with their fiduciary duty under the Advisers Act; however, we recognize that there may be certain current investment advisers who have interpreted their fiduciary duty to require something less, or something more, than the Commission's interpretation. We lack data to identify which investment advisers currently understand the practices necessary to comply with their fiduciary duty to be different from the standard of conduct in the Commission's interpretation. Based on our experience, however, we generally believe that it is not a significant portion of the market.
B. Economic Impacts
Based on our experience as the long-standing regulator of the investment adviser industry, the Commission's interpretation of the fiduciary duty under section 206 of the Advisers Act described in this Release generally reaffirms the current practices of investment advisers. Therefore, we expect there to be no significant economic impacts from the interpretation. We do acknowledge, however, to the extent certain investment advisers currently understand the practices necessary to comply with their fiduciary duty to be different from those discussed in this interpretation, there could be some potential economic effects, which we discuss below.
Clients of Investment Advisers
The typical relationship between an investment adviser and a client is a principal-agent relationship, where the principal (the client) hires an agent (the investment adviser) to perform some service (investment advisory services) on the client's behalf.
Because investors and investment advisers are likely to have different preferences and goals, the investment adviser relationship is subject to agency problems: That is, investment advisers may take actions that increase their well-being at the expense of investors, thereby imposing agency costs on investors.
A fiduciary duty, such as the duty investment advisers owe their clients, can mitigate these agency problems and reduce agency costs by deterring agents from taking actions that expose them to legal liability.
To the extent the Commission's interpretation of investment adviser fiduciary duty would cause a change in behavior of those investment advisers, if any, who currently interpret their fiduciary duty to require something different from the Commission's interpretation, we expect a potential reduction in agency problems and, consequently, a reduction of agency costs to the client. The extent to which agency costs would be reduced is difficult to assess given that we are unable to ascertain whether any investment advisers currently interpret their fiduciary duty to be something different from the Commission's interpretation, and consequently we are not able to estimate the agency costs these advisers, if any, currently impose on investors. However, we believe that there may be potential benefits for clients of those investment advisers, if any, to the extent the Commission's interpretation is effective at strengthening investment advisers' understanding of their obligations to their clients. For example, to the extent that the Commission's interpretation enhances the understanding of any investment advisers of their duty of care, it may potentially raise the quality of investment advice given and that advice's fit with a client's individual profile and preferences or lead to increased compliance with the duty to provide advice and monitoring over the course of the relationship.
Additionally, to the extent the Commission's interpretation enhances the understanding of any investment advisers of their duty of loyalty it may potentially benefit the clients of those investment advisers. Specifically, to the extent this leads to a higher quality of disclosures about conflicts for clients of some investment advisers, the nature and extent of such conflict disclosures would help investors better assess the quality of the investment advice they receive, therefore providing an important benefit to investors.
Further, to the extent that the interpretation causes some investment advisers to properly identify circumstances in which disclosure alone cannot cure a conflict of interest, the proposed interpretation may lead those investment advisers to take additional steps to mitigate or eliminate the conflict. The interpretation may also cause some investment advisers to conclude in some circumstances that even if disclosure would be enough to meet their fiduciary duty, such disclosure would have to be so expansive or complex that they instead voluntarily mitigate or eliminate the conflicts of interest. Thus, to the extent the Commission's interpretation would cause investment advisers to better understand their obligations as part of their fiduciary duty and therefore to make changes to their business practices in ways that reduce the likelihood of conflicted advice or the magnitude of the conflicts, it may ameliorate the agency conflict between investment advisers and their clients and, in turn, may improve the quality of advice that the clients receive. This less-conflicted advice may therefore produce higher overall returns for clients and increase the efficiency of portfolio allocation. However, as discussed above, we would generally expect these effects to be minimal. Finally, this interpretation would also benefit clients of investment advisers to the extent it assists the Commission in its oversight of investment advisers' compliance with their regulatory obligations.
Investment Advisers and the Market for Investment Advice
In general, we expect the Commission's interpretation of an investment adviser's fiduciary duty would affirm investment advisers' understanding of the obligations they owe their clients, reduce uncertainty for advisers, and facilitate their compliance. Furthermore, by addressing in one release certain aspects of the fiduciary duty that an investment adviser owes to its clients, the Commission's interpretation could reduce the costs associated with comprehensively assessing their compliance obligations. We acknowledge that, as with other Start Printed Page 21211circumstances in which the Commission speaks to the legal obligations of regulated entities, affected firms, including those whose practices are consistent with the Commission's interpretation, incur costs to evaluate the Commission's interpretation and assess its applicability to them. Moreover, as discussed above, there may be certain investment advisers who currently understand the practices necessary to comply with their fiduciary duty to be different from the standard of conduct in the Commission's interpretation. Those investment advisers if any, would experience an increase in their compliance costs as they change their systems, processes and behavior, and train their supervised persons, to align with the Commission's interpretation.
