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183

A FIDUCIARY DUTY FOR ALL?

Kristina A. Fausti∗

INTRODUCTION ....................................................................... 183 1. Two Regimes: The Investment Adviser Standard versus

the Broker-Dealer Standard .......................................... 184 A. Separate Regulatory Structures ............................. 185 B. The Standards of Conduct ...................................... 187

2. Addressing Investor Confusion ..................................... 190 3. Defining Fiduciary ........................................................ 192 4. Fiduciary in New Legislation and Regulation .............. 194

A. The State of Legislation ......................................... 194 B. The Role of Regulation........................................... 197

5. Regulatory Application of Fiduciary Measures ............ 200 A. Balancing Principles and Rules ............................. 200 B. Fiduciary-like Measures ........................................ 203

6. The Practical Reality..................................................... 205 A. Effect on Investors.................................................. 205 B. Effect on Professionals .......................................... 207

CONCLUSION ........................................................................... 209

INTRODUCTION

For years, the investment adviser community has called for all fi-nancial 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 Com-puter & Information Systems, Robert Morris University, 1997). The author pre-viously 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 spe-cialized 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.


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 Administra-tion’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 Representa-tives 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 legisla-tive uncertainty, awareness of the fiduciary issue in the public arena appears to have prompted regulators to seek out ways to advance fidu-ciary 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 ser-vices industry and investors. First, I will examine the fiduciary stan-dard 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 require-ments). 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 ad-dress the practical ramifications of legislative and regulatory changes on both financial professionals and investors, and how these conse-quences should shape any ultimate recommendations for reform.

1. Two Regimes: The Investment Adviser Standard versus the Bro-ker-Dealer Standard

Since the release of the Obama Administration’s recommendation to extend the fiduciary duty, main stream media journalists, profes-sionals, 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), http://financialstability.gov/roadtostability/regulatoryreform.html. 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.


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 nec-essarily 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 Conse-quently, 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 invest-ment 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 regulato-ry 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 1934. Both are generally defined as persons engaged in the busi-ness 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, http://www.suntimes.com/business/savage/2115151,CST-NWS-savage22.savagearticle; Tara Siegel Bernard, Trusted Advisor or Stock Pusher? Finance Bill May Not Settle It, N.Y. TIMES, March 4, 2010, at B1, available at http://www.nytimes.com/2010/03/04/your-money/brokerage-and-bank-accounts/04advisers.html?ref=business; 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, 43-51 (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), http://www.sec.gov/about/offices/oia/oia_investman/rplaze-042006.pdf; see also Suitability of Investment Advice Provided by Investment Advisers, Investment Ad-visers Act Release No. 1406, 59 Fed. Reg. 13,464 (Mar. 16, 1994). 5. Securities Exchange Act of 1934 § 3(a)(4), 15 U.S.C. § 78c(a)(4) (2006). 6. Securities Exchange Act of 1934 § 3(a)(5), 15 U.S.C. § 78c(a)(5) (2006).



level by the SEC and a self-regulatory organization (“SRO”), usually the Financial Industry Regulatory Authority (“FINRA”).7 Broker-dealers 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 person10 that is engaged in the business of pro-viding advice to others regarding securities.11 Most investment advis-ers 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 in-vestment 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, deal-er, 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 compensa-tion therefor . . . .”13 It should be noted that this exemption includes two key components: (1) advice must be solely incidental to broker-dealers’ business; and (2) broker-dealers can receive no special com-pensation, 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. 56145, 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), http://www.sec.gov/divisions/marketreg/bdguide.htm. 9. Id. 10. “Person” under the federal securities laws generally refers to both natural persons and companies. See Investment Advisers Act of 1940 § 202(a)(16), 15 U.S.C. § 80b-2(a)(16); Securities Exchange Act of 1934 § 3(a)(9), 15 U.S.C. § 78c(a)(9). 11. Investment Advisers Act of 1940 § 202(a)(11), 15 U.S.C. § 80b-2(a)(11). 12. See PLAZE, supra note 4, at 6-11. 13. Investment Advisers Act of 1940 § 202(a)(11), 15 U.S.C. § 80b-2(a)(11).



