13.1 Fiduciary Duty
Key Takeaways
Investment advisers owe a fiduciary duty comprised of duty of care AND duty of loyalty.
Fiduciary duty requires acting in the client's BEST interest, not just a suitable option.
The duty of care includes providing advice, seeking best execution, and ongoing monitoring.
The duty of loyalty requires putting client interests first and avoiding self-dealing.
Fiduciary duty CANNOT be waived, though specific terms can be shaped by contract.
All conflicts of interest must be disclosed and managed or eliminated.
Broker-dealers are subject to Regulation Best Interest (Reg BI), not full fiduciary duty.
Reg BI has four components: Disclosure, Care, Conflict of Interest, and Compliance.
Investment advisers owe a fiduciary duty to their clients - the highest standard of care in the financial services industry.
The SEC's Fiduciary Interpretation
In 2019, the SEC issued a formal interpretation clarifying that an investment adviser's fiduciary duty under the Investment Advisers Act of 1940 has two main components:
Duty of Care
The duty of care requires advisers to provide advice with diligence and skill, always in the client's best interest.
| Component | Description |
|---|---|
| Provide suitable advice | Based on client's goals, risk tolerance, and financial situation |
| Seek best execution | Obtain the most favorable terms reasonably available |
| Provide advice and monitoring | Ongoing guidance throughout the relationship |
| Make reasonable inquiry | Understand client's circumstances before advising |
Duty of Loyalty
The duty of loyalty requires placing the client's interests ahead of the adviser's.
| Component | Description |
|---|---|
| Put client first | Never subordinate client interests to your own |
| Avoid self-dealing | Don't benefit at the client's expense |
| Disclose conflicts | Full and fair disclosure of all material conflicts |
| Obtain informed consent | Client must understand and agree to any conflicts |
Key Principles
Cannot Waive Fiduciary Duty
The SEC expressly stated that the federal fiduciary duty cannot be waived entirely. However:
- Advisers and clients can shape the relationship by contract
- Specific scope of services can be limited
- Full and fair disclosure is always required
- Informed consent must be obtained
Best Interest Standard
The "best interest" obligation is an overarching principle that encompasses both duties:
- Not just suitable - the BEST option for the client
- Considered at the time advice is given
- Must continue throughout the relationship
Fiduciary vs. Suitability vs. Reg BI
| Standard | Applies To | Key Requirement |
|---|---|---|
| Fiduciary Duty | Investment Advisers | Act in client's BEST interest always |
| Reg BI | Broker-Dealers | Best interest at time of recommendation |
| Suitability | Historical BD standard | Recommendation must be suitable |
Important Distinctions
| Factor | Fiduciary (IA) | Reg BI (BD) |
|---|---|---|
| Scope | Entire relationship | Point of recommendation |
| Ongoing duty | Yes, continuous | At recommendation only |
| Monitoring | Required | Not required |
| Standard | Highest standard | Elevated suitability |
Regulation Best Interest (Reg BI)
Effective June 30, 2020, Reg BI requires broker-dealers to act in the retail customer's best interest at the time of a recommendation.
Four Component Obligations
| Obligation | Requirement |
|---|---|
| Disclosure | Provide Form CRS; disclose material facts |
| Care | Exercise reasonable diligence and skill |
| Conflict of Interest | Establish policies to identify and mitigate conflicts |
| Compliance | Written policies and procedures for supervision |
Form CRS (Client Relationship Summary)
Both investment advisers and broker-dealers must provide Form CRS to retail investors:
- Maximum 2 pages (4 pages for dual registrants)
- Plain language format
- Key questions to consider
- Comparison of services (for dual registrants)
Conflicts of Interest
Common Conflicts for Investment Advisers
| Conflict Type | Example |
|---|---|
| Compensation conflicts | Higher fees for recommending certain products |
| Principal trading | Selling securities from own inventory |
| Soft dollars | Using client commissions for research |
| Referral fees | Compensation for sending business |
| Outside activities | Board seats, side businesses |
| Personal trading | Trading same securities as clients |
Managing Conflicts
| Strategy | Description |
|---|---|
| Eliminate | Remove the conflict entirely if possible |
| Disclose | Full and fair disclosure in ADV Part 2A |
| Mitigate | Implement policies to reduce harm |
| Obtain consent | Client's informed agreement |
Disclosure Requirements
Advisers must disclose in Form ADV Part 2A:
- All fees and compensation arrangements
- Conflicts of interest
- Disciplinary history
- Material facts about business practices
- Code of ethics summary
Exam Tip: Fiduciary duty CANNOT be waived entirely. It has TWO components: duty of CARE and duty of LOYALTY. Reg BI applies to broker-dealers, not investment advisers. Conflicts must be DISCLOSED, not just avoided.
Under the SEC's fiduciary interpretation, an investment adviser's fiduciary duty consists of:
Duty of suitability only
Duty of care and duty of loyalty
Duty of disclosure only
Duty of best execution only
Which statement about an investment adviser's fiduciary duty is TRUE?
The duty can be completely waived with client consent
The duty applies only at the time of recommendation
The duty cannot be entirely waived but can be shaped by contract
The duty is identical to a broker-dealer's Reg BI obligation
Regulation Best Interest (Reg BI) applies to:
Investment advisers only
Broker-dealers making recommendations to retail customers
Both investment advisers and broker-dealers equally
Federal covered advisers only
The four component obligations of Regulation Best Interest are:
Suitability, Disclosure, Registration, and Supervision
Disclosure, Care, Conflict of Interest, and Compliance
Loyalty, Care, Best Execution, and Monitoring
Transparency, Fairness, Competence, and Ethics
Sections you finish are checked off in the contents.