Feds Nix ‘flicts for Brokers and Advisers

AUG 13, 2019 | PRACTUS LLP

Feds Nix ‘flicts for Brokers and Advisers



Creates an enhanced standard of conduct applicable to broker-dealers at the time they recommend to a retail customer a securities transaction or investment strategy involving securities.

  • Retail customer: any individual who receives a recommendation from the broker-dealer for the individual’s own account (but not an account for a business that he or she works for), including individual plan participants. “Legal representative of such natural person’’ includes the nonprofessional legal representatives of such an individual (e.g., a nonprofessional trustee who represents the assets of an individual).
  • Securities Transaction or Investment Strategy Involving Securities: includes recommendations of account types and rollovers or transfers of assets and also covers implicit hold recommendations, resulting from agreed-upon account monitoring.

When making a recommendation, a broker-dealer must act in the retail customer’s best interest and cannot place its own interests ahead of the customer’s interests. To satisfy this, a broker-dealer must comply with the following four obligations.

A: Disclosure Obligation

Before or at the time of making a recommendation, a broker-dealer must disclose, in writing, material facts about the scope and terms of its relationship with the customer. This includes:

  1. a disclosure that the broker-dealer or associated person is acting in a broker-dealer capacity;
  2. the material fees and costs the customer will incur;
  3. the type and scope of the services to be provided, including any material limitations on the recommendations that could be made to the retail customer; and
  4. all material facts relating to conflicts of interest associated with the recommendation that might incline a broker-dealer to make a recommendation that is not disinterested, including, for example:
    • proprietary products;
    • payments from third parties; and
    • compensation arrangements.

B: Care Obligation

A broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation to a retail customer. The broker-dealer must understand the potential risks, rewards, and costs associated with the recommendation.

  1. The broker-dealer must then consider those risks, rewards, and costs in light of the retail customer’s investment profile and have a reasonable basis to believe that the recommendation is in the customer’s best interest and does not place the broker-dealer’s interest ahead of the retail customer’s interest.
  2. When recommending a series of transactions, the broker-dealer must have a reasonable basis to believe that the transactions taken together are not excessive, even if each is in the retail customer’s best interest when viewed in isolation.

C: Conflict of Interest Obligation

A broker-dealer must establish, maintain, and enforce reasonably designed written policies and procedures addressing conflicts of interest associated with its recommendations to retail customers.

  1. These policies and procedures must be reasonably designed to identify all such conflicts and at a minimum disclose or eliminate them.
  2. The policies and procedures must be reasonably designed to mitigate conflicts of interests that create an incentive for an associated person of the broker-dealer to place its interests or the interest of the firm ahead of the retail customer’s interest.
  3. When a broker-dealer places material limitations on recommendations that may be made to a retail customer (e.g., offering only proprietary or other limited ranges of products), the policies and procedures must be reasonably designed to disclose the limitations and associated conflicts and to prevent the limitations from causing the associated person or broker-dealer to place the associated person’s or broker-dealer’s interests ahead of the customer’s interest.
  4. The policies and procedures must be reasonably designed to identify and eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.

PRACTUS TIP: The SEC explicitly declined to define what would constitute a “limited period of time”. However, it did express concern about “time limitations that create high-pressure situations for associated persons to increase the sales of specific securities or specific types of securities which compromise the best interests of their customers.” We believe that any period of time less than 60 days is likely to be viewed as one that creates a high-pressure situation for associated persons.

D: Compliance Obligation

A broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest as a whole. This includes compliance with its Disclosure and Care Obligations under Regulation Best Interest.

2. Form CRS

Creates a new relationship summary of not more than 2 pages for investment advisers or broker-dealers (4 pages for dual registrants) to provide to retail investors.

  • Retail investor: an individual, or the legal representative of the individual, who seeks to receive or receives services primarily for personal, family or household purposes.

A: Delivery Obligation

  1. Investment Advisers: An investment adviser must deliver an electronic or paper version of the relationship summary to each retail investor before or at the time the adviser enters into an investment advisory contract with the retail investor.
  2. Broker-Dealers: a broker-dealer must deliver an electronic or paper version of the relationship summary, with respect to a retail investor that is a new or prospective customer, before or at the earliest of: (i) A recommendation of an account type, a securities transaction or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor.

B: Content of Relationship Summary

Every investment adviser and broker-dealer must use the same headings and present the information in the same order.

i. Introduction:

  1. state the name of the broker-dealer or investment adviser and whether the firm is registered with the SEC as a broker-dealer, investment adviser, or both;
  2. indicate that brokerage and investment advisory services and fees differ and that it is important for the retail investor to understand the differences; and
  3. state that free and simple tools are available to research firms and financial professionals at Investor.gov/CRS, which also provides educational materials about broker-dealers, investment advisers, and investing.

ii. Relationship and Services:

The relationship summary requires an overview of the services that the firm provides to retail investors. The topics that the firm must discuss include:

  1. principal brokerage and advisory services;
  2. monitoring;
  3. investment authority;
  4. limited investment offerings; and
  5. account minimums and other requirements.

iii. Fees and Costs, Standard of Conduct, and Conflicts of Interest:

The relationship summary requires several prescribed questions and required responses about fees, conflicts of interest, and the standard of conduct.