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 invest-ment 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 broker-dealers, 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 broker-dealer 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 stan-dards that reflect the role of broker-dealers as salespeople in the in-vestment 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 relation-ship 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 broker-dealer represents it will deal fairly with customers, consistent with the standards of the profession. Id. 17. Securities Exchange Act of 1934 §§ 9(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 http://finra.complinet.com /en/display/display_main.html?rbid=2403&element_id=5504. 19. See, e.g., Securities Exchange Act of 1934 §§ 6(b)(5), 7(c), 15 U.S.C. §§ 78f(b)(5), 78g(c); FINRA Manual, FINRA Rule 2114, available at http://finra.complinet.com/en/display/display_viewall.html?rbid=2403&element_id=8228&record_id=11290.



rules include suitability,20 best execution,21 disclosure of material in-formation,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 du-ties, 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 inves-tor’s trust.26 To reflect the fact that the relationship goes beyond a commercial interaction, investors who are served by investment ad-visers 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 http://finra.complinet.com /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 “reasona-ble basis suitability” which relates to a particular security or strategy, and “custom-er-specific suitability” which relates to the customer’s financial situation and needs. See DIVISION OF TRADING AND MARKETS, supra note 8. 21. FINRA Manual, NASD Rule 2320, available at http://finra.complinet.com/ en/display/display_main.html?rbid=2403&element_id=3643. 22. Securities Exchange Act of 1934 § 10(b), 15 U.S.C. § 78j(b); Securities Ex-change Act of 1934 Rules 10b-5, 10b-10, 17 C.F.R. §§ 240.10b-5, 240.10b-10 (2010); see also DIVISION OF TRADING AND MARKETS, supra note 8. 23. FINRA Manual, NASD Rule 2440, available at http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=3660. Broker-dealers are also subject to several other substantive requirements re-lated to, inter alia, trading securities, extending credit, and customer privacy. See DIVISION OF TRADING AND MARKETS, supra note 8. 24. 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 Bu-reau, Inc., 375 U.S. 180 (1963); see also PLAZE, supra note 4, at 13-14. 25. 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’ Associa-tion Annual Awards Dinner (June 18, 2009), available at http://www.sec.gov/news/speech/2009/spch061809mls-2.htm. 27. See, e.g., Investment Advisers Act of 1940 §§ 203(b), 206, 15 U.S.C. §§ 80b-3, 80b-6.



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 in-vestment advisers and broker-dealers under the fiduciary and fair deal-ing standards. An investment adviser must always seek to avoid con-flicts of interest with clients and may not overreach or take unfair ad-vantage of a client’s trust.31 In this regard, the fiduciary must be sen-sitive 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 Pro-fessor Mercer Bullard33 noted, an investment adviser would be re-

28. The SEC does not have a suitability rule for investment advisers, but en-forces suitability violations through the anti-fraud rules contained in the federal securities laws. Investment advisers must have a reasonable basis for making rec-ommendations 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 ad-viser made highly risky investments that were unsuitable in light of his clients' in-vestment objectives, assets, income and degree of sophistication concerning securi-ties); 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. 13464 (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 fidu-ciary 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 prin-cipal requires a fiduciary to disclose all material circumstances fully and complete-ly”). 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 17-25. 31. See PLAZE, supra note 4, at 13. 32. See Capital Gains Research, 375 U.S. at 188-192. 33. See Capital Markets Regulatory Reform: Strengthening Investor Protection, Enhancing Oversight of Private Pools of Capital, and Creating a National Insur-



quired under the fiduciary standard to disclose any differential com-pensation it receives as the result of recommending different products to its client because of the conflict of interest such differential com-pensation 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 emp-tor” 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 differ-ence in regulatory standards for broker-dealers and investment advis-ers, 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 finan-cial regulatory reform set forth a specific initiative to empower the SEC to establish a fiduciary duty for broker-dealers offering invest-ment advice. In addition to extending the fiduciary standard, the Ad-ministration’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 call-ing 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 http://www.house.gov/ apps/list/hearing/financialsvcs_dem/hr_092909.shtml; Meeting of the SEC Investor Advisory Committee (Oct. 5, 2009), archived webcast available at http://www.sec.gov/cgi-bin/goodbye.cgi?www.connectlive.com/events/ secadvisory100509/. Mercer Bullard, an Associate Professor of Law at the Univer-sity of Mississippi School of Law, teaches courses on securities, banking, corpora-tions, corporate finance, and law and economics, and is also the Founder and Presi-dent of Fund Democracy, an advocacy group for mutual fund shareholders. 34. See, e.g., In re Morgan Stanley and Van Kampen Mutual Fund Sec. Litiga-tion, 2006 U.S. Dist. LEXIS 20758 (S.D.N.Y. Apr. 14, 2006); United States v. Alva-rado, 2001 U.S. Dist LEXIS 21100 (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.