Moreover, to the extent any investment advisers that understood their fiduciary obligation to be different from the Commission's interpretation change their behavior to align with this interpretation, there could potentially also be some economic effects on the market for investment advice. For example, any improved compliance may not only reduce agency costs in current investment advisory relationships and increase the value of those relationships to current clients, it may also increase trust in the market for investment advice among all investors, which may result in more investors seeking advice from investment advisers. This may, in turn, benefit investors by improving the efficiency of their portfolio allocation. To the extent it is costly or difficult, at least in the short term, to expand the supply of investment advisory services to meet an increase in demand, any such new demand for investment adviser services could potentially put some upward price pressure on fees. At the same time, however, if any such new demand increases the overall profitability of investment advisory services, then we expect it would encourage entry by new investment advisers—or hiring of new representatives, by current investment advisers—such that competition would increase over time. Indeed, we recognize that the recent growth in the investment adviser segment of the market, both in terms of firms and number of representatives,
may suggest that the costs of expanding the supply of investment advisory services are currently relatively low.
Additionally, we acknowledge that to the extent certain investment advisers recognize, due to the Commission's interpretation, that their obligations to clients are stricter than how they currently interpret their fiduciary duty, it could potentially affect competition. Specifically, the Commission's interpretation of certain aspects of the standard of conduct for investment advisers may result in additional compliance costs to meet their fiduciary obligation under the Commission's interpretation. This increase in compliance costs, in turn, may discourage competition for client segments that generate lower revenues, such as clients with relatively low levels of financial assets, which could reduce the supply of investment adviser services and raise fees for these client segments. However, the investment advisers who already are complying with the understanding of their fiduciary duty reflected in the Commission's interpretation, and may therefore currently have a comparative cost disadvantage, could potentially find it more profitable to compete for the customers of those investment advisers who would face higher compliance costs as a result of the proposed interpretation, which would mitigate negative effects on the supply of investment adviser services. Furthermore, as noted above, there has been a recent growth trend in the supply of investment advisory services, which is likely to mitigate any potential negative supply effects from the Commission's interpretation.
Finally, to the extent the proposed interpretation would cause some investment advisers to reassess their compliance with their disclosure obligations, it could lead to a reduction in the expected profitability of certain products associated with particularly conflicted advice for which compliance costs would increase following the reassessment.
As a result, the number of investment advisers willing to advise a client to make these investments may be reduced. A decline in the supply of investment adviser advice on these investments could potentially reduce the efficiency of portfolio allocation of those investors who might otherwise benefit from investment adviser advice on these investments.
IV. Request for Comment Regarding Areas of Enhanced Investment Adviser Regulation
In 2011, the Commission issued the staff's 913 Study, pursuant to section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, in which the staff recognized several areas for potential harmonization of broker-dealer and investment adviser regulation.
We have identified a few discrete areas where the current broker-dealer framework provides investor protections that may not have counterparts in the investment adviser context, and request comment on those areas. The Commission intends to consider these comments in connection with any future proposed rules or other proposed regulatory actions with respect to these matters.
A. Federal Licensing and Continuing Education
Associated persons of broker-dealers that effect securities transactions are required to be registered with the Financial Industry Regulatory Authority (“FINRA”),
and must meet Start Printed Page 21212qualification requirements, which include passing a securities qualification exam and fulfilling continuing education requirements.
The federal securities laws do not require investment adviser representatives to become licensed or to meet qualification requirements, but most states impose registration, licensing, or qualification requirements on investment adviser representatives who have a place of business in the state, regardless of whether the investment adviser is registered with the Commission or the state.
These qualification requirements typically mandate that investment adviser representatives register and pass certain securities exams or hold certain designations (such as Chartered Financial Analyst credential).
The staff recommended in the 913 Study that the Commission consider requiring investment adviser representatives to be subject to federal continuing education and licensing requirements.
We request comment on whether there should be federal licensing and continuing education requirements for personnel of SEC-registered investment advisers. Such requirements could be designed to address minimum and ongoing competency requirements for the personnel of SEC-registered advisers.
- Should investment adviser representatives be subject to federal continuing education and licensing requirements?
- Which advisory personnel should be included in these requirements? For example, should persons whose functions are solely clerical or ministerial be excluded, similar to the exclusion in the FINRA rules regarding broker-dealer registered representatives? Should a subset of registered investment adviser personnel (such as supervised persons, individuals for whom an adviser must deliver a Form ADV brochure supplement, “investment adviser representatives” as defined in the Advisers Act, or some other group) be required to comply with such requirements?