  1. Fees: Firms must discuss under separate question headers:
    • the principal fee and the incentive that it creates for the firm; and
    • other fees and costs that the investor will pay.
  2. Standard of Conduct. Firms must use language dictated by the SEC to
    describe their standard of conduct.
  3. Conflicts of interest in the firm’s business. A firm must summarize the following ways in which it and its affiliates make money from brokerage or investment advisory services and investments it provides to retail investors, to the extent they are applicable to the firm. A firm must include specific information to describe each of the applicable conflicts.
    • Proprietary Products: Investments that are issued, sponsored, or managed by the firm or its affiliates;
    • Third-Party Payments: Compensation received from third parties when a firm recommends or sells certain investments;
    • Revenue Sharing: Investments where the manager or sponsor of those investments or another third party (such as an intermediary) shares with the firm revenue it earns on those investments; and
    • Principal Trading: Investments the firm buys from a retail investor, and/or investments the firm sells to a retail investor, for or from the firm’s own accounts, respectively.
    • If none of those conflicts apply to the firm, it must summarize at least one of its material conflicts of interest that affect retail investors. Firms will be required to explain the incentives created by each of these examples.
  4. Financial Professional Conflicts: in addition to requiring firm-level conflicts, the relationship summary includes a separate question and required response about how financial professionals are compensated and the conflicts of interest those payments create.

iv. Disciplinary History:

The relationship summary will contain a section where firms must state in yes/no terms whether they have disciplinary history, as well as include a reference to Investor.gov/CRS, where investors can conduct a further search for additional information on those events.

PRACTUS TIP: Remember that certain events that investment advisers can stop disclosing after 10 years must continue to be disclosed indefinitely by broker-dealers. Consequently, dual-registrants and broker-dealer affiliates of investment advisers need to carefully review disciplinary history rather than simply cut and paste whatever the investment adviser prepares.

v. Additional Information:

The relationship summary will conclude with a section where registrants will let investors know where investors can find additional information about their services and request a copy of the relationship summary.

Conversation Starters: Disclosures currently required by investment advisers and broker-dealers generally do not have suggested questions for investors to ask their financial professionals. The relationship summary will require firms to incorporate suggested follow-up questions for the investor to ask, which the instructions refer to as “conversation starters.” Conversation starters appear throughout the relationship summary.


An investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty. It applies to the entire adviser-client relationship. It reflects 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.”

A: Scope of Fiduciary Duty Determined by Scope of Relationship

  1. The specific obligations that flow from the adviser’s fiduciary duty depend upon what functions the adviser, as an agent, has agreed to assume for the client, its principal.
  2. An adviser’s federal fiduciary duty may not be waived, though its application may be shaped by agreement.

B: Duty of Care

  1. Duty to Provide Advice That Is in the Best Interest of the Client:
    • An adviser must have a reasonable understanding of the client’s objectives.
    • An adviser must have a reasonable belief that the advice it provides is in the best interest of the client based on the client’s objectives.
  2. Duty to Seek Best Execution:
    • The “determinative factor” is not the lowest possible commission cost, “but whether the transaction represents the best qualitative execution.”
    • An adviser should “periodically and systematically” evaluate the execution it is receiving for clients.
  3. Duty to Provide Advice and Monitoring Over the Course of the Relationship:
    • An adviser’s duty to monitor extends to all personalized advice it provides to the client, including, for example, in an ongoing relationship, 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.
    • In the absence of any agreed limitation or expansion, the scope of the duty to monitor will depend upon the duration and nature of the agreed advisory arrangement.

C: Duty of Loyalty

An adviser must not subordinate its clients’ interests to its own.

  1. An adviser must eliminate – or at least expose through full and fair disclosure – all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.
  2. Whenever an adviser cannot fully and fairly disclose a conflict of interest to a client such that the client can provide informed consent (typically, a scenario involving a retail client), the adviser should either eliminate the conflict or adequately mitigate (i.e., modify practices to reduce) the conflict such that full and fair disclosure and informed consent are possible.


A section of the Advisers Act excludes from the definition of “investment adviser” any broker or dealer that provides advisory services when, among other things, such services are ‘‘solely incidental’’ to the conduct of the broker or dealer’s business.

  1. Investment Discretion: A broker-dealer’s exercise of unlimited discretion would not be solely incidental to the business of a broker-dealer consistent with the meaning of the broker-dealer exclusion.
    • However, situations where a broker-dealer may exercise discretion that is limited in time, scope, or other manner and lacks the comprehensive and continuous character of investment discretion that would suggest that the relationship is primarily advisory could be solely incidental.
  2. Account monitoring:
    • broker-dealers may include in their policies and procedures that a registered representative may agree to monitor a customer’s account at specific time frames (e.g., quarterly) for the purpose of determining whether to provide a buy, sell, or hold recommendation to the customer.
    • these policies and procedures should not permit a broker-dealer to agree to monitor a customer account in a manner that in effect results in the provision of advisory services that are not in connection with or reasonably related to the broker-dealer’s primary business of effecting securities transactions, such as providing continuous monitoring.

Practus, LLP provides this information as a service to clients and others for educational purposes only. It should not be construed or relied on as legal advice or to create an attorney-client relationship. Readers should not act upon this information without seeking advice from professional advisers.

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