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 wide-spread 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 2008.38 The RAND Report concluded that investors did not understand key distinctions between investment advisers and broker-dealers, including their du-ties, the titles they use, and the services they offer.39 Also contribut-ing 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, fi-nancial consultant, advisor, financial planner, and stockbroker.40

The RAND report also showed that investors struggled to under-stand the different legal standards of care to which investment advis-ers 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 obli-gation to put investors’ interest first.43 As a result of investor miscon-ception highlighted in the RAND Report, policy and lawmakers began considering proposals for improving investor protections, including

36. Id. at 72. 37. Id. at 71. 38. 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), http://www.sec.gov/news/press/2008/2008-1_randiabdreports.pdf. The RAND Report was the result of a study commissioned by the SEC. The Study spe-cifically addressed two questions: (1) What are the current business practices of broker-dealers and investment advisers; and (2) do investors understand the differ-ences between the relationships among broker-dealers and investment advisers. Id. at xiv. 39. Id. at 117. 40. Id. at 90-92. 41. Id. at 113. The RAND study used fiduciary and suitability requirements as their point of comparison for investors. Id. 42. Id. at 118. 43. HUNG, supra note 38.



broadening the scope of the fiduciary standard. As will be explored further below, these proposed solutions have ignited much controver-sy 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 In-stitute (“FSI”) and Securities Industry and Financial Markets Associa-tion (“SIFMA”) have claimed that the fiduciary is defined differently in various federal and state laws and, therefore, has a limited useful-ness.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, http://www.investmentadvisor.com/ 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, Securi-ties Industry and Financial Markets Association), available at http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Testimony&Hearing_ID=faf91bea-ca58-4bc1-873d-33739dbb4f76&Witness_ID=f2cf02f4-d63e-4bd0-a16c-3786fbc08c19). 45. See Industry Perspectives on the Obama Administration’s Financial Regula-tory Reform Proposals, Hearing Before the House Committee on Financial Services, 111th Cong. (July 17, 2009) (statement of Randolph C. Snook, Executive Vice Pres-ident of the Securities Industry and Financial Markets Association), available at http://www.house.gov/apps/list/hearing/financialsvcs_dem/snook.pdf; see also In-dustry Groups Differ on Fiduciary Standard, FINANCIAL ADVISOR, Oct. 6, 2009, http://www.fa-mag.com/fa-news/4532-industry-groups-differ-on-fiduciary-standard-.html.



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 profes-sional 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 un-der a theory of caveat emptor. Moreover, the creation of a new stan-dard would introduce elements of uncertainty because industry profes-sionals, investors, and regulators would have little experience with how to apply a new standard. With investment advisers already oper-ating 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 ex-ists.

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 delay-ing regulatory action. Any claims that the definition of fiduciary is unclear ignore key points about the framework of fiduciary obliga-tions. 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 dif-ferences 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 dif-fering 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, http://www.advisorperspectives.com/newsletters09/ 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. §§ 1001 et seq.; NATIONAL CONFERENCE OF COMMISSIONERS ON



standard exists under the Advisers Act and that uniformity is pro-moted under this standard.48 Accordingly, legislators and regulators should focus on preserving and strengthening this federally estab-lished 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 pro-pose and implement changes.

A. The State of Legislation

Soon after the Obama plan was released in 2009, U.S. Depart-ment of Treasury staff began drafting key pieces of legislation aimed at advancing the Administration’s plan. A key piece of that legisla-tion 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 2009.49 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 compensa-tion 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), availa-ble at http://www.law.upenn.edu/bll/archives/ulc/fnact99/1990s/upia94.pdf. 48. PLAZE, supra note 4, at 14 n.80; Memorandum from the Investor as Purchas-er Subcommittee, to the SEC Investor Advisory Committee (Feb. 15, 2010), http://www.sec.gov/spotlight/invadvcomm/iacmemofiduciaryduty.pdf. 49. Investor Protection Act of 2009, H.R. 3817, 111th Cong. (2009).



