Lawrence P. Stadulis

Lawrence Stadulis advises clients in matters pertaining to the registration and regulation of investment advisers and investment companies under federal and state securities laws. He also manages related issues pertaining to investment advisers and investment companies, including matters involving ERISA, broker-dealer regulation and banking laws.

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SEC Staff Previews Regulation Best Interest Examinations

The Security and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) issued on April 7, 2020, a Risk Alert providing broker-dealers with information about the scope and content of initial examinations for compliance with Regulation Best Interest after June 30, 2020, the compliance date. The Risk Alert states that these initial examinations, which will likely occur during the first year after the compliance date, will focus on assessing whether firms have made a good faith effort to implement policies and procedures reasonably designed to comply with Regulation Best Interest, including the operational effectiveness of broker-dealers’ policies and procedures. Examples of areas the staff may focus on and the types of documents that may be requested are discussed below.

Disclosure Obligation — The staff may assess how a firm has met the Disclosure Obligation’s requirement to disclose material facts relating to the scope and terms of the relationship, including: (i) the capacity in which the recommendation is being made, (ii) material fees and costs that apply to the retail customer’s transactions, holdings, and accounts, and (iii) material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer. In assessing compliance with this obligation, it may request the following documents, among others:

  • Schedules of fees and charges assessed against retail customers and disclosures regarding such fees and charges, including disclosures regarding the fees and costs related to services and investments that retail customers will pay or incur directly and indirectly (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product level fees);
  • The broker-dealer’s compensation methods for registered personnel, including (i) compensation associated with recommendations to retail customers, (ii) sources and types of compensation (e.g., direct payments by an investor, payments by a product sponsor), and (iii) related conflicts of interest (e.g., conflicts associated with recommending proprietary products or with receiving payments for inclusion on a product menu);
  • Disclosures related to monitoring of retail customers’ accounts;
  • Disclosures on material limitations on accounts or services recommended to retail customers; and
  • Lists of proprietary products sold to retail customers.

Care Obligation — To assess compliance with this obligation, the staff may review:

  • Information collected from retail customers to develop their investment profiles (including any new account forms, correspondence, and any agreements the customer has with the broker-dealer).
  • The broker-dealer’s process for having a reasonable basis to believe that the recommendations are in the best interest of the retail customer (which may include, for example, any process for establishing, understanding, and implementing the scope of reasonably available alternatives when making a recommendation).
    • The factors the broker-dealer considers to assess the potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile.
    • The broker-dealer’s process for having a reasonable basis to believe that it does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer.
  • How the broker-dealer makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the broker-dealer has a reasonable basis to believe that such investment strategies are in a retail customer’s best interest.
  • How the broker-dealer makes recommendations related to more complex, risky or expensive products and how the broker-dealer has a reasonable basis to believe that such investments are in a retail customer’s best interest.

Conflict of Interest Obligation — To assess compliance with this obligation, staff may review the broker-dealer’s policies and procedures to assess:

  • Whether and how the policies and procedures address the following, as required by Regulation Best Interest:
    • Conflicts that create an incentive for an associated person to place its interest or the interest of a broker-dealer ahead of the interest of the retail customer;
    • Conflicts associated with material limitations (e.g., a limited product menu, offering only proprietary products, or products with third-party arrangements) on the securities or investment strategies involving securities that may be recommended to a retail customer; and
    • The elimination of sales contests, sales quotas, bonuses, and non-cash compensation arrangements based on the sale of specific securities or specific types of securities within a limited period of time.
  • How the policies and procedures establish a structure for identifying the conflicts that the broker-dealer or its associated person may face. In this connection, the s staff may request documentation identifying all conflicts associated with the broker-dealer’s recommendations.
  • How the policies and procedures establish a structure to identify and assess conflicts in the broker-dealer’s business as it evolves. The staff may request all policies and procedures in place during the scope period of the examination.
  • How the policies and procedures provide for disclosure of conflicts and what conflicts are disclosed.
  • How the policies and procedures provide for mitigation or elimination of conflicts and what conflicts are mitigated or eliminated.

Compliance Obligation — To assess compliance with this obligation, staff may review the broker-dealer’s policies and procedures and evaluate any controls, remediation of noncompliance, training, and periodic review and testing included as part of those policies and procedures.

OCIE also issued a Risk Alert on Form CRS compliance, which we described on our blog.

SEC Proposes to Modernize the Advertising and Cash Solicitation Fee Rules for Investment Advisers

On November 4, 2019, the Securities and Exchange Commission (the “SEC”) proposed amendments to its investment adviser advertising and cash solicitation fee rules under the Investment Advisers Act of 1940 (the “Advisers Act”), as well as related amendments to its investment adviser books and records rule and registration form (collectively, the “Proposals”).1  Specifically, the Proposals seek to amend Rule 206(4)-1, which governs how a registered investment adviser can market its products and services (the “Advertising Rule”); Rule 206(4)-3, which regulates an adviser’s cash solicitation fee arrangements (the “Solicitor Rule”); Rule 204-2, which sets forth an adviser’s books and records and obligations (the “Books and Records Rule”); and Form ADV, the adviser registration and disclosure form.

The current Advertising Rule and Solicitor Rule have remained largely unchanged since their adoption in 1961 and 1979, respectively. The SEC states in its release containing the Proposals (the “Proposing Release”) that they are principally designed to bring the rules and disclosure form up to speed with current industry practices and technological advancements.

This alert provides an overview of the Proposals and discusses how an investment adviser’s existing regulatory obligations pertaining to advertising and the payment of cash solicitation fees would be altered if the Proposals are adopted. Part I discusses the proposed amendments to the Advertising Rule, and Part II discusses the proposed amendments to the Solicitor Rule.

The proposed amendments relating to the Advertising Rule are numerous and substantive, and go well beyond mere updates. They would include the following:

  • Significantly expand the definition of “advertisement” to include online communications, third-party communications disseminated “by or on behalf of” an adviser, and private fund marketing materials.
  • Permit the use of client testimonials, non-client endorsements and third-party ratings, subject to certain enumerated conditions.
  • Impose substantive conditions on advertisements that present actual or hypothetical investment performance (including model, target and projected performance).
  • In certain instances, such as the presentation of gross-of-fee investment performance, impose regulatory conditions on advertisements distributed to retail investors that are more extensive than those provided solely to non-retail investors.
  • Require a designated employee of an adviser to review and approve each advertisement, other than certain excluded communications, prior to distribution.

The proposed amendments to the Solicitor Rule are also significant, and would include the following:

  • Encompass non-cash compensation arrangements.
  • Apply to private fund investor solicitation arrangements.
  • Eliminate the current requirement that the solicitor provide a copy of the adviser’s Form ADV Part 2A to solicited prospects.
  • Ease the solicitor’s brochure delivery requirement in connection with certain mass solicitations.
  • Revise and expand the list of disciplinary events that disqualify a solicitor from receiving compensation.

Part I – Proposed Amendments to the Advertising Rule

The Advertising Rule currently prohibits all investment advisers registered, or required to be registered, with the SEC from distributing, directly or indirectly, advertisements that contain any of the following:

  1. Testimonials of any kind concerning the adviser’s advisory services;
  2. Past specific recommendations of an investment adviser that were or would have been profitable;
  3. Charts and graphs to help investors decide which securities to buy or sell, without prominently disclosing the limitations of such material;
  4. Offers to provide reports or services free of charge unless such reports or services are actually free; and
  5. Untrue statements of material fact, or otherwise false or misleading statements of material fact.

The proposed amendments would restructure and expand the Advertising Rule to five main subsections: (1) definitions; (2) general prohibitions; (3) testimonials, endorsements and third-party ratings; (4) performance information; and (5) review and approval. A brief overview of each subsection follows.


The definitions subsection would define key terms used throughout the Advertising Rule. Without a doubt, the most important of these terms is “advertisement.” The proposed amendments would substantially expand the scope of this defined term to include the following types of communications that promote an adviser’s investment advisory services to prospective and existing customers: oral communications; online communications; communications to a single person; communications to private fund investors; and communications by or on behalf of an adviser. By focusing this definition on the goal of the communication, not the method of delivery, the SEC expects the proposed definition to be flexible enough to keep pace with advancing technology and evolving industry practices.

The Proposing Release indicates that the inclusion of private fund communications was intended to supplement and enhance the prohibitions from making misleading statements to private fund investors under Rule 206(4)-8.2 Thus, private fund communications would be subject to both the Advertising Rule and Rule 206(4)-8.

The expanded definition of advertisement would include not only communications that an adviser disseminates, but also communications that some other party distributes “by or on behalf” of the adviser. The Advertising Rule would not expressly define this phrase, but the Proposing Release indicates that it would encompass adviser-authorized communications made by intermediaries, such as consultants and solicitors, as well as adviser affiliates. The Proposing Release also discusses in some detail the circumstances under which communications by unaffiliated third-parties could be considered by or on behalf of an adviser.3

The proposed amendments to the Advertising Rule would expressly exclude the following four types of communications from the definition of advertisement: (1) non-broadcast live oral communications; (2) communications responding to unsolicited requests for information about the adviser or its services, other than communications to retail persons, including performance results or communications to anyone that include hypothetical performance; (3) an advertisement about a registered investment company or public business development company that is within the scope of Rule 482 or Rule 156 under the Securities Act of 1933; and (4) any information required to be contained in a regulatory notice, filing or other communication.

General Prohibitions

The proposed general prohibitions subsection of the Advertising Rule contains an expanded and enhanced list of general advertising prohibitions. Violations of these provisions can rest on a finding of mere negligence; proof of scienter would still not be required. This subsection includes the following new prohibitions:

  1. Unsubstantiated claims. Unsubstantiated material claims or statements, such as exaggerated statements about an adviser’s skill or experience. This prohibition is designed to prohibit the same conduct currently prohibited regarding the use of charts and graphs in advertisements, but is broader in scope to prevent other misleading advertisements, such as guaranteed returns and unsubstantiated statements about an adviser’s skill or experience.
  2. Untrue or misleading implications or inferences. This prohibition is aimed at advertisements that are likely to cause misleading inferences to be drawn by an investor regarding some material fact about the adviser. The Proposing Release notes examples of advertisements that could present a true statement of fact in materially misleading ways.4  For instance, it would be misleading for an advertisement to include a single investor testimonial stating that an investor’s account was profitable, which may be factually true, if the investor’s results were atypical among all the adviser’s investors.
  3. Failing to disclose risks and limitations. Failing to clearly and prominently disclose any material risks or other limitations when advertising the benefits of an adviser’s services. The proposed amendments to the Advertising Rule do not specifically address the circumstances under which disclosures will be deemed “clear and prominent” for purposes of this prohibition. The SEC does state in the Proposing Release, however, that what is considered clear and prominent may vary by type of advertising medium. However, merely including a hyperlink to risks within an online advertisement would not be sufficient.
  4. Cherry-picking. Referencing specific investment advice that is not presented in a fair and balanced manner. This provision is principally concerned with an adviser “cherry-picking” and presenting in a misleading manner favorable aspects of its investment advice, including but not limited to past and current profitable securities recommendations. The SEC states in the Proposing Release that what is “fair and balanced” will depend on the specific facts and circumstances.

