CBA Record Jan-Feb 2021

commissions charged by the advisory firm’s affiliates and other charges into the fee. Typically, the fee is a small percentage of the assets under management. For the $100,000 account in the example, a 1% fee would be $1,000 per year. If the inves- tor held the stock for five years, the total fees over that period would be $5,000. If the investor then sold the stock, the advi- sor would not charge a “commission” on the sale. For the five-year investment in the example, the broker (with $500 at most in commissions) was much less expensive than the advisor ($5,000 in fees). Some commentators argue that the difference in compensation favors a dif- ference in the standard of care. A broker’s one-time commission suggests one-time service (and no monitoring of the port- folio), whereas an advisor’s continuous fees suggest continuous service (including monitoring). Indeed, for much of the 1900s, commission-based brokers sold stock, and fee-based advisors provided more comprehensive investment advice. Worlds Collide Beginning in the 1980s, many brokers began expanding services beyond merely buying and selling stock for customers. They began recommending stocks and investment plans. They abandoned the “stockbroker” moniker and began hold- ing themselves out as “financial advisors,” “financial planners,” and “financial con- sultants,” suggesting more than an arms- length salesperson. Regulators and investor advocacy groups grew concerned. So did advisors who feared losing market share to brokers who were holding themselves out as offering similar advisory services at a lower price and without the same standard of care or attendant compliance costs. As Hester M. Peirce, an SEC Commis- sioner observed, “[s]tudies have shown that, as a result of loose language, inves- tors are confused regarding the nature of the services offered by, and the standards of conduct applicable to, broker-dealers and investment advisers, and regarding whether their firm or financial profes- sional is a broker dealer or an investment adviser, or both.” See Hester M. Peirce,

What’s in a Name? Regulation Best Interest v. Fiduciary, Harvard Law School Forum on Corporate Governance (July 31, 2018). Available at edu/2018/07/31/whats-in-a-name-regu- lation-best-interest-v-fiduciary/. Brokers crossing into investment advice continued largely unimpeded until the Financial Crisis of 2008. In the lead- up, many brokers and advisors received storm warnings about impending stock or broader market meltdowns. Advi- sors—with a fiduciary duty (including monitoring)—were more likely to call their customers to mitigate losses. Bro- kers—with no fiduciary duty—did not call their customers and feared losing money if they were stuck buying the customer’s stock. This situation prompted Congress, in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act, to mandate that the SEC clarify customer expectations. The SEC engaged in a years’ long study and received comments from investment advocates, industry advocates, and regula- tors. Many argued that brokers should be held to the same fiduciary duty as advisors. For their part, broker-dealers argued that regulators should stick with the suitabil- ity standard and not impose the higher, fiduciary standard because increased compliance costs from the broader fidu- ciary standard would make investing cost- prohibitive for many Americans. Solution: “Best Interest” for Brokers, “Fiduciary” for Advisors In 2019 the SEC adopted important rules concerning the standard of care for brokers and advisors. The rules went into effect in 2020 and will be implemented by invest- ment firms for years to come. The SEC did not impose a fiduciary standard on brokers. But, as explained below, it did impose a “best interest of the client” standard that is much higher than that of a salesperson. At the same time, the SEC clarified the longstanding fiduciary standard to which advisors are subject. As to brokers, the SEC adopted Regula- tion Best Interest. It requires that, “when making a recommendation of any securi- ties transaction or investment strategy

involving securities” to a retail customer, the broker “shall act in the best interest of the retail customer at the time the recom- mendation is made, without placing the financial or other interest of the broker . . . ahead of the interest of the retail customer.” 17 C.F.R. 240.15l-1(a)(1) (emphasis added). The broker-dealer must also fully “[u]nderstand the recommendation,” and “[h]ave a reasonable basis to believe that the recommendation is in the best interest of [the] particular retail customer based on that retail customer’s investment profile.” 17 C.F.R. 240.15l-1(a)(2)(ii). The broker must also “[i]dentify and at a minimum disclose . . ., or eliminate, all conflicts of interest associated with such recommenda- tions.” 17 C.F.R. 240.15l-1(a)(2)(iii). The SEC also clarified the advisor’s fiduciary standard. In its Commission Inter- pretation Regarding Standard of Conduct for Investment Advisors , 84 Fed. Reg. 33669-1 (2019), the SEC stated that the federal Adviser’s Act “equitable common law principles” require advisors to abide by a fiduciary duty. It “comprises a duty of care and a duty of loyalty” requiring the advisor to adopt the client’s “goals, objectives, or ends,” and “at all times,” to “serve the best interest of its client and not subordinate its client’s interests to its own.” Importantly, unlike the broker’s transaction-based duties, the advisor has a “principles-based fiduciary duty” that “applies to the entire relationship between the adviser and its client.” (emphasis added). Although both standards require service of the client’s “best interests,” by default, only advisors are obligated to continue monitoring an investor’s portfolio, whereas brokers remain free of this obligation. These default rules can be changed by account paperwork, however, as explained below. In conjunction with Regulation Best Inter- est, the SEC requires brokers and advisors to provide a “Customer Relationship Sum- mary” or “Form CRS” to the customer at the outset of the relationship (or, if not previously supplied, the next time an investment recommendation is made). Account Opening Paperwork and Contracts

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