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 inves-tor confusion and provide strong safeguards for investors. In Novem-ber 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 Ameri-can Financial Stability Act of 2009,51 which included a markedly dif-ferent 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 ex-emption, 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 profession-als 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 brokers-dealers and investment advisers, which could result in differences in the standard for each group.52

50. 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, http://banking.senate.gov/public/_files/111609FullBillTextofTheRestoringAmericanFinancialStabilityActof2009.pdf. 52. Maintaining separate sets of rules also has presented opportunities for legis-lators 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



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 considera-tion 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 pro-ponents 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 finan-cial professionals providing personalized investment advice and rec-ommendations 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 insur-ance 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 ser-vices 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 stan-dard. 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 ultimate-ly 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, general-ly 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 http://www.nytimes.com/2009/12/02/ business/02regulate.html?_r=3&hpw. 54. Discussion Draft, Restoring American Financial Stability Act of 2010, http://banking.senate.gov/public/_files/ChairmansMark31510AYO10306_xmlFinancialReformLegislationBill.pdf. 55. Id. at § 913.



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, Sena-tor 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 recon-cile 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 con-sumer 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 ex-tending the fiduciary standard will lie with the SEC. And it has be-come 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 har-monize investment adviser and broker-dealer regulatory schemes and extend the fiduciary duty to all investment advice providers likely ori-ginated 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 inves-tors 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), http://banking.senate.gov/public/index.cfm? FuseAction=Hearings.Hearing&Hearing_ID=b8c4a3bd-db46-4b8d-a759-5024b72204cd. As of April 14, 2010, a number had not been assigned to the Senate bill yet.



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 sym-pathy to the lobbying efforts of the brokerage industry.57 Indeed, in-vestor and advisory groups expressed concern early on that the SEC would lower the fiduciary standard in order to accommodate broker-dealer business practices.58

Despite these concerns, public statements from several SEC commissioners, including Chairman Schapiro and Commissioner Wal-ter 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 fidu-ciary 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 uni-form standard of care for financial professionals, Commissioner Agui-lar 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, empha-sizing 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.”60

57. See Dan Jamieson, RIAs Fretful about Finra Grabbing Regulatory Oversight, INVESTMENT NEWS, Jan. 4, 2009, http://www.investmentnews.com/article/ 20090104/REG/901059997. 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, http://www.bloomberg.com/ apps/news?pid=20603037&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 An-nual Conference (May 7, 2009), available at http://www.sec.gov/news/speech/ 2009/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 http://www.sec.gov/news/speech/2010/ spch032610laa.htm.



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 fidu-ciary duty in her public remarks and testimony before Congress.62 In June 2009, she provided extensive remarks on the regulation of finan-cial professionals, noting that “If broker-dealers and investment advis-ers 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 in-cluded in the financial regulatory reform legislation.65

61. Elisse B. Walter, SEC Comm’r, Remarks at 2010 Investment Adviser Com-pliance Forum (Feb. 25, 2010), available at http://www.sec.gov/news/speech/ 2010/spch022510ebw.htm. 62. See, e.g., Mary L. Schapiro, SEC Chairman, Address to Financial Services Roundtable – 2009 Fall Conference (Sept. 24, 2009), available at http://www.sec.gov/news/speech/2009/spch092409mls.htm; 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 http://www.house.gov/apps/list/ hearing/financialsvcs_dem/sec_testimony.pdf. 63. Schapiro, supra note 26. 64. 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 http://www.sec.gov/news/speech/ 2009/spch120309mls.htm. 65. Fawn Johnson, SEC Asked Senate for Tougher Dealer Standards in Finan-cial Bill, DOW JONES, Mar. 19, 2010, available at http://www.nasdaq.com/aspx/ stock-market-news-story.aspx?storyid=201003191415dowjonesdjonline 000585&title=sec-asked-senate-for-tougher-dealer-standards-in-financial-billCite article.