It is important to note that these general prohibitions are in addition to the proposed amendments, discussed below, relating to testimonials, endorsements, third-party ratings and performance results. Thus, for example, an advertisement containing a testimonial satisfying the proposed testimonial-related provisions of the Advertising Rule would still violate the Advertising Rule if it violated one or more of the general prohibitions discussed above.

Testimonials, Endorsements and Third-Party Ratings in Advertisements

The proposed amendments to the Advertising Rule would permit the use of testimonials, which are currently prohibited, and permit non-client endorsements and third-party ratings, which are not addressed by the current rule. The proposed definitions of “testimonials” and “endorsements” are broad and capture all advertisements containing any direct or indirect approval, support, recommendation or experience by clients or investors in connection with an adviser’s advisory services. Third-party ratings are defined in the proposed Advertising Rule as ratings provided by a non-related person who provides such ratings in the ordinary course of business. The Proposing Release states that the ordinary course of business requirement is intended to relate to persons with experience developing and promoting ratings, and would distinguish third-party ratings from testimonials and endorsements.5

Under the proposed amendments, advertisements containing testimonials, endorsements or third-party ratings must satisfy certain disclosure and other conditions intended to alert recipients to any relationship with the adviser, compensation received by the author and related conflicts of interest. As a result, for testimonials and endorsements, a disclosure must be provided as to who provided the recommendation and whether such person was compensated for the recommendation (including non-cash compensation). Third-party ratings must be accompanied by prominent disclosure of the date the rating was made, the period of time the rating is based upon, and the party who is providing the rating. Although the Proposing Release indicates that third-party statements or ratings hosted on third-party platforms generally will fall outside the scope of the Advertising Rule, the Proposing Release cautions that such a determination requires an analysis of the facts and circumstances.6  To use third-party ratings, the adviser must also reasonably believe that the questionnaire used to generate the rating makes it equally easy to provide positive and negative ratings and was not prepared to solicit certain results.

Testimonials, endorsements and third-party ratings that are not themselves “advertisements” or appear within an advertisement will not be subject to the Advertising Rule. However, if the adviser takes steps to influence reviewers or commentary, such as preparing, editing, prioritizing or paying for the content, then this would bring the materials under the scope of the Advertising Rule because such content would be “by or on behalf of” the adviser.

Performance Information 

The performance information subsection identifies six types of performance information that advisers may include in their advertisements: (1) net performance; (2) gross performance; (3) related performance; (4) extracted performance and (5) hypothetical performance. It also sets forth the specific conditions that must be met depending on the type of performance that is presented and the nature of the audience. In this connection, the subsection distinguishes between non-retail advertisements and retail advertisements. A “non-retail advertisement” is defined, essentially, as any advertisement that is disseminated solely to a “qualified purchaser,” as defined in Section 2(a)(51) of the Investment Company Act of 1940 (the “1940 Act”), or a “knowledgeable employee,” as defined in Rule 3c-5 under the 1940 Act. A “retail advertisement” is any advertisement that is not a non-retail advertisement. An adviser that seeks to publish a “non-retail advertisement” will be required to adopt and implement policies and procedures reasonably designed to ensure dissemination only to qualified purchasers and knowledgeable employees. The adviser must also periodically review the adequacy of this policy.

Each type of performance information that advisers would be permitted to include in their advertisements, and the applicable conditions that must be met, are briefly discussed below.

  1. Net Performance. “Net performance” would be defined as the performance results of an account or portfolio after the deduction of all fees and expenses that a client or investor has paid or would have paid an adviser for its investment advisory services. While no particular methodology is prescribed for calculating net performance, the proposed rule contains a list of recommended fees and expenses to be considered, such as direct advisory fees, advisory fees paid to underlying investment vehicles, and payments by the investment adviser for which the client or investor reimburses the investment adviser.The proposed amendments to the Advertising Rule would, effectively, require all retail advertisements containing performance information to include net performance. The net performance would have to be presented for one-, five- and ten-year periods, each with equal prominence and ending on the most recent practicable date. This net performance presentation requirement essentially codifies the SEC staff’s long-standing position in Clover Capital Management, Inc. (Oct. 28, 1986). Significantly, this requirement would not apply to non-retail advertisements, including those for private funds excluded under Section 3(c)(7) of the 1940 Act.
  2. Gross Performance. “Gross performance” is defined as the performance results of an account or portfolio that is presented before the deduction of all fees and expenses charged for the provision of investment advisory services. The proposed amendments to the Advertising Rule would require all advertisements containing gross performance to provide or offer to provide promptly a schedule of the specific fees and expenses (presented in percentage terms) deducted to calculate net performance. Retail advertisements could not include gross performance unless equally prominent net performance accompanies it. The accompanying gross performance must be calculated over the same time period as the net performance using the same methodology.
  3. Related Performance. “Related performance” would be defined as the performance results of one or more portfolios with substantially similar investment policies, objectives and strategies as those of the services being offered or promoted in the advertisement. The proposed amendments to the Advertising Rule would prohibit the presentation of related performance in an advertisement without including all portfolios with substantially similar investment policies, objectives and strategies, unless the advertised performance is no higher than if all related portfolios had been included. Such requirements seek to prevent an adviser from selectively excluding poor performing portfolios that are similarly managed. The adviser also cannot exclude performance information if such exclusion would alter the Proposals’ prescribed time periods. The adviser would be permitted to present related performance information on a portfolio-by-portfolio basis or as composites. It should be noted that the Financial Industry Regulatory Authority (“FINRA”) does not currently allow related performance to be included in advertisements to retail investors.
  4. Extracted Performance. “Extracted performance,” which is also often referred to as carveout performance, would be defined as the performance results of a subset of investments extracted from a portfolio. The proposed amendments to the Advertising Rule would prohibit the presentation of extracted performance, unless the advertisement provides or offers to provide promptly the performance results of all investments in the portfolio from which the performance was extracted.
  5. Hypothetical Performance. Finally, “hypothetical performance” would be defined as performance results that were not actually achieved by any portfolio of any client of the investment adviser. This defined term would include, but not be limited to, the following: (1) performance derived from representative model portfolios that are managed contemporaneously alongside portfolios managed for actual clients; (2) backtested performance; and (3) targeted or projected performance. Since hypothetical performance is perceived as carrying a higher risk of being misleading, if an adviser decides to provide hypothetical performance, it must adopt policies and procedures reasonably designed to ensure that such information is disseminated only to persons for which it is relevant to their financial situation and investment objectives. Sufficient information must also be provided so that the recipient can understand the criteria and assumptions in calculating the performance, as well as the risks and limitations of such performance information (although only an offer to provide such information promptly is required in the case of a non-retail investor). Note that FINRA currently prohibits hypothetical backtested performance in “retail communications,” as that term is defined in Conduct Rule 2210.

The Proposals also provide guidance with regard to the portability of performance. For instance, where an adviser wishes to use the performance results in its advertisement from a predecessor firm or from personnel that have joined the adviser from a different firm, it must disclose that the predecessor performance was achieved by a different firm or by personnel from a different firm to make the advertisement not misleading. In addition, an advertisement may be misleading if the personnel that joined the adviser were not primarily responsible for the predecessor performance. While an adviser must maintain books and records required to substantiate performance, the SEC recognized that documentation related to predecessor performance may be unavailable to an adviser, and asked for comment as to whether the rule should permit other forms of verification (e.g., using publicly available contemporaneous information).

Review and Approval of Advertisements

Except as noted below, the proposed amendments to the Advertising Rule would require that an advertisement be reviewed, approved and determined to be in compliance with the Advertising Rule by a designated employee of the adviser before the advertisement could be disseminated. The Proposing Release indicates that the designated reviewer should be competent and knowledgeable, and the SEC expects that the designated employee should generally include legal or compliance personnel of the adviser. The proposed Advertising Rule would not permit the designated reviewer to be an outside third-party, such as a compliance consultant or law firm, but the Proposing Release asks for comment on this limitation.

Preapproval would not be required, however, for the following two types of communications:

  • Communications to individual persons. Communications to a single person, household or private fund investor would not require preapproval. However, an adviser cannot seek to utilize this exemption by customizing a template presentation or mass mailing and then simply filling in different investor names or other basic client details; and
  • Live oral communications. Live oral communications that are broadcast over television, the internet or other similar media would not require preapproval. However, if a live communication is recorded, then approval would be required prior to a distribution.

Books and Records

The Proposals would amend the Books and Records Rule in light of the proposed amendments to the Advertising Rule. Thus, among other things, the Books and Records Rule would be amended to require an adviser to make and keep copies of all communications sent to one or more persons. Currently, this requirement applies only to communications sent to 10 or more persons. In addition, it would require an adviser to maintain copies off all third-party questionnaires and surveys used to create third-party ratings. Finally, an adviser would be required to keep and maintain those records necessary to demonstrate the calculations of the various types of performance information discussed above, such as hypothetical performance.

Amendment to Form ADV

The Proposals would amend Form ADV to require an adviser to report additional information about its advertising activities. Specifically, five new “yes/no” questions would be added to Part 1A of Form ADV, which would request information about an adviser’s use of advertisements that contain performance results, testimonials, endorsements, third-party ratings and its previous investment advice. The SEC would use this information to help prepare for examinations of advisers.

Advertising Rule’s Harmonization With Other Regulators

While the proposed amendments would bring investment advisers closer in line with the principles-based advertising regime of other regulators, such as the Commodity Futures Trading Commission (the “CFTC”) and the National Futures Association (the “NFA”), an adviser that is also registered as a commodity pool operator and/or commodity trading advisor should note that compliance with the amended adviser advertising rule, as proposed, may not satisfy its obligations under similar CFTC and NFA rules. The proposed Advertising Rule is also different from the obligations imposed on broker dealers by FINRA, which may create compliance challenges for dual-registrants and broker dealers seeking to advertise pooled investment vehicles.

Part II – Proposed Amendments to the Solicitor Rule

The existing Solicitor Rule sets forth the conditions under which a registered investment adviser may compensate related and unrelated third-party solicitors for prospective client referrals. The rule prohibits cash payments to persons subject to certain specified legal and disciplinary actions (“Disqualifying Events”). The term “solicitor” is defined broadly to include “any person who, directly or indirectly, solicits any client for, or refers any client to, an investment adviser.”

All solicitor arrangements currently must be memorialized in a written agreement between the adviser and solicitor (the “Solicitor Agreement”). The Solicitor Agreement must obligate any solicitor, other than one who is an officer, director, employee or control affiliate of the adviser, to provide each client prospect, at the time of solicitation, with a copy of the adviser’s Form ADV, Part 2A (the “Adviser Brochure”) and a separate written disclosure document concerning the solicitor arrangement (the “Solicitor Disclosure”). The Solicitor Disclosure must contain specified types of information about the arrangement, including the name of the solicitor, the name of the adviser, the nature of the relationship between the parties and the terms of compensation. Finally, the adviser must receive from the client prospect, prior to, or at the time of, entering into any advisory contract, a signed and dated acknowledgment of receipt of the Adviser Brochure and Solicitor Disclosure.