- How should the continuing education requirement be structured? How frequent should the certification be? How many hours of education should be required? Who should determine what qualifies as an authorized continuing education class?
- How could unnecessary duplication of any existing continuing education requirement be avoided?
- Should these individuals be required to register with the Commission? What information should these individuals be required to disclose on any registration form? Should the registration requirements mirror the requirements of existing Form U4 or require additional information? Should such registration requirements apply to individuals who provide advice on behalf of SEC-registered investment advisers but fall outside the definition of “investment adviser representative” in rule 203A-3 (because, for example, they have five or fewer clients who are natural persons, they provide impersonal investment advice, or ten percent or less of their clients are individuals other than qualified clients)? Should these individuals be required to pass examinations, such as the Series 65 exam required by most states, or to hold certain designations, as part of any registration requirements? Should other steps be required as well, such as a background check or fingerprinting? Would a competency or other examination be a meritorious basis upon which to determine competency and proficiency? Would a competency or other examination requirement provide a false sense of security to advisory clients of competency or proficiency?
- If continuing education requirements are a part of any licensing requirements, should specific topics or types of training be required? For example, these individuals could be required to complete a certain amount of training dedicated to ethics, regulatory requirements or the firm's compliance program.
- What would the expected benefits of continuing education and licensing be? Would it be an effective way to increase the quality of advice provided to investors? Would it provide better visibility into the qualifications and education of personnel of SEC-registered investment advisers?
- What would the expected costs of continuing education and licensing be? How expensive would it be to obtain the continuing education or procure the license? Do those costs scale, or would they fall more heavily on smaller advisers? Would these requirements result in a barrier to entry that could decrease the number of advisers and advisory personnel (and thus potentially increase the cost of advice)?
- What would the effects be of continuing education and licensing for investment adviser personnel in the market for investment advice (i.e., as compared to broker-dealers)?
- What other types of qualification requirements should be considered, such as minimum experience requirements or standards regarding an individual's fitness for serving as an investment adviser representative?
B. Provision of Account Statements
Fees and costs are important to retail investors,
but many retail investors are uncertain about the fees they will pay.
The relationship summary that we are proposing in a concurrent release would discuss certain differences between advisory and brokerage fees to provide investors more clarity concerning the key categories of fees and expenses they should expect to pay, but would not require more complete, specific or personalized disclosures or disclosures about the amount of fees and expenses.
We believe that delivery of periodic account statements, if they specified the dollar amounts of Start Printed Page 21213fees and expenses, would allow clients to readily see and understand the fees and expenses they pay for an adviser's services. Clients would receive account statements close in time to the assessment of periodic account fees, which could be an effective way for clients to understand and evaluate the cost of the services they are receiving from their advisers.
Broker-dealers are required to provide confirmations of transactions with detailed information concerning commissions and certain other remuneration, as well as account statements containing a description of any securities positions, money balances or account activity during the period since the last statement was sent to the customer.
Broker-dealers generally must provide account statements no less than once every calendar quarter. Brokerage customers must receive periodic account statements even when not receiving immediate trade confirmations.
Although we understand that many advisers do provide clients with account statements, advisers are not directly required to provide account statements under the federal securities laws. Notably, however, the custody rule requires advisers with custody of a client's assets to have a reasonable basis for believing that the qualified custodian sends an account statement at least quarterly.
In addition, in any separately managed account program relying on rule 3a-4 under the Investment Company Act of 1940, the program sponsor or another person designated by the sponsor must provide clients statements at least quarterly containing specified information.
We request comment on whether we should propose rules to require registered investment advisers to provide account statements, either directly or via the client's custodian, regardless of whether the adviser is deemed to have custody of client assets under Advisers Act Rule 206(4)-2 or the adviser is a sponsor (or a designee of a sponsor) of a managed account program relying on the safe harbor in Investment Company Act rule 3a-4.
- To what extent do retail clients of registered investment advisers already receive account statements? To what extent do those account statements specify the dollar amounts charged for advisory fees and other fees (e.g., brokerage fees) and expenses? Would retail clients benefit from a requirement that they receive account statements from registered investment advisers? If clients are uncertain about what fees and expenses they will pay, would they benefit from a requirement that, before receiving advice from a registered investment adviser, they enter into a written (including electronic) agreement specifying the fees and expenses to be paid?
- What information, in addition to fees and expenses, would be most useful for retail clients to receive in account statements? Should any requirement to provide account statements have prescriptive requirements as to presentation, content, and delivery? Should they resemble the account statements required to be provided by broker-dealers, under NASD Rule 2340 with the addition of fee disclosure?
- How often should clients receive account statements?