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 be-lieves a single standard should apply to financial professionals and it should be the fiduciary standard.66 In fact, in recent remarks, Ket-chum 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 legis-lation passes. Chairman Schapiro has acknowledged that the SEC lacks statutory authority to extend the fiduciary standard to broker-dealers.68 Thus, regulatory action will take different forms and have different effects on financial professionals depending on how Con-gress acts.

A. Balancing Principles and Rules

As noted earlier, much of the debate over defining what a fidu-ciary 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 Com-mittee on Financial Services, 111th Cong. (Oct. 6, 2009), available at http://www.finra.org/Newsroom/Speeches/Ketchum/P120108. 67. Finra CEO Expects Eventual Move to Fiduciary Standard, DOW JONES, Mar. 16, 2010, available at http://www.fa-mag.com/fa-news/5339-finras-ceo-expects-eventual-move-to-fiduciary-standard.html. 68. See Donna Rosato, How Well Is the SEC Protecting You?, MONEY

MAGAZINE, Feb. 24, 2010, http://money.cnn.com/2010/02/24/news/economy/ SEC_Schapiro.moneymag/index.htm.



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 fidu-ciary 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 prin-ciples 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 Fidu-ciary 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 per-ceived 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 26. 70. The Committee for the Fiduciary Standard was formed by a group of like-minded financial professionals and industry experts on the fiduciary standard. The Committee for the Fiduciary Standard, http://www.thefiduciarystandard.org/ 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.



vices provided.73 Given the potential shortcomings of both principles-based and rules-based regulation, it will be important for regulators to seek a proper balance of each with regard to the application of the fi-duciary 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 re-quirements 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 re-gard, she believes in prohibiting certain conflicted behavior or requir-ing 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 sophistica-tion of an investor appears to be a concept that has been adopted by Congress, which has focused on advice provided to a “retail inves-tor.”78 Thus, because Congress has failed to address the broker ex-

73. For example, although FINRA has an established suitability rule, it has is-sued several notices to its members providing additional guidance on suitability issues related to specific products and practices. See, e.g., NASD Notice to Mem-bers 05-59, Structured Products (Sept. 2005), available at http://www.finra.org/web/ groups/industry/@ip/@reg/@notice/documents/notices/p014997.pdf; NASD Notice to Members 01-23, Suitability Rule and Online Communications (Apr. 2001), avail-able at http://www.finra.org/Industry/Regulation/Notices/2001/p003886. 74. NORTH AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION, PROCEEDINGS OF THE NASAA FINANCIAL SERVICES REGULATORY REFORM

ROUNDTABLE: A MAIN STREET AGENDA FOR WALL STREET REFORM 11-12 (Dec. 11, 2008), http://www.nasaa.org/content/Files/Proceedings_NASAA_Regulatory_ 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 http://www.sec.gov/news/speech/2009/spch050509ebw.htm. 77. Id. 78. See, e.g., Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. (2009).



emption in the Advisers Act, the SEC could have latitude to continue to exempt broker-dealers in specific circumstances or to create differ-ent regulatory requirements for professionals serving institutional in-vestors. These are all important considerations that will drive the SEC as it seeks to find an appropriate balance between principles-based and rules-based regulation for financial professionals.

B. Fiduciary-like Measures

Absent legislation addressing the extension of the fiduciary stan-dard and harmonization, the SEC will be faced with how it can seek a more harmonized regulatory structure without complete statutory au-thority to extend the fiduciary standard. In this vein, SEC staff is al-ready considering what approaches the agency will be able to take if the fiduciary standard is not addressed through legislation.79 It is also expected that the Commission will receive recommendations from the newly formed SEC Investor Advisory Committee on how to pro-ceed.80

Indeed, work done to date by the SEC Investor Advisory Com-mittee provides some insight into how the Commission may act with regard to proposing and implementing fiduciary-like measures. The Investor Advisory Committee specifically chose to study and consider the fiduciary standard, and delegated work on the issue to its Investor as Purchaser Subcommittee.81 In February 2010, the Subcommittee delivered a memo examining the “federal fiduciary duty,” defined as the fiduciary duty owed by an investment adviser to his clients under the Advisers Act.82 The Subcommittee noted that statutes, SEC rules,