The Proposals would amend the Solicitor Rule in several important areas, briefly discussed below.

Definition of Solicitor 

The proposed amendments to the Solicitor Rule would expand the definition of “solicitor” to also include any person who solicits prospective or existing private fund investors, as opposed to only advisory clients. Although not addressed directly in the proposed amendments, the Proposing Release also discusses the circumstances under which a person receiving compensation for providing testimonials or endorsements in an adviser’s advertisements would be deemed a solicitor. The Proposing Release further notes that, depending on the facts and circumstances, a solicitor may also meet the Advisers Act’s definition of “investment adviser,” and, therefore, have to register with the SEC under the Advisers Act, absent an available exemption from registration.

Permissible Compensation 

The Solicitor Rule would be expanded to cover solicitation arrangements involving all forms of compensation rather than only cash compensation. Non-cash compensation would include, but not be limited to, directed brokerage; sales awards or other prizes; training or education meetings; outings, tours or other forms of entertainment; and free or discounted advisory services. The Proposing Release states that compensation “could also include the adviser providing investment advice that directly or indirectly benefits the solicitor.” For example, if the solicitor is a broker-dealer or affiliated with a broker-dealer, an adviser’s payment for solicitation could be the adviser’s recommendation that its investors purchase the solicitor’s proprietary investment products or products that the adviser knows have revenue sharing or other pecuniary arrangements with the solicitor or its affiliates.

Solicitor Agreement

The proposed amendments to the Solicitor Rule would alter the requirements relating to the Solicitor Agreement in certain key respects. Specifically, an adviser would no longer be required to enter into a Solicitor Agreement with its officers, directors, employees and control affiliates (“Solicitor Affiliates”), provided that (1) the Solicitor Affiliate’s affiliation with the adviser is readily apparent and (2) the adviser documents the Solicitor Affiliate’s status at the time it enters into the solicitation arrangement (“Solicitor Affiliate Conditions”).

In addition, the solicitor would no longer be required to deliver the Adviser Brochure under the terms of the Solicitor Agreement. The Solicitor Disclosure would still need to be delivered at the time of solicitation, except in connection with solicitations made through mass communications, where delivery must be made as soon as reasonably practicable. Either the adviser or the solicitor could agree to deliver the Solicitor Disclosure under the terms of the Solicitor Agreement.

The information that must be contained in the Solicitor Disclosure would largely remain the same, with two exceptions. First, the Solicitor Disclosure would have to disclose any potential material conflicts of interest on the part of the solicitor resulting from the investment adviser’s relationship with the solicitor and/or the compensation arrangement. Second, it would have to disclose the amount of any additional cost to the investor as a result of solicitation.

Adviser Oversight of Solicitor 

An adviser would be required to have a reasonable basis for believing that the solicitor has complied with the terms of the Solicitor Agreement. Whether an adviser satisfies this “reasonable basis” requirement would depend on the circumstances. The SEC states in the Proposing Release, however, that “a reasonable basis generally should involve periodically making inquiries of a sample of investors referred by the solicitor in order to ascertain whether the solicitor has made improper representations or has otherwise violated” the Solicitor Agreement. The proposed amendments would omit Solicitor Affiliates from this solicitor oversight requirement, provided that the Solicitor Affiliate Conditions are met.

Disqualifying Events

The proposed amendments to the Solicitor Rule would revise the provisions relating to Disqualifying Events. Specifically, they would reorganize the list of Disqualifying Events and add certain new legal and disciplinary proceedings to this list. In addition, an adviser would be required to exercise reasonable care in determining that a solicitor is not subject to a Disqualifying Event and thus prohibited from receiving compensation. This reasonable care standard would continue to apply throughout the term of the solicitation arrangement. It is important to note that the Disqualifying Event provisions would continue to apply to Solicitor Affiliates. Moreover, the proposed amendments would provide a conditional exemption from the Disqualifying Event provisions for certain SEC administrative actions, including proceedings under Section 9(c) of the 1940 Act and those proceedings that are not, themselves, Disqualifying Events.


The proposed amendments would exempt from the Solicitor Rule certain charitable programs and arrangements under which a solicitor has received $100 or less in compensation over the preceding 12 months.

Books and Records

The proposed amendments to the Solicitation Rule would be accompanied by corresponding amendments to the Books and Records Rule to require investment advisers to make and keep records of (1) copies of the Solicitor Disclosure delivered to investors, (2) any communication or other document related to the investment adviser’s determination that it has reasonable basis for believing that any solicitor it compensates under the Solicitor Rule has complied with the Solicitor Agreement, and that such solicitor is not an ineligible solicitor and (3) a record of the names of all solicitors who are an adviser’s partners, officers, directors or employees, or other affiliates.

Existing SEC Staff Guidance

The Proposing Release notes that various no-action letters and other guidance addressing the application of the advertising and solicitation rules issued by the staff of the SEC’s Division of Investment Management (the “Division”) are under review for withdrawal (or for withdrawal with respect to a certain topic) in connection with the potential adoption of the amendments. More than 180 letters have been identified for review (including almost 100 “bad actor” letters issued under the Solicitor Rule). A number of notable letters are also specifically discussed in the Proposing Release.7  The SEC has requested that interested parties identify additional letters for potential withdraw.

Public Comment Period

The public comment period will remain open for 60 days following publication of the Proposing Release in the Federal Register. The Division has recently been focused on expanding the views considered in the rulemaking comment process, and asset managers and industry participants of all sizes are encouraged to comment on the Proposal.8 The SEC is also soliciting information from investors about the Proposals via Appendix B of the Proposing Release, titled “Investor Feedback.”

The SEC indicated that, should the Proposals be adopted, advisers and their solicitors would have one year to comply with the new rules.


1 Investment Adviser Advertisements; Compensation for Solicitations, Investment Advisers Act Release No. IA-5407 (Nov. 4, 2019).
2 See Proposing Release, p. 35 (noting there may be some overlap between the prohibition in Rule 206(4)-8 and the proposed Advertising Rule).
3 See Proposing Release, pp. 24-28.
4 See Proposing Release, pp. 57-59.
5 See Proposing Release, pp. 80-81.
6 See Proposing Release, p. 81.
7 See, e.g., Investment Adviser Association, SEC No-Action Letter (Dec. 2, 2005); TCW Group, SEC No-Action Letter (Nov. 7, 2008); Investment Counsel Association of America, Inc., SEC No-Action Letter (Mar. 1, 2004); Horizon Asset Management, LLC, SEC No-Action Letter (Sept. 13, 1996); Munder Capital Management, SEC No-Action Letter (May 17, 1996); Clover Capital Mgmt., Inc., SEC No-Action Letter (Oct. 28, 1986).
8 Comments can be submitted via the SEC’s internet comment form (available at or by sending an email to rule-comments@sec.govwith “File Number S7-21-19” in the subject line.

Watch Webcast: The Practical Effects of Regulation Best Interest, Form CRS, and Advisers Act Interpretations on Broker-Dealers, Investment Advisers and Investment Companies

On Tuesday, July 9th, John Baker, Alan Goldberg and I presented a webcast titled “The Practical Effects of Regulation Best Interest, Form CRS, and Advisers Act Interpretations on Broker-Dealers, Investment Advisers and Investment Companies.” Watch a replay of the webcast here:

NY Senate considering companion bill to Dinowitz’s proposed Investment Transparency Act

The draft legislation, which has been introduced in the New York State Assembly and Senate, is identical to last year’s proposed Investment Transparency Act.  As is the case with last year’s legislation, it would apply to: (1) investment advisers and other financial intermediaries that, essentially, hold themselves out as financial planners, financial consultants, retirement planners or as engaged in comparable types of businesses; and (2) which are not fiduciaries under federal law, state law, or the terms of their own internal policies (collectively, “Non-Fiduciary Financial Advisors”).  It would require Non-Financial Advisors to provide certain disclosures to existing and prospective customers about the non-fiduciary nature of their relationship and the surrounding limitations.  In essence, the legislation would serve as a sort of “truth in labelling” consumer protective mechanism.  It would not apply to federally registered advisers, broker-dealers who are fiduciaries under state law, or broker-dealers who are not Non-Fiduciary Financial Advisors.  Consequently, its scope and application would be far narrower than the Nevada’s proposed regulations or even the SEC’s proposed Regulation Best Interest, for that matter.

Nevada Proposes Sweeping Fiduciary Regulation

On July 1, 2017, Nevada broker-dealers and investment advisers became subject to the state’s financial planner statute (NRS 628A), making them fiduciaries to their clients and requiring them to submit to a rigorous disclosure regime. This legislation removed existing exemptions for broker-dealers, investment advisers and their respective representatives from the definition of a “financial planner.” As a result, broker-dealers, investment advisers and their respective representatives are “financial planners” under Nevada law if they advise others for compensation upon the investment of money or upon provision for income to be needed in the future, or if they hold themselves out as qualified to perform either of these functions. As financial planners, they will now be subject to Nevada’s statutory fiduciary duty with respect to advice that they provide to Nevada clients. Under NRS 628A.010, a “client” is a “person” who receives advice from a financial planner.

The statutory fiduciary duty specifically requires financial planners to “disclose to a client, at the time advice is given, any gain the financial planner may receive, such as profit or commission, if the advice is followed.” The statutory fiduciary duty also requires financial planners, through a “diligent inquiry of each client,” to make an initial determination of suitability of the advice to be given to each client as well as to evaluate such suitability on an ongoing basis. In making such determinations of suitability, the financial planner should consider “the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.” A violation of the statutory fiduciary duty by these regulated persons and entities will be a violation of the Nevada Uniform Securities Act.

Clients of financial planners have a statutory right of action if the financial planner (1) violates any element of the fiduciary duty, (2) is grossly negligent in the provision of advice to the client, in light of all of the client’s financial circumstances known to the financial planner or (3) violated any state law in the provision of investment advice. If any of the above violations occur, the client is entitled to recover, in a civil action, the amount of any economic loss resulting from the advice and all costs of litigation and attorney’s fees.

Since July 2017, the Nevada Securities Division has been working to further define the statutory fiduciary duty, as applicable to broker-dealers, investment advisers and their respective representatives, through the inclusion or exclusion of certain actions as violations and to prescribe means reasonably designed to prevent violations of the fiduciary duty.

The Proposed Draft Regulation

On January 18, the Nevada Securities Division released its long-awaited proposed draft regulation (“Proposal”). The Proposal begins by stating that a broker-dealer or its sales representatives will owe a fiduciary duty to its clients if it: (1) provides “investment advice” (as defined below) to the clients; (2) manages the clients’ assets1; (3) performs discretionary trading2 of client assets; (4) who otherwise establishes a fiduciary relationship with clients,3 or (5) uses the following titles and terms in their title, name, biographical description, or otherwise holds themselves out as having such role: (a) advisor/adviser, (b) financial planner/financial consultant, (c) retirement consultant/retirement planner, (d) wealth manager, (e) counselor, or (f) “other titles that the Administrator may by order deem appropriate.”4 A broker-dealer and sales representative are presumed to owe a fiduciary duty to the client.