- How costly would it be to provide account statements? Does that cost depend on how those account statements could be delivered (e.g., via U.S. mail, electronic delivery, notice and access)? Are there any other factors that would impact cost?
C. Financial Responsibility
Broker-dealers are subject to a comprehensive financial responsibility program. Pursuant to Exchange Act rule 15c3-1 (the net capital rule), broker-dealers are required to maintain minimum levels of net capital designed to ensure that a broker-dealer under financial stress has sufficient liquid assets to satisfy all non-subordinated liabilities without the need for a formal liquidation proceeding.
Exchange Act rule 15c3-3 (the customer protection rule) requires broker-dealers to segregate customer assets and maintain them in a manner designed to ensure that should the broker-dealer fail, those assets are readily available to be returned to customers.
Broker-dealers are also subject to extensive recordkeeping and reporting requirements, including an annual audit requirement as well as a requirement to make their audited balance sheets available to customers.
Broker-dealers are required to be members of the Securities Investor Protection Corporation (“SIPC”), which is responsible for overseeing the liquidation of member broker-dealers that close due to bankruptcy or financial trouble and customer assets are missing. When a brokerage firm is closed and customer assets are missing, SIPC, within certain limits, works to return customers' cash, stock, and other securities held by the firm. If a firm closes, SIPC protects the securities and cash in a customer's brokerage account up to $500,000, including up to $250,000 protection for cash in the account.
Finally, FINRA rules require that broker-dealers obtain fidelity bond coverage from an insurance company.
Under Advisers Act rule 206(4)-2, investment advisers with custody must generally maintain client assets with a “qualified custodian,” which includes banks and registered broker-dealers, and must comply with certain other requirements.
In 2009 the Commission adopted amendments to the custody requirements for investment advisers that, among other enhancements, required all registered investment advisers with custody of client assets to undergo an annual surprise examination by an independent public accountant. SEC-registered investment advisers, however, are not subject to any net capital requirements comparable to those applicable to broker-dealers, although they must disclose any material financial condition that impairs their ability to provide services to their clients.
Many investment advisers have relatively small amounts of capital, particularly compared to the amount of assets that they have under management.
When we discover a serious fraud by an adviser, often the assets of the adviser are insufficient to compensate clients for their loss. In addition, investment advisers are not required to obtain fidelity bonds, unlike Start Printed Page 21214many other financial service providers that have access to client assets.
In light of these disparities, we request comment on whether SEC-registered investment advisers should be subject to financial responsibility requirements along the lines of those that apply to broker-dealers.
- What is the frequency and severity of client losses due to investment advisers' inability to satisfy a judgment or otherwise compensate a client for losses due to the investment adviser's wrongdoing?
- Should investment advisers be subject to net capital or other financial responsibility requirements in order to ensure they can meet their obligations, including compensation for clients if the adviser becomes insolvent or advisory personnel misappropriate clients' assets? 
Do the custody rule and other rules 
under the Advisers Act adequately address the potential for misappropriation of client assets and other financial responsibility concerns for advisers? Should investment advisers be subject to an annual audit requirement?
- Should advisers be required to obtain a fidelity bond from an insurance company? If so, should some advisers be excluded from this requirement? 
Is there information or data that demonstrates fidelity bonding requirements provide defrauded clients with recovery, and if so what amount or level of recovery is evidenced?
- Alternatively, should advisers be required to maintain a certain amount of capital that could be the source of compensation for clients? 
What amount of capital would be adequate? 
- What would be the expected cost of either maintaining some form of reserve capital or purchasing a fidelity bond? Specifically, in addition to setting aside the initial sum or purchasing the initial bond, what would be the ongoing cost and the opportunity cost for investment advisers? Would one method or the other be more feasible for certain types of investment advisers (particularly, smaller advisers)?
- Would the North American Securities Administrators Association Minimum Financial Requirements For Investment Advisers Model Rule 202(d)-1 
(which requires, among other things, an investment adviser who has custody of client funds or securities to maintain at all times a minimum net worth of $35,000 (with some exceptions), an adviser who has discretionary authority but not custody over client funds or securities to maintain at all times a minimum net worth of $10,000, and an adviser who accepts prepayment of more than $500 per client and six or more months in advance to maintain at all times a positive net worth), provide an appropriate model for a minimum capital requirement? Why or why not?
- Although investment advisers are required to report specific information about the assets that they manage on behalf of clients, they are not required to report specific information about their own assets.
Should advisers be required to obtain annual audits of their own financials and to provide such information on Form ADV? Would such a requirement raise privacy concerns for privately held advisers?
End Supplemental Information
By the Commission.
Dated: April 18, 2018.
Brent J. Fields,
[FR Doc. 2018-08679 Filed 5-8-18; 8:45 am]
BILLING CODE 8011-01-P