79. In an interview, Chairman Schapiro stated that the SEC has an internal task force figuring out how to implement the fiduciary standard depending on what legis-lation is passed. Rosato, supra note 68. 80. On June 3, 2009, the SEC announced the formation of the Investor Advisory Committee to give investors a greater voice in the Commission’s work. Press Re-lease, Securities and Exchange Commission, SEC Announces Creation of Investor Advisory Committee (June 3, 2009), available at http://www.sec.gov/news/press/ 2009/2009-126.htm. 81. Press Release, Securities and Exchange Commission, SEC Investor Advisory Committee Forms Subcommittees to Tackle Ambitious Agenda on Behalf of Inves-tors (Sept. 15, 2009), available at http://www.sec.gov/news/press/2009/2009-197.htm. 82. Memorandum from the Investor as Purchaser Subcommittee, to the SEC Investor Advisory Committee 2 (Feb. 15, 2010), available at http://www.sec.gov/ spotlight/invadvcomm/iacmemofiduciaryduty.pdf.



and common law principles comprise an important aspect of the SEC's role in developing and implementing the federal fiduciary duty.83 The Subcommittee, however, chose not to address the impact of pending legislation on the fiduciary duty due, in part, to the uncertain fate of such legislation.84 By taking this approach, the Subcommittee was able to draw attention to the areas where it believes the SEC already holds authority with regard to the federal fiduciary standard and how the agency can exercise that authority.

In its February 2010 memo, the Subcommittee also noted that while the federal fiduciary duty applies only under the Advisers Act, a non-federal fiduciary duty can apply nonetheless in other contexts outside of the Advisers Act.85 Moreover, the scope and substance of non-federal fiduciary duties can be greatly impacted by SEC action that may range from informally guiding parties in their application of the fiduciary duty to formally preempting a conflicting standard.86 On the other hand, SEC inaction could leave room for other actors and entities, such as state and federal courts, state regulators, FINRA, and arbitration panels to fill the fiduciary space.87

The Subcommittee also noted that broker-dealer rules promulgat-ed by the SEC and FINRA can impose fiduciary requirements, such as pending rules that would require mutual fund point of sale disclo-sures.88 The Subcommittee acknowledged that the SEC and FINRA “might object to the suggestion that they have shoehorned fiduciary standards into a non-fiduciary regulatory scheme,” but pointed out that “some broker rules have a decidedly fiduciary flavor.”89 With this acknowledgement that the SEC and FINRA may adopt rules that promote fiduciary principles, it appears more likely that the regulators will seek to adopt disclosure and other rules that promote transparency and clarity of investor’s relationships with financial professionals if legislation fails to address the fiduciary standard. Later this year the Investor Advisory Committee is expected to deliver concrete recom-

83. Id. 84. Id. at 2, n.1. 85. Id. at 7. 86. Id. at 8. 87. Memorandum from the Investor as Purchaser Subcommittee, to the SEC Investor Advisory Committee 8-9 (Feb. 15, 2010), available at http://www.sec.gov/ spotlight/invadvcomm/iacmemofiduciaryduty.pdf. 88. Id. at 7-8. 89. Id. at 7-8.



mendations on how the SEC can promote and expand the federal fidu-ciary standard and fiduciary-related measures, which would put great-er impetus on the SEC to respond and act. Consequently, given the recognition of authority the SEC possesses in the fiduciary space, fi-nancial professionals should expect the SEC to take the lead on effect-ing change in this area.

6. The Practical Reality

Whatever legislative or regulatory action is taken, there will be practical implications for both investors and financial professionals. Examining some of those ramifications is useful in analyzing the overall financial reform debate as it relates to the fiduciary standard in order to arrive at appropriate recommendations for moving forward.

A. Effect on Investors

As revealed by the RAND Report, in everyday situations, inves-tors trust broker-dealers and investment advisers and anyone else who holds himself out as providing advice at exactly the same level.90 Fur-thermore, they assume that because all of these professionals provide similar services, they are subject to the same regulatory and legal re-quirements.91 Thus, the real confusion that most investors experience occurs when they think they can trust their financial advisor (whether an investment advisor or broker-dealer), and that the professional is operating under a fiduciary obligation.92 When investors realize this is not always the case, their confusion then prompts them to wonder whom can they trust.