The Securities Division opted to have the Proposal be read “in harmony” with the Securities Exchange Act of 1934, as amended by the National Securities Market Improvement Act of 1996’s recordkeeping requirements, thereby attempting to address some of the preemption concerns.

Key Definitions

The Proposal provides a detail definition of “investment advice.” Specifically, “investment advice” includes, but not limited to:

  1. providing advice or a recommendation regarding the buy, hold, or sale of a security to a client,
  2. providing advice or a recommendation regarding the value of a security to a client,
  3. providing analyses or reports regarding a security to a client,
  4. providing account monitoring for the purpose of potentially recommending a buy, hold, or sale of a security,
  5. providing advice or a recommendation regarding the type of account a client should open,
  6. providing advice or a recommendation regarding the fee options available for the services provided by the investment adviser, representative of an investment adviser, broker-dealer, or sales representative,
  7. providing information on a personalized investment strategy,
  8. providing a financial plan that includes consideration of buying, holding, or selling a security,
  9. providing a limited list of securities for consideration by a client or by a limited group of clients that is tailored to the client or group of clients,
  10. providing information about a security that is not provided in the offering documents or is an opinion regarding the security or its potential performance,
  11. recommending a broker dealer, sales representative, investment adviser, representative of an investment adviser, or financial planner, and
  12. providing advice or a recommendation regarding an insurance product or an investment by comparison to a security, or that includes the buy, sale, or hold of a security.

The Proposal notes that “providing information about a security that is specifically contained in the security’s offering documents is presumptively not investment advice unless, as part of the discussion, the investment adviser, representative of an investment adviser, sales representative, or broker-dealer recommends one product over another, recommends a buy, hold, or sale, or advises on the purchase, hold, sale, or value of a security to a client or limited group of clients.” Moreover, communications regarding a general investment strategy that applies to the general public, or is publishing an investment company ranking or a bond mutual fund volatility rating ranking consistent with FINRA rules, are not investment advice, provided they are “not targeted to any particular group or individual clients.”

Investment Advisers and their Representatives

The fiduciary duty also applies to investment advisers and their representatives. Notably, the Proposal provides that dual-registered entities and individuals who are both investment adviser representatives and “sales representatives” (presumably, registered representatives) will be presumed to be acting as investment advisers.


The fiduciary duty imposed on both broker-dealers and investment advisers generally includes the time period during which it provides investment advice, performs discretionary trading, maintains assets under management, acts in a fiduciary capacity towards the client, discloses fees or gains, through the completion of any contract, and through the term of engagement of services. Broker-dealers, but not investment advisers, may qualify for the Episodic Fiduciary Duty Exemption, which would limit the fiduciary duty to the specific investment advice provided, but not, unless otherwise required by law, have an ongoing fiduciary duty towards the client. This means that, under the Episodic Fiduciary Duty Exemption, the broker-dealer or sales representative would not have an ongoing duty to keep informed about the client’s financial circumstances and obligations.

The conditions of the Episodic Fiduciary Duty Exemption are:

  1. The broker-dealer or sales representative does not manage the client’s assets or perform discretionary trading for the client;
  2. The broker-dealer or sales representative does not create periodic financial plans for the client, provide ongoing investment advice, or enter into a contract to provide investment advice;
  3. The broker-dealer or sales representative has not otherwise developed a fiduciary relationship with the client from previous or concurrent services undertaken on behalf of the client;
  4. The broker-dealer and sales representative do not the use terms/titles, described above.
  5. The “facts and circumstances surrounding the transaction do not indicate that additional or ongoing investment advice is reasonably expected by the client relative to that transaction, type of product or advice,” and,
  6. The client solicited any investment advice.

The Standard of Care

The Proposal provides that the fiduciary duty is breached if the broker-dealer, investment adviser or their representatives, inter alia:

  1. Fails to perform adequate and reasonable due diligence on a product or investment strategy prior to transacting sale or providing investment advice;
  2. Recommends to a client a security or an investment strategy that is not in the client’s best interest, or the recommendation or sale deviates from firm policies, offering limitations, or other law;
  3. Provides investment advice on a product or investment strategy without understanding or conveying all risks or features of the product or investment strategy;
  4. Puts their own interest, other client’s interests, or the firm’s interest ahead of the client;
  5. Fails to provide current offering documents on the product prior to execution of the transaction;
  6. Fails to disclose that a recommended product was a proprietary product or that the advice was based upon a limited pool of products, or fails to convey all material risks or features of the product;
  7. Fails to adequately disclose all information regarding a potential conflict of interest;
  8. Fails to comply with best execution rules;
  9. Recommends or sells a security without disclosure of a bad actor disqualification as defined in Regulation D, Rule 506;
  10. Recommends or charges a fee that is unreasonable;
  11. Violates an applicable FINRA rule or other applicable self-regulatory organization rule that relates to client communications or disclosure;
  12. Engages in conduct prohibited by NAC 90.321, 90.327, or 90.328 (relating to fraudulent and unethical practices); or
  13. Limits the availability of securities to certain clients unless based upon a client’s investment goals, a client’s investment strategy, a firm’s limitation of quantity or type of investment that can be sold to a client, or the security’s own sale limitations.

Conduct that is Not a Per Se Violation of the Fiduciary Duty

The Proposal sets forth three instances of conduct that do not amount to a per se violation of the fiduciary duty:

  1. The sale of a proprietary product by a broker-dealer or sales representative alone is not a breach of the fiduciary duty, provided:
    1. The broker-dealer’s and sales representative’s conduct does not otherwise violate the law;
    2. The broker-dealer’s and sales representative’s conduct does not otherwise violate an applicable self-regulatory organization rule; and,
    3. They advised the client that the product is proprietary and advised the client of all risks associated with the product.
  1. A broker-dealer, investment adviser and their representatives who hold or manage a client’s position in cash does not breach the fiduciary duty based on that cash position alone if:
    1. They advise the client of all risks associated with the cash position;
    2. The conduct does not otherwise violate the law; and
    3. All applicable self-regulatory organization, custody, and conduct rules are followed regarding the cash position.
  1. A broker-dealer or sales representative’s receipt of commissions does not breach the fiduciary duty provided the commission is both reasonable and in the client’s best interest as opposed to other types of fees.


The Proposal sets forth three exemptions to the fiduciary duty standard:

  1. A broker-dealer or sales representative who executes an unsolicited transaction for a client whose assets are not managed by the broker-dealer or sales representative, and has otherwise complied with all applicable rules, firm policies and procedures, unless the client receives investment advice (impliedly or explicitly), discretionary trading services, ongoing contractual services or a financial plan.
  2. A broker-dealer who executes a trade in good faith that was recommended to a client by a registered or licensed investment adviser or representative, and has otherwise complied with applicable laws, rules, firm policies and procedures, provided the broker-dealer does not provide investment advice, asset management, discretionary trading or provide a financial plan to the client.
  3. A clearing firm that receives a direct instruction for the execution of a transaction from a properly registered or licensed broker-dealer, provided the clearing firm has acted in good faith, otherwise complied with all applicable laws, self-regulatory rules and firm policies and procedures.

Disclosure Requirement

As a general rule, if a broker-dealer, investment adviser or their representatives receives certain types of fees or “gains” “as a result of a client following their advice,” then such compensation need to be disclosed to the client no later than at the time the advice is given. The types of compensation included are: (a) percentage of managed assets fee, (b) commissions, (c) mark ups or mark downs commissions, (d) market-maker commissions (electronic communication network rebates or credits), (e) discounts based upon number of transactions or clients, (f) management fees, (g) deferred or trailed fees or commissions, (h) front end load or back end loads, (i) service fees or (j) payment for order flow. The Proposal explains that “gain” excludes “the profit or gain [that] may accrue as a result of all business activities.”

The Proposal contains a number of caveats:

  1. Where the actual amount of the gain is not known at the time of the advice, the firm and representative would need to disclose to the client that a gain will be received and the manner by which the gain is calculated, and the amount actually received, is provided to the client within a reasonable time period (i.e., within a time period permitted under applicable law or SRO rules).
  2. A firm or its representatives that charge the client a fee based upon a specific percentage of assets under management, and where those charges are “regularly” provided consistent with “other firm documents and law” need not disclose such fees at the time of the advice.
  3. The receipt and amount of finder’s fees, referral fees and “other benefit” for referrals to firms (brokerage and advisory), their representatives and/or a “financial planner,” must be disclosed to the client at the time of the referral, along with any applicable contracts relating to the referral.

Our Initial Impressions

Some of our impressions of the Proposal are:

  1. The Proposal, if adopted, would impose new and additional requirements on both broker-dealers and investment advisers.
  2. It remains unclear whether investment advice to plan participants, fiduciaries, investment managers or entities would fall within the scope of the Proposal.
  3. For all intents and purposes, broker-dealers and registered representatives are foreclosed from using the following titles, or otherwise holding themselves out as, (a) advisor/adviser, (b) financial planner/financial consultant, (c) retirement consultant/retirement planner, (d) wealth manager, or (e) counselor, because doing so would disqualify them from relying upon the Episodic Fiduciary Duty Exemption. Use of such titles would mean that broker-dealers and their representatives would owe a continuing fiduciary duty to their client even after the transaction at issue was consummated.
  4. The Securities Division reserves the right to add to the list of terms and titles that connotate fiduciary status, creating an uncertain business environment for firms. Commenters may wish to have a final regulation confirm that any additional titles will not have retroactive effect.
  5. Dual-registrants and their affiliates should pay particular attention to the Proposal.
  6. The definition of “investment advice” appears to go well beyond existing definitions and interpretations under federal law. For example, the definition refers to both “advice” and “recommendations,” without explaining how the terms differ and how a recommendation can amount to advice. Moreover, seemingly any information about a specific security to a specific client could be deemed to constitute investment advice, even such general information as price and historical performance. Though the Proposal indicates that the provision of information about a security “that is specifically contained in the security’s offering documents is presumptively not investment advice,” it leaves open-ended whether providing general information not contained in such documents would give rise to investment advice. The Proposal does not unequivocally state that general information about a specific security to a specific client is not advice.
  7. There is uncertainty over the scope and application of the Episodic Fiduciary Duty Exemption.
  8. The Proposal is silent on whether and how the fiduciary status (or inability to rely on an exemption) of a representative applies to the entire firm (and its other representatives).
  9. The Proposal helpfully indicates that the sale of proprietary products is not a per se violation of the fiduciary duty, but the firm or the representative would need to inform the client that the product is proprietary and advise the client “of all risks associated with the product.” The Proposal does not define the term “risks” or the level of materiality triggering risk disclosure. Broker-dealers may wish to have this condition clarified to provide that disclosure in a manner consistent with federal law would satisfy this condition.
  10. Firms should carefully review the proposed disclosure requirements regarding fees and gains, which may create substantial operational burdens.
  11. The Proposal suggests that the mere holding of client cash could create a fiduciary obligation under certain circumstances. The Proposal curiously provides that a firm (broker-dealer or investment adviser) could, under certain circumstances, be subject to a fiduciary duty simply by holding or managing the client’s position in cash.
  12. The Proposal says that the fiduciary duty standard of care extends to the time during which a broker-dealer “maintains assets under management,” even though the fiduciary duty is only supposed to apply, in pertinent part, when broker-dealers “manage” assets or perform “discretionary” trading. This could potentially ensnare custodial functions after investment advice was given. We don’t necessarily think this conclusion is the Securities Division’s intent, but it may make sense to seek clarification.
  13. Commissions are seemingly preserved as a method of compensation, but the Proposal imposes “best interest” and “reasonable compensation” requirements. Unfortunately, the Proposal fails to define “best interest” or otherwise provide any guidance on how a firm could demonstrate satisfaction of such requirements.
  14. Clearing firms are potentially ensnared by the Proposal, as they are covered by an exemption that contains a number of conditions. This seems to assume that clearing firms could otherwise be subject to the fiduciary duty.
  15. Brokerage firms may be deemed to be exercising trading discretion, and, therefore, subject to the fiduciary duty, for selecting the trading venue from which to buy or sell a security on behalf of a client.
  16. A breach of fiduciary duty would occur if a firm or representative provides investment advice on a product or investment strategy “without understanding” all of the risks and features of the product or strategy. It leaves to the imagination how a firm could ensure that its representatives understand risks and features of a product or strategy.
  17. The Proposal bars putting one client’s interest ahead of another client’s interest.
  18. The Proposal acknowledges the Securities and Exchange Commission’s (“SEC”) preemptive authority under the Exchange Act with respect to broker-dealer books and records requirements, but is silent with regard to federal preemption of state authority under the Investment Advisers Act of 1940, as amended (“Advisers Act”), and ERISA; therefore, it appears the Securities Division is of the view that the Proposal, if adopted, would not be preempted under the Advisers Act and ERISA.
  19. The Proposal authorizes the Securities Division to adopt any rule, form or exemption approved by the SEC for application to broker-dealers, investment advisers and their representatives so long as the adoption does not materially diminish the fiduciary duty under applicable Nevada law. This appears to give them the flexibility to adopt SEC’s best interest proposals (including Regulation Best Interest, if adopted). As a practical matter, we think this is unlikely given that the Securities Division opted to propose the Proposal seemingly mere months away from the SEC’s adoption of its own rulemaking package and the numerous differences between the Proposal and the SEC’s proposals.

Next Steps

Those interested in submitting a comment letter on the Proposal may do so by March 1, 2019. Written comments should be sent to: Diana Foley, Nevada Secretary of State’s Office Securities Division, 2250 Las Vegas Boulevard North, Suite 400, North Las Vegas, Nevada 89030.

We expect that the Securities Division will hold a second workshop (open to the public) at some point, and, prior to a final rulemaking, a public hearing. It is unclear if the Proposal has been blessed by the Nevada Legislative Counsel Bureau at this point.

1 We note that “assets” may not necessarily be limited to securities.

2 The Proposal defines “discretionary trading” by what it’s not, namely, that it does not encompass the “limited conduct of exercising discretion as to time and price of buying or selling a security that is based upon a client’s direction, or transactions executed to satisfy customer margin obligations.

3 It is unclear whether a fiduciary relationship established under federal law (e.g., Employee Retirement Income Security Act of 1974, as amended (“ERISA”)) would trigger fiduciary status here.

4 A broker-dealer and sales representative will be presumed to owe a fiduciary duty to their client. This means that they would have the burden of showing that an exemption applies.

A Fiduciary’s 2018 Retrospective (and Predictions for 2019)

Our inaugural 2019 Risk & Reward will both get you up to speed on 2018 fiduciary-related developments that affected financial institutions, as well as preview the 2019 landscape. We’ll refrain from screaming predictions, that, while attention-grabbing, are unlikely to materialize. Instead, we will provide context and nuance that anchors our predictions. We take this role very seriously, considering that the Fiduciary Governance Group’s very genesis was in the heady days between the Department of Labor’s (DOL) fiduciary rule demise and the Securities and Exchange Commission’s (SEC) standard of conduct proposal. While standards of conduct will dominate our discussion and predictions, many other fiduciary issues also manifested themselves in 2018, including proxy voting and environmental, social and governance (ESG) investing, and those will be addressed, too.

DOL Fiduciary Rule

The DOL fiduciary rule was already in purgatory when we rung in 2018. While it was clear the rule was unlikely to survive in its Obama-era form, the question was more over whether a scalpel or wrecking ball would be the preferred instrument and whether it would be at the hands of Trump’s DOL or a court.

The administrative complaint filed against Scottrade by the Massachusetts Securities Division in February 2018 was the first salvo of the year. Here, William Galvin, Massachusetts’ Secretary of State, alleged that Scottrade violated the DOL fiduciary rule’s “impartial conduct standards,” and, therefore, violated state law. As we noted, “Massachusetts was effectively seeking to enforce the DOL rule.” The worry, of course, was that the complaint against Scottrade would be the first of many lodged by Massachusetts and others against firms who may have been working off policies and procedures put in place due to the DOL fiduciary rule but by then no longer strictly required. For now, however, no other such actions have been filed.

The second salvo occurred on March 15, 2018, when the Fifth Circuit Court of Appeals flatly rejected the fiduciary rule’s expansive scope of investment advice fiduciary status under the Employee Retirement Income Security Act of 1974 (ERISA), and with it, the prohibited transaction exemptive relief the DOL bundled together with the 2016 rule. Efforts by the states of California, New York and Oregon, along with the American Association of Retired Persons, to have the Fifth Circuit reconsider its judgment were unsuccessful. The DOL, unsurprisingly, declined to appeal the decision to the U.S. Supreme Court. Some wondered whether the ruling had nationwide effect; we believed it did. Our very own Bill Mandia said:

“I don’t see there being any question about the nationwide impact. The Fifth Circuit determined that the DOL’s actions were not a proper exercise of its statutory authority. That ruling should, under the Administrative Procedures Act, vacate the rule nationwide. The mandate is drafted in that manner because it provides that the Fifth Circuit ‘vacat[ed] the Fiduciary Rule in toto.’”1

(Click on image to enlarge.)

At first glance, the Court’s decision to toss out both the fiduciary rule and the related exemptions (e.g., Best Interest Contract Exemption) may seem like throwing out the baby with the bathwater. You will recall, however, that by the time of the Court’s ruling, most of the more complicated and expensive conditions of those exemptions had already been relaxed. As we cheerily noted in November 2017, “[a]n early holiday gift to many, the [DOL] on November 27 formalized an extension of the transition period of the Best Interest Contract (BIC) Exemption, the Principal Transactions Exemption, and certain conditions of Prohibited Transaction Exemption 84-24. The transition period will now end on July 1, 2019 rather than January 1, 2018.” The transition period was, by definition, transitory, and ultimately the DOL would have to find a final fix. In this sense, the Fifth Circuit saved the DOL from having to iron out enough of the 2016 rule’s wrinkles to make the rule (more) workable.

On May 7, 2018, the DOL issued Field Assistance Bulletin (FAB) 2018-02, which states that the DOL and Internal Revenue Service (IRS) will not bring an enforcement action against firms for non-exempt prohibited transactions that arise from providing fiduciary investment advice to plans and IRA holders when they exercise reasonable diligence and act in good faith in complying with the impartial conduct standards. This non-enforcement policy binds only the DOL and IRS; state regulators and private plaintiffs could potentially seek to bring an action for alleged non-compliance with the impartial conduct standards. The industry was already familiar with the impartial conduct standards because they were originally set forth in the Best Interest Contract Exemption.

The original five-part test now determines whether one is an investment advice fiduciary under ERISA. We expect that the DOL will issue interpretive guidance, and propose exemptive relief, in the summer or fall of 2019. The interpretive guidance will most likely address the circumstances under which rollover recommendations constitute fiduciary investment advice. The proposed DOL exemption will probably apply to services and products that the DOL views as presenting fewer conflicts of interest, one of the conditions being adherence to the final form of Regulation Best Interest (more on that, below). While we cannot completely predict whether multiple exemptions will be proposed, we can say, with some level of confidence, that the DOL is quite unlikely to modify the five-part test for when one becomes an investment advice fiduciary. We do not think the DOL has the appetite or bandwidth to do that.

SEC Best Interest Rulemaking Initiatives

SEC Chairman Jay Clayton

Without question, the big fiduciary news of 2018 was the SEC’s April 18 release of its rulemaking proposals on the standards of conduct and required disclosures for broker-dealers and investment advisers who provide services to retail investors.2 Though SEC Chairman Jay Clayton garnered four votes to secure the release of the proposal (Stein dissenting), the commissioners had enough misgivings to give the impression that a final rulemaking could look quite different from the proposal.​ By way of background, the Dodd-Frank Act authorized the SEC to adopt rules on the standards of care for broker-dealers, investment advisers and their associated persons.3 The SEC staff, in 2011, issued a study recommending that the SEC engage in rulemaking to adopt and implement a uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.

Last April, the SEC acted. The SEC did not, however, propose a uniform fiduciary standard. Rather, it proposed a best interest standard for broker-dealers that it characterized as an enhancement to existing standards (but separate and distinct from the fiduciary duty applicable to investment advisers). The SEC also proposed a new requirement for both broker-dealers and investment advisers to provide a brief relationship summary to retail investors, and it published for comment a proposed interpretation of the standard of conduct for investment advisers.

Proposed Regulation Best Interest would require broker-dealers and registered representatives to act in the “best interest” of a “retail customer”4 at the time a “recommendation”5 of a securities transaction or investment strategy involving securities is made to that customer, without placing the financial or other interest of the broker-dealer or associated person ahead of the interest of the customer.6

The SEC release states that the proposed best interest obligation both draws from principles applying to investment advice in other contexts where conflicts of interests exist, and builds upon the existing regulatory obligations in light of the unique structure of broker-dealer relationships with retail customers. The proposed best interest release reflects the underlying intent of many of the recommendations of the 2011 staff report, and also generally draws from the principles underlying the DOL’s 2016 fiduciary rulemaking.

Crucially, the SEC opted not to define “best interest,” and this omission has largely dominated the discussion over the entire proposed package. The proposed best interest standard is, in fact, not a fiduciary standard, such as the one imposed on investment advisers under the Investment Advisers Act of 1940 (Advisers Act). Rather, it’s a suitability-plus standard with enhanced disclosures and a requirement to mitigate or eliminate certain conflicts of interest. For example, the broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to identify and then to, at a minimum, (1) disclose, or eliminate, material conflicts of interest associated with the recommendation; and (2) disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with the recommendation.

We think that, most likely, Regulation Best Interest will be finalized this spring (in the fall at the latest) largely intact. We would not be surprised if the SEC opted to provide examples of how firms can meet their best interest duties, while still avoiding the rhetorical exercise of trying to define them.