90. HUNG ET AL., supra note 38, at 118. 91. Id. 92. An investor’s confusion can also be further compounded in specific situa-tions, such as where a financial professional is a “dual hatter.” “Dual hatter” or “dual hat” is meant to refer to a professional who is registered both as a broker-dealer and an investment adviser representative and who, therefore, switches profes-sional hats for different services and products. For example, the professional would be a fiduciary and subject to Adviser Act and the fiduciary duty when providing investment advice, but subject to Exchange Act and FINRA rules when executing recommended transactions; thus, switching back and forth between acting as a fidu-ciary. For investors to be truly protected, proponents of the fiduciary standard have argued that the highest standard of care applicable must apply in such a relationship where a professional acts in more than one capacity.



Regulators have expressed concern about the role differing regu-latory requirements play in creating investor confusion and have ar-gued that only consistent regulation can address the issue.93 In this vein, regulators have also expressed concern that the legislation being considered on Capitol Hill fails to fully address investor confusion and also fails to promote more consistent regulation.94 For example, Commissioners Aguilar and Walter have questioned the need the one-year study proposed by the Senate to review financial professionals’ standards of conduct.95 In Aguilar’s words: “I don’t believe we need a study to conclude that investor protection requires that broker-dealers providing investment advice be subject to fiduciary duties. I think that question has long ago been asked and answered.”96

Based on these remarks on the Senate proposal, it would appear that regulators would favor the House bill, which takes a more direct approach to implementing fiduciary obligations for broker-dealers. Commissioner Aguilar, however, has questioned the limited scope of the House legislation, as it would apply “only to those providing per-sonalized services to retail customers,” noting that “[t]his language limits the application of the fiduciary standard and excludes many investors from its protection.”97

Based on these comments, regulators are clearly worried about perpetuating gaps in regulation. In addition, regulators also are con-cerned that regulatory reforms adequately address investor perceptions and needs. Commissioner Walter noted in recent remarks that by get-ting caught up in the debate over the fiduciary standard, law and poli-cy makers seem to be making it too hard on themselves.98 She then used the following pledge from a New York Times reporter’s blog to illustrate her point:

I, the undersigned, pledge to exercise my best efforts to always act in good faith and in the best interests of my client, [-and I will insert my now-famous Aunt Millie here-], and will act as a fiduciary. I will provide written disclosure, in advance, of any conflicts of interest, which could reasonably compromise the impartiality of

93. See Walter, supra note 76. 94. See Aguilar, supra note 60. 95. Id. See also Walter, supra note 61. 96. Aguilar, supra note 60. 97. Id. 98. Walter, supra note 61.



my advice. Moreover, in advance, I will disclose any and all fees I will receive as a result of this transaction and I will disclose any and all fees I pay to others for referring this client transaction to me. This pledge cov-ers all services provided.99

According to Walter, “it’s important to realize that the language [in the pledge] seems to capture the essence of the way that all finan-cial professionals should treat investors.”100 Once regulators and pro-fessionals can agree on this, regulatory solutions should come more easily.

In sum, while impact on professionals is also an important con-cern, as discussed below, such concern should not override investor concerns to the point that lawmakers miss out on the true opportunity that exists here. And that is the opportunity to strengthen and build upon the existing fiduciary foundation that investors already appear to rely upon in all of their dealings with financial professionals and that greatly improve investor confidence.

B. Effect on Professionals

A large issue that is hampering the extension of the fiduciary duty is an improper understanding of the scope of both the problem and proposed solution. The brokerage and insurance industries quickly became defensive of the Obama Administration’s proposal out of con-cern of the impact changes would have on their business models. What both advocates and opponents of the extension of the fiduciary standard have failed to adequately address is the parameters of the regulatory issue at hand.

As noted by Commissioner Aguilar, we are currently talking about the extension of the fiduciary standard to financial professionals who provide “personalized investment advice” to “retail investors.” If this is the true scope that the Obama Administration, Congress, and the SEC wish to apply to the extension of the duty, then these policy and lawmakers need to appropriately set expectations for change and identify how far such changes will reach.

99. Id. (citing Tara Siegel Barnard, Will You Be My Fiduciary?, available at http://bucks.blogs.nytimes.com/2010/02/16/will-you-be-my-fiduciary/?scp=1&sq= fiduciary&st=cse). 100. Id.



Several proposals for achieving true harmonization have been put forth, but have been susceptible to criticism because of a lack of un-derstanding of their true reach. For example, there are those that have called for the implementation of the original Dodd proposal to remove the broker exemption from the Advisers Act and require all financial professionals providing advice to register as investment advisers un-der the Advisers Act to ensure consistent regulation.101 Others have called for a single standard of care to apply to all financial profession-als coupled with functional regulation that would allow rules to devel-op to address the particular functions of different intermediaries (but fiduciary law always applies at the foundation).102 Either of these proposals could be workable, but have failed to gain momentum and widespread support out of industry fear of potential broad changes to financial products and services because of new regulations.

Accordingly, any final approach must recognize the proper scope of (1) the issue being addressed, (2) the professionals who will be im-pacted, (3) investors who will (and will not) be impacted, and (4) ap-plication of a final recommendation. This requires thoughtful rule-making and guidance by the regulators in order to promote a smooth transition to fiduciary principles and related rules by both broker-dealers and investment advisers.

Though broker-dealers who provide advice stand to be affected by financial regulatory reforms that institute fiduciary and related ob-ligations, not all broker-dealers will be affected in the same way de-pending on the services and products they provide. Little discussion in the public arena to date has distinguished between the roles of most broker-dealers. A few academics and practitioners, however, have highlighted key functions of broker-dealers, such as selling securities from their own inventory, acting as a securities underwriter, and plac-ing and executing securities trades, which must be addressed if bro-ker-dealers are to be held to a fiduciary duty.103 Regulators will need to be especially sensitive to clearly identifying how these functions as well as broker-dealer sales practices will and will not be affected un-der a fiduciary standard.

101. See Laby, supra note 14. 102. See Walter, supra note 74; Michael Koffler, Six Degrees of Separation: Prin-ciples to Guide the Regulation of Broker-Dealers and Investment Advisers, SEC. REG. & LAW REP., Apr. 27, 2009. 103. See Laby, supra note 14; Koffler, supra note 102.



Investment advisers should expect to be impacted by regulatory change as well. Specifically, the call for harmonization of regulatory structures could result in a more rules-based approach for investment advisers under the fiduciary standard in order to maintain consistency of regulations that govern both broker-dealers and investment advis-ers. In addition, an outlying issue is the oversight of investment ad-visers. Specifically, to ease the SEC’s regulatory burden and truly harmonize regulation of financial professionals, some industry ob-servers and regulators have argued investment advisers should be sub-ject to regulation by SROs.104 Whether investment advisers should and/or will ultimately become subject to SRO jurisdiction is outside the scope of the discussion in this paper, but is an issue that could greatly impact investment advisers and the way they are regulated.

Overall, it should also be expected that as regulations change, the financial services industry will react and evolve in new ways. In this case, given the increased focus on investment advice and interactions with retail investors, the adoption of a fiduciary standard of care for advice givers could result in a clearer division of responsibilities be-tween financial professionals who are investment service providers and financial professionals who are investment product providers, which would make it somewhat easier to define and identify fiduciary obligations. In any case, it will be imperative that regulators clearly define the scope of financial professionals’ roles and how they will be affected under regulatory changes that seek to either extend the fidu-ciary standard itself or simply promote fiduciary principles in new rules.

CONCLUSION

Overall, investment professionals should expect financial regula-tory reform to bring greater transparency and accountability to the financial marketplace. Extending the fiduciary standard is a key measure that would bring about such change, while also reducing in-vestor confusion and closing regulatory gaps. Even if legislation does not address the fiduciary standard, financial professionals should ex-pect the SEC to move forward with introducing new rules that seek to

104. See, e.g., Rick Ketchum, Address Before the Exchequer Club (June 17, 2009), available at http://www.finra.org/Newsroom/Speeches/Ketchum/P119009; Sara Hansard, SEC’s Donohue Mulling Adviser SRO, INVESTMENT NEWS, May 5, 2009, http://www.investmentnews.com/article/20090505/FREE/905059980.



promote fiduciary principles and reduce or expose conflicts of inter-est. Thus, financial professionals, whether acting in a fiduciary capac-ity or not, would be wise to embrace fiduciary concepts now as a way to prepare for new regulatory guidance that could greatly impact their conduct and practices.

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