The SEC also included title reforms for broker-dealers and investment advisers which include (1) a requirement of broker-dealers and investment-advisers to prominently disclose their registration status and (2) a prohibition against standalone broker-dealers and their financial professionals from using the terms “adviser” and “advisor” as part of their name or title.

We believe that the SEC is unlikely to adopt the proposed title reform changes given their limited application to just a few terms out of a possible universe of many, and the fact that this initiative was championed by Michael Piwowar, who has since left the SEC. If the SEC does not adopt title reform, we would not be surprised to continue to see state legislatures and regulators view this as an area of focus.

The SEC also proposed requiring that both broker-dealers and investment advisers provide retail investors7 with information intended to clarify the relationship via the proposed Form CRS Relationship Summary. Form CRS would be limited to four pages, with a mix of tabular and narrative information, and contain sections covering (1) the relationships and services the firm offers to retail investors; (2) the standard of conduct applicable to those services; (3) the fees and costs that retail investors will pay; (4) comparisons of brokerage and investment advisory services (for standalone broker-dealers and standalone investment advisers); (5) conflicts of interest; (6) where to find additional information, including whether the firm and its financial professionals currently have reportable legal or disciplinary events and who to contact about complaints; and (7) key questions for retail investors to ask the firm’s financial professional. Form CRS would be provided to investors, filed with the SEC, and available online.8

Form CRS has also proven to be a controversial component of the SEC proposal. If Form CRS was supposed to allay investor confusion over a broker-dealer standard of care and an investment adviser standard of care, the jury still appears to be out. While testing of the Form confirmed investors’ desire for clarity on standards of care, it is still an open question whether investors understand the Form or the concepts addressed in it. As a result, industry comments criticized Form CRS for adding to the confusion. We believe that the SEC will move forward with Form CRS, making some adjustments to address industry concerns and perhaps incorporating some of the models industry submitted.

One other aspect of the SEC standards of conduct package proposal is also worth watching. The SEC published for comment a proposed interpretation of the existing fiduciary duty owed by investment advisers under the Advisers Act. The proposed interpretation is intended to summarize the SEC’s understanding of that fiduciary duty and put the market on notice of the SEC’s views. This has been somewhat controversial within the adviser industry because some believe it goes beyond existing precedents, guidance and interpretations to impose new obligations on advisers. Most notably, the proposed release suggests that certain conflicts of interest may no longer be addressed through disclosure and informed client consent.

In light of the controversy surrounding the release, we predict that the SEC will either choose not to move forward with the interpretation at this time or modify it to delete the more controversial interpretations for which there is no existing strong precedent.

The public had until August 7, 2018 to submit comment letters regarding the proposal. There was general support amongst commenters that the SEC’s proposals were well-intentioned and that the SEC should continue to take a lead on formulating a best interest standard for broker-dealers. However, many commenters felt the SEC’s proposal was vague and went far beyond current broker-dealer obligations. Many commenters hoped the final rules would show significant improvements over the proposals.

William F. Galvin,
Secretary of the
Commonwealth of

William Galvin submitted a comment letter to the SEC criticizing the proposed Regulation Best Interest and suggested that, absent the SEC’s withdrawal of the proposal, “Massachusetts is prepared to adopt a fiduciary standard for broker-dealers.” Meanwhile, the attorneys general of New York, California, Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Mexico, Oregon, Pennsylvania, Rhode Island, Vermont, Washington and the District of Columbia submitted a comment letter calling for a uniform fiduciary standardand, inter alia, for Regulation Best Interest to “require the elimination of certain conflicted compensation incentives that cannot be sufficiently mitigated and to base any differential compensation to individuals on neutral factors.”

State Developments

As we noted early in the year, 2018 promised to be very eventful at the state level driven in large measure by a perception that regulatory rollback was well afoot at the federal level. It did not fail to deliver. Regulators and legislators in New Jersey, New York, Nevada and Maryland, among others, raced to fill a perceived void created by federal deregulation. The National Association of Insurance Commissioners (NAIC) also was hard at work in an attempt to form a model standard of conduct for states to follow in connection with the sale of life insurance products.

On October 15, the New Jersey Bureau of Securities (Bureau) issued a notice of pre-proposal to solicit comments on whether to adopt rule amendments that would require broker-dealers, agents, investment advisers and investment adviser representatives to be subject to an express fiduciary duty. The notice highlighted concerns that investors are often unaware of whether and to what extent those they trust to make financial recommendations are receiving undisclosed financial benefits in exchange for steering their clients to certain products.9 The pre-proposal did not include any specific language, but the Bureau did indicate it was considering “making it a dishonest or unethical business practice for failing to act in accordance with a fiduciary duty when recommending to a customer, an investment strategy, or the purchase, sale, or exchange of any security or securities, or providing investment advisory services to a customer.”10 The Bureau held two public hearings last November; the comment period closed on December 14. The Bureau currently expects to release a formal proposal in the first quarter of 2019, followed again by another comment period. This timeline could be extended, depending on when the SEC finalizes its standards of conduct rulemaking. The Bureau could also shelve its proposal if the final Regulation Best Interest is modified in such a way as to assuage state legislatures and regulators.

Early in 2018, the New Jersey Senate reintroduced a bill that would have required non-fiduciary investment advisers to make a plain language disclosure stating that they are not required to act in the client’s best interest, that they are allowed to recommend investments that earn them higher fees, and also keep records of the client’s acknowledgement of those disclosures. The bill stalled. With that said, we understand that the sponsor of the bill has not lost faith and is open to re-introducing the bill this session. It may simply be a matter of politics if legislation is introduced while the Bureau works through its regulatory process.

New Jersey has certainly not been alone. Early last year, New York Assemblyman Jeffrey Dinowitz introduced the Investment Transparency Act, which would have required brokers, dealers, investment advisers and other financial planners that are not otherwise subject to a fiduciary standard under existing state or federal law to make a “plain language disclosure to clients orally and in writing” at the outset of the relationship that states:

I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks, and expected returns for you.11

The bill’s language is virtually identical to the New Jersey bill we noted above. While the Investment Transparency Act did not advance to a floor vote following a third reading before the State Assembly in May 2018, Dinowitz has indicated that he plans to re-propose legislation.

One of the most significant state developments over the past year occurred on July 18, 2018 when New York’s Department of Financial Services (NYDFS) approved an amendment to its insurance regulation to impose a “best interest” standard on the sale of life insurance and annuity contracts.12 Specifically, the regulation requires insurers and “producers” to establish standards and procedures for recommendations to consumers with respect to annuity contracts or insurance policies delivered or issued for delivery in the state, so that any transaction with respect to those policies is in the best interest of the consumer and appropriately addresses the insurance needs and financial objectives of the consumer at the time of the transaction. The amendment is to take effect on August 1, 2019 for annuity contracts and February 1, 2020 for life insurance policies.

The New York regulation marked a sea change and raised concerns about what might happen with the NAIC model drafting process as well as in other jurisdictions. The regulation not only heightened the standard of care owed by the sellers of life insurance products, but also vastly expanded the breadth of the products covered from annuities to all life insurance products, including term life insurance. Some industry groups quickly challenged the NYDFS regulation.13 Does this regulation presage how other states respond to the rollback of regulations at the federal level?

On that point, the outcome of the NAIC’s model rulemaking process is of particular note. The NAIC committee tasked with revising the NAIC’s model suitability rule for the sale of annuity products was hard at work in 2018 seeking to revise its current “suitability” standard for the sale of annuity products with a rule that would apply a “best interest” standard. The committee faced great debate among NAIC members regarding among the future of the model rule. With states like New York and California leading the charge, the NAIC was pressured to adopt a rule that, like New York’s regulation, would impose a best interest standard for the sale of both annuity and life insurance products. Other states have pushed back, arguing that such an approach goes too far and would be unlikely to pass in many state legislatures. Because the NAIC is working to harmonize its advice standards with those of the SEC, it is unlikely that NAIC will have its final model rule promulgated until after the SEC finalizes its rule. The future of the NAIC’s model regulation will continue to be a hot topic of debate in 2019.

Maryland is also worth watching. Last May, legislation passed in the House and Senate as part of a larger financial reform bill (titled the Financial Consumer Protection Act of 2018), which instructed the Maryland Financial Consumer Protection Commission (the MFCPC) to study the DOL’s 2016 fiduciary rule and SEC’s proposed Regulation Best Interest, to determine whether it would be in the best interest of the state to adopt its own fiduciary rule. The MFCPC has since held two public hearings where it has heard testimony from interested parties. Last we heard, the MFCPC hopes to issue a final report and draft fiduciary rule to Maryland’s General Assembly and to the Governor any day now. Although there seems to be some support for such a rule in the Maryland legislature, Chair Gary Gensler has recognized that adopting a new fiduciary standard will be a “tough lift” for the General Assembly.

Though the passage of a Nevada bill in 2017, which imposed a statutory fiduciary duty on broker-dealers, sales representatives, and investment advisers14 was met with great fanfare and surprise, it left financial services firms that were subject to the new law in limbo because its scope and core requirements were left to the Nevada Securities Division to decide. While repeatedly promised, a regulation explaining how this uniform fiduciary standard was to work in practice, and whether firms registered with the SEC would be exempted, has yet to materialize. The Nevada Securities Division has been made aware of the preemption concerns by reason of The National Securities Markets Improvement Act of 1996 (NSMIA) and other federal law, which may be the holdup.

Last April, we noted, “Nevada Democratic Senate Majority Leader Aaron Ford, the sponsor of the legislation (who subsequently announced his intention to run for state attorney general), said in an interview that he is ‘confident’ the law will ‘comport with what the federal government may do,’ specifically referencing the DOL Fiduciary Rule.” We also mentioned that, “Ford intimated that he and others would not hesitate to send the Securities Division back to the drawing board if the regulation does not reflect (enough) of their legislative intent. He also vowed, ‘We’ll be back again in 2019’ should the law be struck down by a court on preemption grounds.” Since then, Ford has won his race for state attorney general. We wonder if this means Nevada pursues its agenda of imposing a uniform fiduciary standard through the courts (e.g., filing suit against a final SEC rulemaking) rather than through the legislature.

Also on the legislative front, Illinois took a preliminary step toward promulgating a standard of care for investment advisers. On February 13, 2018, Illinois introduced the Investment Advisor Disclosure Act. While the bill does not yet provide any text, it appears to target disclosure-related standards and mimics the approach taken by New York in its proposed Investment Transparency Act. It also has yet to advance.

With the states’ legislative approach to addressing the standards of conduct issue largely unsuccessful, we expect most states will await final rulemaking from the SEC and the NAIC, and only then propose and promulgate regulations directly or indirectly imposing uniform standards of care. We do not expect many other states, besides the ones already mentioned, to be involved (with one or two exceptions). While regulations may face better odds than legislation, they also remain vulnerable to court challenge that the regulator acted beyond its powers. This means that litigation both by, and against, the states involved, such as New York and potentially New Jersey, will likely characterize state activity regarding broker-dealer and investment adviser standards of conduct in 2019.

Proxy Voting

On September 13, 2018, Clayton announced a review of all SEC staff guidance to determine if prior positions “should be modified, rescinded or supplemented in light of market or other developments.”15 In conjunction with the Chairman’s statement, IM staff withdrew two interpretive letters that gave guidance to investment advisers seeking to comply with the proxy voting requirements of rule 206(4)-6 under the Advisers Act, which, among other things, requires investment advisers to vote client securities in the best interest of clients and to describe how they address material conflicts of interest between themselves and the clients on whose behalf they are voting.16 While rule 206(4)-6 does not dictate how an investment adviser must address conflicts, the adopting release discusses options, including engaging a third party to vote a proxy involving a material conflict or voting in accordance with a pre-determined policy based on recommendations of an independent party. The letters addressed how investment advisers that have a material conflict can determine that a proxy advisory firm is capable of making impartial recommendations in the best interests of the adviser’s clients. The SEC left in place 2014 staff guidance that enshrines the principles of the two interpretive letters.17

IM staff indicated in its statement that its withdrawal of the letters was designed to “facilitate discussions” at the Roundtable on the Proxy Process,18 which was held in November, and that staff was seeking views on the 2014 staff guidance. The U.S. Chamber of Commerce and some corporate secretaries have criticized proxy advisory firms for years, claiming proxy advisory firms lack transparency and accountability, and as part of these efforts, the corporate community has lobbied to withdraw the letters.19 Legislative efforts to directly regulate proxy advisory firms also have been proposed.20

John Baker and Michael Wallace attended the Staff Roundtable on the proxy process on November 15, 2018. The Roundtable consisted of three panels on each of the following topics: (1) proxy voting mechanics and technology; (2) shareholder proposals; and (3) the role of proxy advisory firms. Clayton opened the discussion by expressing his personal goal to improve the quality of the voting process for long term investors, such that they can make more informed, company-specific voting decisions. He requested that the panel continue to work on and present recommendations for change to the SEC. Notably, Clayton did not make the same request after the other two panel discussions. Also notable was the absence of any discussion at all about the two interpretive letters from 2004, which were recently withdrawn by the SEC. Much of the panel’s time was spent discussing how proxy advisory firms operated, what services they provide, and how those services are used by asset managers, investment advisers, and issuers.

In December, Clayton gave a speech that included priorities for the SEC in 2019.21 Among other things, he indicated that improving the proxy process is a significant initiative. With regard to proxy advisory firms, Clayton indicated that “there should be greater clarity regarding the division of labor, responsibility and authority between proxy advisors and the investment advisers they serve.” Additionally, Clayton pointed to the need for “clarity regarding the analytical and decision-making processes advisers employ,” and indicated that “it is clear to me that some matters put to a shareholder vote can only be analyzed effectively on a company-specific basis, as opposed to applying a more general market or industry-wide policy.” Clayton indicated that he intended to move forward with staff recommendations.


Environmental, social and/or governance issues are a fact of life. Cybersecurity and climate change are two examples. Some investment funds that incorporate ESG factors, for instance, scrutinized their holdings in Facebook because they viewed the recent privacy scandals “as the digital equivalent of a toxic waste spill,”22 while other funds and managers focus on the myriad other environmental (E), social (S) and/or governance (G) issues and risks when making investment decisions. ESG continues to proliferate at breakneck speed across asset classes. In fact, we’re helping both our registered and private fund clients incorporate various ESG strategies, and advising fiduciaries on the fiduciary implications, such as how integration, shareholder engagement and divestment can be conducted in a manner consistent with ERISA. We simply don’t see ESG going away anytime soon.

We also appreciate that there is widespread confusion over what ESG actually means. How does “ESG investing” differ from “impact investing,” “socially responsible investing,” “economically targeted investing,” and “sustainable investing”? It is also helpful to remember that gone are the days when ESG investing consisted primarily of either screening out, or divesting, of certain issuers/sectors because they did not meet some moral or other non-economic test. Today’s ESG is much more driven by data linking one or more ESG factors and investment performance – i.e., an ESG factor can now be a material risk. On an even more fundamental level, there is not unanimity on what constitutes an E, S or G factor. ESG is an umbrella term capturing as many as 40 different topics. To better align fiduciary duty nuance and industry practice, George Michael Gerstein, in An ESG Proposal for You, proposed this glossary:

ENGAGEMENT: Exercising one or more rights of a holder of interests in an ISSUER, such as proxy voting, introducing resolutions or participating in formal or informal meetings with the ISSUER board, in respect of an ESG FACTOR where (A) the exclusive purpose is to enhance portfolio return or reduce portfolio risk, (B) the primary purpose is for non-investment performance reasons, such as the promotion of an ESG policy, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (C) the exclusive purpose is for one or more non-investment performance reasons, such as the promotion of an ESG policy.

ENVIRONMENTAL: Issues or facts related to the natural environment, such as climate change, carbon emissions, waste management, recycling, energy, biodiversity, pollution, and conservation.

ESG (FACTOR): ENVIRONMENTAL, SOCIAL and/or GOVERNANCE-related issues or facts.



GOVERNANCE: Issues or facts related to the governance of an ISSUER, such as executive compensation, board structure, shareholder rights, bribery and corruption, and cybersecurity.

IMPACT INVESTING: Selecting investments in respect of an ESG FACTOR where the primary purpose is for non-investment performance reasons, such as the promotion of an ESG public policy, and a secondary purpose is to enhance portfolio return or reduce portfolio risk.

INTEGRATION: Incorporating ESG-related data and/or information in respect of an ESG FACTOR into the usual process when making an investment decision where such data or information is material to investment performance and where the exclusive purpose is to enhance portfolio return or reduce portfolio risk.

ISSUER: Any issuer, such as a corporation or country, whether in the public or private markets, that issue investible holdings, whether a security or not, in which an investment can be made.

NEGATIVE SCREENING: Avoiding the purchase of prospective investments, or DIVESTING from existing investments, on the basis of such investments not meeting a designated ESG standard, rating or requirement where (A) the exclusive purpose is to enhance portfolio return or reduce portfolio risk, (B) the primary purpose is for non-investment performance reasons, such as the promotion of an ESG public policy, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (C) the exclusive purpose is for one or more non-investment performance reasons, such as the promotion of an ESG public policy. Also called EXCLUSIONARY SCREENING.

POSITIVE SCREENING: Selecting investments on the basis of meeting a designated ESG standard, rating or requirement where (A) the exclusive purpose is to enhance portfolio return or reduce portfolio risk, (B) the primary purpose is for non-investment performance reasons, such as the promotion of an ESG public policy, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (C) the exclusive purpose is for one or more non-investment performance reasons, such as the promotion of an ESG public policy.

RESPONSIBLE INVESTING: Selecting investments where (A) the primary purpose is for non-investment performance reasons, namely the promotion of a GOVERNANCE ESG FACTOR, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (B) the exclusive purpose is for one or more non-investment performance reasons, namely the promotion of a GOVERNANCE ESG FACTOR.

SOCIAL: Issues or facts related to human relations of an ISSUER, such as employee relations, community relations, board diversity, human rights, demography, food security, poverty/inequality, child labor and health and safety.

SOCIALLY RESPONSIBLE INVESTING: Selecting investments where (A) the primary purpose is for non-investment performance reasons, namely the promotion of a SOCIAL ESG FACTOR, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (B) the exclusive purpose is for one or more non-investment performance reasons, namely the promotion of a SOCIAL ESG FACTOR.

SUSTAINABLE INVESTING: Selecting investments where (A) the primary purpose is for non-investment performance reasons, namely the promotion of an ENVIRONMENTAL ESG FACTOR, and a secondary purpose is to enhance portfolio return or reduce portfolio risk or (B) the exclusive purpose is for one or more non-investment performance reasons, namely the promotion of an ENVIRONMENTAL ESG FACTOR.

THEMATIC INVESTING: Utilizing NEGATIVE SCREENING, POSITIVE SCREENING, INTEGRATION and/or ENGAGEMENT to invest in ISSUERS that share a common ESG purpose, industry or product.

On April 23, 2018, the DOL issued Field Assistance Bulletin 2018-01. At the time of its publication, we noted that it, “reflects an unease by the DOL over certain ESG practices and largely clarifies existing fiduciary obligations in this space.” Specifically, FAB 2018-01 preserved integration as an ESG approach. As defined above, integration is where the fiduciary thinks that one or more ESG factors will have a material impact on investment performance. There is a good amount of data coming out that links investment performance with various (but not all, yet) ESG factors.

We think the DOL might prefer integration as an ESG approach over strategies that make investment decisions for moral reasons or to otherwise promote a public policy. The DOL stressed the importance of documenting why the fiduciary believes the respective ESG factor will have a material effect on performance, without having to make a series of wishful assumptions to reach that conclusion. We suggested that, “fiduciaries will want to build a record in support of the view that a particular factor bears a relationship with investment performance, and carefully consider how much weight to put on that specific factor.”

FAB 2018-01 also warned plan fiduciaries against selecting an ESG-themed fund as a qualified default investment alternative (QDIA) for purposes of section 404(c) of ERISA. However, we thought the DOL left open the possibility of selecting a QDIA that integrates ESG factors, again, seemingly demonstrating a preference for that approach.

We also noted in April that the DOL “zeroed-in on shareholder engagement in respect of ESG issues that have a connection to the value of the plan’s investment in the company, where the plan may be paying significant expenses for the engagement or development of proxy resolutions.” If anything, this aspect of FAB 2018-01 has the most significant ramifications. If plans are viewed as paying indirectly for engagement through the management fee, which view we think the DOL takes, then proxy voting and other forms of shareholder engagement need to be monitored for both costs and benefits, particularly as the time spent on the engagement increases.

On May 22, 2018, the Government Accountability Office (GAO) released a report on ERISA fiduciaries’ incorporation of ESG factors into its investment process. Though the report provides a really helpful overview of ESG’s evolution, we noted the following:

Rather unfortunately, the report was largely completed prior to the DOL’s issuance of Field Assistance Bulletin (FAB) 2018-01, which we discussed here. The principal recommendation by the GAO is for the DOL to issue guidance on whether a fiduciary can incorporate ESG factors into the management of a default investment option in a defined contribution plan. As you may know, FAB 2018-01 seemed to do just that, though not in an entirely clear manner. Nevertheless, the GAO addressed FAB 2018-01 at the end of the report and narrowed its initial recommendation, namely, that the DOL better explain how fiduciaries can utilize the integration strategy in a QDIA. In the DOL’s defense, FAB 2018-01 seems to address (to some extent) whether a QDIA can utilize the integration strategy; the DOL instead hit the brakes on offering a themed ESG product as a QDIA.

In our view, ESG will continue to evolve and proliferate, while also garnering the attention of both the DOL and SEC on a number of levels. ESG is, in essence, entirely fluid and will continue to present business opportunities and compliance challenges. We will likely have more to say on this in the coming weeks.


1 Citing Chamber of Commerce of the U.S.A. v. U.S. Dep’t of Labor, No. 17-10238, slip op. 46 (5th Cir. Mar 15, 2018).

2 See Regulation Best Interest, SEC Rel. No. 34-83062 (April 18, 2018); Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles, SEC Rel. Nos. 34-83063; IA- 4888 (April 18, 2018); Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation, SEC Rel. No. IA-4889 (April 18, 2018).

3 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 913, 124 Stat. 1376, 1824-30 (2010).

4 A “retail customer” is proposed to be defined under Regulation Best Interest as a person who receives a recommendation and uses it primarily for personal, family or household purposes.

5 “Recommendation” is not defined but is proposed to be interpreted consistent with existing FINRA rules, under which factors that have historically been considered in the context of broker-dealer suitability obligations include whether the communication “reasonably could be viewed as a ‘call to action’” and “reasonably would influence an investor to trade a particular security or group of securities.”

6 Regulation Best Interest, Release No. 34-83062 (April 18, 2018), available at

7 For purposes of the Form CRS delivery requirement, a “retail investor” is proposed to be defined as a prospective or existing client or customer who is a natural person, including a trust or other similar entity that represents natural persons.

8 The form would not supersede the Form ADV Part 2 brochure, which investment advisers would continue to prepare and provide to clients.

9 Both New Jersey and FINRA rules require securities recommendations to meet a suitability standard. See N.J. Admin. Code § 13:47A-6.3(a)(3); FINRA Rule 2111.

10 50 N.J.R. 2142(a) (Oct. 15, 2018).

11 An Act to Amend the General Obligations Law, in Relation to Mandating Greater Levels of Disclosure by Non-Fiduciaries that Provide Investment Advice, New York State Assembly, A02464A (N.Y. 2017), available here.

12 Suitability and Best Interests in Life Insurance and Annuity Transactions, New York State Department of Financial Services, First Amendment to 11 NYCRR 224, available at

13 For example, the National Association of Insurance and Financial Advisors of New York filed a lawsuit in November 2018 against the NYDFS in New York’s Supreme Court alleging various claims regarding the regulation’s constitutionality. To view the complaint, please visit:

14 Assembly Amendment to S.B. 383, 79th Sess. (Nev. 2017), available at

15 Statement Regarding SEC Staff Views, available at The Chairman noted that other federal financial agencies had instituted similar reviews of staff guidance.

16 Statement Regarding Staff Proxy Advisory Letters, available at Commissioner Jackson issued a statement in conjunction with the Investor Advisory Committee meeting critical of IM staff’s withdrawal of the letters. Statement on Shareholder Voting, available at

17 Staff Legal Bulletin No. 20 (June 30, 2014), available at

18 Statement Announcing SEC Staff Roundtable on the Proxy Process, available at

19 See, e.g., Statement of the U.S. Chamber of Commerce on the Market Power and Impact of Proxy Advisory Firms (June 5, 2013) (“For a number of years, the Chamber has expressed its long-standing concerns with . . . proxy advisory firms”), available at; James K. Glassman and J.W. Verret, “How to Fix our Broken Proxy Advisory System,” (2013) (recommending that the letters be rescinded to “[e]nd the preferential regulatory treatment that proxy advisors currently enjoy in the law”). Both the corporate community and the asset management industry discussed their views on the letters and proxy advisory firms generally in a prior SEC roundtable in 2013. See Transcript of the Proxy Advisory Firms Roundtable (Dec. 5, 2013), available at

20 For example, HR 5311 was introduced in May 2016 and later folded into the Financial CHOICE Act. More recently, in October 2017, HR 4015, which is mostly a resubmission of HR 5311 was introduced. These bills generally require registration of proxy advisory firms with the SEC, and require firms to meet extensive disclosure requirements relating to methodologies and conflicts of interest, require firms to hire an ombudsperson to handle complaints, and give corporate issuers the ability to vet proxy advisory firms’ recommendations before the recommendations are released.

21 SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks, available at

22 Emily Chasan, Facebook Turns Toxic for Some ESG Funds, Bloomberg, March 26, 2018.

A Striking Shot Across the Bow: New Jersey Launches Uniform Fiduciary Standard Rulemaking

New Jersey can be credited as the first state to take up a uniform fiduciary standard applicable to broker-dealers and investment advisers in the wake of Regulation Best Interest and the rest of the Securities and Exchange Commission’s (SEC) major standard of care proposal. On October 15, the New Jersey Bureau of Securities (Bureau) announced, in the form of a notice of pre-proposal, that it is soliciting comments on whether to adopt rule amendments to require that broker-dealers, agents, investment advisers, and investment adviser representatives be subject to an express fiduciary duty. The rule amendments likely would apply to all persons who conduct brokerage services in New Jersey, including federally registered broker-dealers. It likely would also apply to state-registered investment advisers, but it is not clear whether the rule amendments would apply to SEC-registered investment advisers.

According to the notice, while investment advisers already owe a fiduciary duty to their clients under case law,1 broker-dealers are held only to a suitability standard2 (i.e., broker-dealers and their agents are required to have a reasonable basis to believe a recommended transaction or investment strategy involving securities is suitable for the customer).3 The notice expresses concern that investors remain without adequate protection from broker-dealers who, under the suitability standard, are permitted to consider their own interests ahead of their client’s interests when making investment recommendations.4 In particular, the notice warns that investors are often unaware of whether and to what extent those they trust to make financial recommendations are receiving undisclosed financial benefits in exchange for steering their clients to certain products.

The pre-proposal does not include specific regulatory language, but the notice indicates that the Bureau is considering “making it a dishonest or unethical business practice for failing to act in accordance with a fiduciary duty when recommending to a customer, an investment strategy, or the purchase, sale, or exchange of any security or securities, or providing investment advisory services to a customer.” The Bureau contemplates a uniform standard that would protect investors against the abuses that can result when financial professionals place their own interests above those of their customers, but does not set out the precise scope of the duties that would apply.

By opening up a comment period before issuing a rule proposal, and holding two public hearings in November, New Jersey appears to recognize the complexities associated with a uniform fiduciary rule. Specifically, the Bureau is seeking comment on:

  1. The legal and factual bases for applying a fiduciary standard to all financial services professionals;
  2. The scope of the duty in terms of duration and when it arises;
  3. The types of recommendations that would trigger the duty; and
  4. The scope of the duty in terms of to whom it is owed.

Comments should be sent by December 14, 2018, to: Christopher W. Gerold, Bureau Chief, Bureau of Securities, PO Box 47029, Newark, New Jersey 07101, or electronically.

The Bureau will also host two “informal conferences to take testimony from interested parties to gather facts to inform a rulemaking and to afford ample opportunity for the receipt of public comment from the regulated communities, industry representatives, and the public at large.” These conferences will take place on November 2 and November 19 from 9:30 am – 4:30 pm at 124 Halsey Street, 6th Floor, Morris Room, Newark, NJ 07101.

We expect that, following its consideration of public comments, the Bureau will issue a formal rule proposal, which will be subject to notice and comment.

A copy of the pre-proposal can be found here.

This is not the first time New Jersey has waded into these waters post-Department of Labor (DOL) fiduciary rule. Earlier this year, the New Jersey Senate considered a bill that would impose a disclosure obligation on “non-fiduciary investment advisors,” including broker-dealers, that would consist of a Plain English declaratory statement that those entities do not owe fiduciary duties to their clients. This legislation has since stalled. A nearly identical bill was introduced in the New York Assembly and has similarly stalled.

New Jersey Governor Phil Murphy, a Democrat, announced last month that the Bureau would initiate a rulemaking that “would impose a fiduciary duty on all New Jersey investment professionals, requiring them to place their clients’ interests above their own when recommending investments.” While the October 15 pre-proposal merely solicits comments on what a uniform fiduciary standard should look like under New Jersey law, it comes at a time when the SEC is currently working to address federal standards of conduct. As we noted recently, the SEC could issue a final rule in the first half of next year. Though it remains to be seen how the SEC will ultimately address the numerous concerns stakeholders have over Regulation Best Interest and other aspects of the rulemaking, the Governor and the Bureau are not waiting for the SEC to address these concerns.

As with some other states and public officials, the Governor may be holding up the DOL fiduciary rule as a model. He charged the DOL with “abandoning” its controversial fiduciary rule by not appealing the decision of the Fifth Circuit Court of Appeals to vacate the rule. It is possible that this apparent affinity for the DOL rule could presage what a final New Jersey rule could look like.

It is also possible that other states will move forward with disparate fiduciary standards and duties before the SEC has the chance to publish a final rule. Ever since the President’s Inauguration, a handful of blue states have cast the Trump Administration as being adverse to Main Street investors, even though both SEC Chairman Jay Clayton and DOL Secretary Alex Acosta have solicited state participation. Nevertheless, several state bills, including those of Illinois, Massachusetts and New York (nearly all of which failed), attempted to address the different standards of conduct of investment advisers and broker-dealers. Enforcement efforts, particularly out of Massachusetts, have also been active during this period.

Not all state efforts in imposing a uniform fiduciary standard, however, have stalled. Nevada, for instance, amended its financial planner statute in 2017 to impose a fiduciary standard on broker-dealers. As we previously noted, Nevada’s amended law raises a number of material interpretive issues, which were supposed to have been addressed in a regulation. To date, no such regulation has been proposed.

Standards of care applicable to broker-dealers and investment advisers remain an entirely fluid area at the federal and state levels. We expect ongoing state regulatory and enforcement developments while the SEC continues to work on its own rulemaking, with the DOL most likely awaiting a final SEC rule before issuing any new guidance in this area. The question then becomes not if a major fiduciary standard of care development will occur in the near future, but by whom and when.


1 A fiduciary duty for investment advisers has been implied under the Investment Advisers Act of 1940. See Transamerica Mortgage Advisors v. Lewis, 444 U.S. 11, 17 (1979); SEC v. Capital Gains Research Bureau, 375 U.S. 180 (1963).

2 In fact, available case law in New Jersey, following precedent from other states, says that broker-dealers generally are not fiduciaries, but do have fiduciary duties if they have investment discretion. See McAdam v. Dean Witter Reynolds, 896 F.2d 750, 767 (3d Cir. 1990); Estate of Parr v. Buontempo Insurance Services, 2006 WL 2620504, at *5 (N.J. Super. Ct. App. Div. 2006) (unpublished opinion).

3 Both New Jersey and FINRA rules require securities recommendations to meet a suitability standard. See N.J. Admin. Code § 13:47A-6.3(a)(3); FINRA Rule 2111.

4 Although the notice states that broker-dealers can consider their own interests ahead of their client’s interests when making investment recommendations, FINRA has stated that the suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests. FINRA Regulatory Notice 12-25 (May 2012).

Watch yesterday’s Fiduciary Governance Group webcast on the SEC Standards of Conduct proposal

On Thursday, October 4th, Investment Company Institute Associate General Counsel Sarah A. Bessin, Fidelity Investments Senior Vice President & Deputy General Counsel Helen E. Rizos, David Grim and I presented a webcast titled “The Latest on the SEC Standards of Conduct Initiative.” Watch a replay of the webcast here: