CRPC Module 9
Objectivity (The CFP Board Code of Ethics and Standards of Conduct)
"A CFP® professional must exercise professional judgment on behalf of the Client that is not subordinated to the interest of the CFP® professional or others (CFP Board)." For example, Mr. Henderson is a client of investment professional John Anderson, and they have agreed that a growth stock mutual fund is suitable for Mr. Henderson's investment portfolio. Their discussion with respect to which growth stock mutual fund to buy has focused on three funds, one of which is sold by a wholesaler that John particularly likes. John must maintain objectivity in advising his client as to which fund is most appropriate. That objectivity would have to overrule John's personal friendship with the wholesaler and ensure the fund that is selected be based on each of the funds' merits. For members of the CFA Institute, objectivity is mandated by the requirement to "use reasonable care and exercise independent professional judgment when conducting investment analysis, making investment recommendations, taking investment actions, and engaging in other professional activities."
What were the two recommendations for a uniform fiduciary standard?
-Consistent with Congress's grant of authority in Section 913 [of Dodd-Frank], the Staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2). -In particular, the staff recommends that the Commission exercise its rulemaking authority under Dodd-Frank Act Section 913(g), which permits the Commission to promulgate rules to provide that: The standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.
What are two things that is very important for investment professionals to do?
-Fill out new account forms completely and without exception, and update them on a regular basis. -Keep logs and notes of meetings and conversations with clients. All advisers and firms need to have a client relationship management (CRM) system in place. This documentation can be quite valuable if there are disputes in the future regarding what was discussed. For example, if a client maintains that they were not informed about the risks of an investment, notes can verify which risks were explained.
What are the best practices for adopting the fiduciary standard?
-Focus on "advice" and not "sales." Always look out for the best interest of your clients. This includes charging reasonable fees and using products and services with reasonable fees. Keep in mind that your main value is the advice that you give, and products are just used for implementation. Be process-driven and not product-driven. -Provide full and adequate disclosure in writing. Avoid conflicts of interest as much as possible, and disclose any material conflict of interests that you cannot eliminate. Disclosure should be transparent, easy to understand, and not misleading. Demand and use transparent products with reasonable costs. -Have a written contract with your client that provides a clear understanding of the scope of the engagement and what services you are providing. Have a compelling value proposition and market niche. -Work with your firm and product providers to ensure compliance with the new rules—don't go it alone. Stay on top of any changes as this story unfolds, and constantly increase and update your skills by (in the words of Stephen Covey) "sharpening the saw."
What are red flags as fees are concerned?
-high initial or recurring fees -any sort of kickback or revenue sharing arrangement between --the fund and the third-party administrator (TPA) -the use of proprietary funds of a fund provider -using a higher fee share class when a lower fee share class for the same fund is available
How can fiduciaries Protect Themselves From Liability?
-keep detailed records of actions taken and the factors that went into the decisions -make sure the records describe in detail the relevant circumstances prevailing at the time—that is, outline the conditions under which the action was taken -make sure all reasonable steps have been taken to acquire the information needed to make informed decisions
What are the general requirements of a Form CRS?
-must be in "plain English" -limited to two pages with reasonable font size -prohibited from including extraneous information not required by the instructions -Form CRS is required to be delivered to prospective clients either at the beginning of the relationship with a firm, following a material change to the Form CRS, or upon certain events such as when the client wants to change to a new or different relationship or service with the firm. For broker-dealers, Form CRS is a new, separate disclosure. For RIAs, Form CRS must become Part 3 of Form ADV and be provided to prospective clients along with Form ADV Part 2A.
What are the six foundational principles of the Code of Ethics?
1. Act with honesty, integrity, competence, and diligence. 2. Act in the client's best interests. 3. Exercise due care. 4. Avoid or disclose and manage conflicts of interest. 5. Maintain the confidentiality and protect the privacy of client information. 6. Act in a manner that reflects positively on the financial planning profession and CFP® certification.
What are the two types of standards?
1. Registered investment adviser (RIA) fiduciary standard 2. Registered representatives (RRs) and agents suitability standard
What are the five fundamental alterations in the former criteria for prudent investing according to the Uniform Prudent Investor Act?
1. The standard of prudence is applied to any investment as part of the total portfolio (all assets) rather than to that investment individually. 2. The trade-off in all investing between risk and return is identified as the fiduciary's central consideration. 3. All categorical restrictions on types of investments have been abrogated; the trustee can invest in anything that plays an appropriate role in achieving the risk/return objectives of the trust and that meets the other requirements of prudent investing. 4. The definition of prudent investing integrates the requirements that fiduciaries diversify their investments. 5. Delegation of trust investment and management functions is now permitted, subject to safeguards.
What is the 5 part test to decide if an adviser is under the fiduciary standard?
1. They rendered advice as to the value of securities or other property, or made recommendations as to the advisability of investing in, purchasing, or selling securities or other property 2. They rendered this advice/recommendations on a regular basis 3. Any advice provided was pursuant to a mutual agreement or understanding, with the plan or plan fiduciary 4. The advice would serve as a primary basis for investment decisions with respect to plan assets 5. The advice would be individualized based on the particular needs of the plan or IRA Because all five criteria must be met under this rule, many advisers are not necessarily considered fiduciaries. For example, the second requirement is that any advice must occur on a "regular" basis. If a client came to an adviser for advice, rolled over their account into an IRA, and purchased a product, the adviser would not be considered a fiduciary under this rule because advice was not being offered on a regular basis—it was an isolated event. Even an investment professional hired by a company for a one-time assessment of its retirement plan and investments would not be considered a fiduciary under this test, no matter how much money was involved. Fiduciary status can also be avoided by claiming that the parties did not have a "mutual agreement" or that the advice would not necessarily serve as the "primary" basis for making investment decisions. One can see that there are numerous loopholes, and it is very easy to avoid being a fiduciary under this standard.
What are the three options if a client has a plan that you are uncomfortable with?
1. do not do it 2. speak with your manager before placing the order 3. do it only after the client signs a statement in which you formally state your reservations about their actions
duty of care (fiduciary)
A corollary to the fiduciary duty is the concept of "reasonable care," the standard for which is the "prudent man rule." The classic definition of the "prudent man," which follows, was articulated in the famous Harvard College v. Amory case of 1830. All that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of capital to be invested. The duty of care requires the fiduciary to have the competency to give fiduciary advice. This requires a certain level of knowledge and skill to know what is in the best interest of someone setting up a retirement plan or in the best interest of a retirement plan participant. Believing that one can exercise a fiduciary duty of loyalty without also being able to exercise a duty of care is like showing up to do a construction project without any tools. Fiduciaries must be competent enough to give advice, or even if they delegate or consult with others, they need to be competent enough to vet any other experts they may go to or rely upon for advice and services.
Registered representatives (RRs) and agents suitability standard
A lesser standard, and the one that registered representatives (RRs—stockbrokers) and insurance agents are held to is the "suitability standard." This is a lesser standard in that an investment can be suitable but not necessarily in the best interest of the client. Verbal disclosure is often all that is needed under this standard, whereas fiduciaries have written disclosure and contract requirements.
Professionalism (The CFP Board Code of Ethics and Standards of Conduct)
According to the CFP Board code, a certificant "must treat clients, prospective clients, fellow professionals, and others with dignity, courtesy, and respect." Along with CFP® certificants, lawyers, and even doctors, stockbrokers must be conscious of how the public perceives their behavior and the quality and effectiveness of their services. A CFA Institute member is required to "practice and encourage others to practice in a professional and ethical manner that will reflect credit on members and their profession." The concept of professionalism is vague, but all recognize its presence—or absence—in the behavior of those encountered in the workplace
Diligence (The CFP Board Code of Ethics and Standards of Conduct)
According to the CFP Board, "A CFP® professional must provide professional services, including responding to reasonable client inquiries, in a timely and thorough manner." One must also be diligent in supervising the people under the certificant's authority.
Competence (The CFP Board Code of Ethics and Standards of Conduct)
According to the CFP Board, Competence means "with relevant knowledge and the skill to apply the knowledge." If someone is not competent to provide a particular service, they must gain competency, get the assistance of someone who is competent, or not provide that particular service. For CFP Board designees and professionals in other fields, a minimum level of competence is required to earn a designation or license; increasing competence through continuing education is required to maintain one's credentials. A member of the CFA Institute is obliged to "Maintain and improve their professional competence and strive to maintain and improve the competence of other investment professionals."
Advertising regulation/investment companies (task of FINRA)
Another FINRA task is evaluating securities' advertising and communications of members to assure that they are fair, accurate, and not misleading. These include advertisements for mutual funds and variable annuities in newspapers, magazines, electronic media, and other sales literature such as direct marketing materials.
Duty to Keep Current (fiduciary)
Because tax laws, product offerings, and the fortunes of individual securities issuers—and, indeed, entire industries—change over time, anyone operating as a professional in the financial services industry has an ethical obligation to keep current with those developments that affect their clients. Recognizing the importance of keeping current, the securities industry has a program consisting of a "firm element," which requires broker-dealers to establish a formal training program to keep registered representatives (brokers) up to date on job- and product-related subjects. Broker-dealers must have a written training plan based on an annual needs analysis, and must maintain records documenting the content and completion of the program. Many professional organizations, such as the CFP Board and the American Institute of Certified Public Accountants (AICPA), require regular and ongoing training and professional development as a condition of continued membership or certification. Many large financial services firms have training departments that offer periodic training in special product areas, new tax laws, retirement planning, and so forth. Individuals who plan to maintain a career in the securities or retirement plan industry should avail themselves of this added training. Individuals who hold themselves out to the public as professionals in a specific field have the duty to keep reasonably abreast of current practice and information in that field.
Form CRS
Customer/Client Relationship Summary
In order to comply with Regulation BI's general obligation best interest rule, what are the four key obligations that broker-dealers must follow?
Disclosure: Under the disclosure obligation, broker-dealers before or at the time of making a recommendation to a retail customer must provide "full and adequate" disclosure of all material facts concerning its relationship with the customer. The broker-dealer can make supplemental disclosures that are oral, but they must be documented so that there is a record of any oral disclosures that have been made. Reasonable Care: In order for a broker to fulfill the care obligation, they must exercise "reasonable diligence, care, and skill" in recommending any single transaction or series of transactions. As we will see in the next section covering the fiduciary standard, under the duty of care in fiduciary law, "prudence," which is characterized in the "prudent man rule," is also an obligation under the fiduciary duty of care; however, Regulation BI does not mention nor require prudence. Generally, the new care obligation under Regulation BI aligns to the existing FINRA Suitability framework, and broker-dealers should be able to continue using their existing systems and processes after some adjustments are made for the new rules. Conflict of Interest: Under this obligation, a broker-dealer must establish and enforce written policies and procedures that identify and address conflicts of interest, either by disclosing them or eliminating them. Compliance:The fourth and final Regulation BI obligation is that broker-dealers must "establish, maintain, and enforce policies and procedures 'reasonably' designed to achieve compliance with Regulation Best Interest as a whole." The SEC recommends policies and procedures that include controls, remediation of non-compliance, training, and periodic review and testing. It is important to note that Regulation BI applies only to broker-dealers, and not to RIAs
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Dodd-Frank was the direct result of the Great Recession of 2008-2009. There was great concern that the global financial system had almost come to a halt, and there was a need to address systemic risk within the financial system. Dodd-Frank addressed the issue of "too big to fail" and required that banks meet certain capital requirements and go through stress tests to make sure they would be able to survive an unexpected shock to the financial system. Dodd-Frank also regulates derivatives. It has shifted derivatives trading from the over-the-counter (OTC) market to central clearing counterparties (CCPs) that facilitate the netting of swap contracts in order to reduce systematic risk. There are also investor protections in the bill, and the Consumer Financial Protection Board (CFPB) was established. Dodd-Frank also directed the SEC to look into a fiduciary standard that would apply to both investment advisers and broker-dealers. Finally, Dodd-Frank directed the SEC to look into a uniform fiduciary standard for both advisers and brokers, and the recommended rule proposals released in April 2018 continue to recommend that there be two standards—a suitability standard for brokers and a fiduciary standard for investment advisers.
Employee Retirement Income Security Act of 1974 (ERISA)
ERISA was enacted to stem company retirement plan abuses and to make sure that employees were protected and that they would be paid any promised benefits. ERISA set standards for participation, vesting, funding, reporting, and disclosure, and it also established the Pension Benefit Guaranty Corporation (PBGC). ERISA requires that anyone giving investment advice to a company retirement plan must be a fiduciary.
Enforcement (task of FINRA)
FINRA has the authority to discipline securities firms and individuals in the securities industry who violate its rules, federal securities laws, and rules enacted by the Municipal Securities Rulemaking Board. Disciplinary actions include fines, suspensions, or expelling members from the industry.
Dispute Resolution (task of FINRA)
FINRA operates the largest dispute resolution forum in the world and handles about 90% of the securities arbitrations and mediations in the United States. It recruits, trains, and manages impartial professional staff and mediators, arbitrators, and other neutrals committed to delivering fair, expeditious, and effective dispute resolution services for investors, brokerage firms, and their employees. Mediation is an informal, voluntary, and nonbinding approach to dispute resolution in which the mediator tries to guide the parties to resolve the dispute rather than having the mediator impose their solution. In arbitration, an impartial person or panel hears the issues as presented by both parties, studies the evidence, and then decides how the issues should be resolved. Arbitration is final and binding, subject to review by a court only on a very limited basis. Unfortunately, up to 30% of monetary awards to investors in arbitration claims go unpaid.
Member Regulation (task of FINRA)
FINRA performs periodic and cause-based examinations of member firms. It also oversees the financial and operational responsibilities of member firms, such as margin issues, operations, and clearing responsibilities. Through its "FINRA BrokerCheck," FINRA helps investors to access members' qualifications, employment, and disciplinary histories. It administers a continuing education program containing two elements: (1) a regulatory element that requires registered individuals to pass mandatory examinations, administered by FINRA, covering both rules and regulations and investment products; and (2) an element that requires broker-dealers to establish a formal training program for employees, through which those employees stay current on subjects relating to their jobs and the products they offer. It also directs and administers preventive compliance initiatives.
Market Regulation (task of FINRA)
FINRA regulates, oversees, and monitors all trading on the NASDAQ Stock Market, NYSE American, International Securities Exchange, Chicago Climate Exchange, over-the-counter markets, and corporate bond markets. To do this, it has regulatory programs and established specialized units focused on determining compliance with specific FINRA rules covering areas such as insider trading, best execution of trades, and money laundering, as well as regulations and federal securities laws. It also conducts on-site inspections of the largest market-making and trading firms in the United States to assess compliance with market-making and trading rules, regulations, and federal securities laws.
What makes the suitability standard?
General approach: Product-driven, Primarily rules-based Adviser disclosure: Verbal Legal: Arbitration Benchmark: Suitable recommendation based on risk profile, age, objectives, and time horizon Major categories: Registered reps, agents Regulators: FINRA/states
What makes the fiduciary standard?
General approach: Solution-driven, Primarily principle-based Adviser disclosure: Written Legal: Public courts Benchmark: Align recommendations with the best interests of the client, taking into account all relevant factors Major categories: RIAs, trustees, and individuals advising ERISA plans if five-part test is met Regulators: SEC/states/DOL
Integrity (The CFP Board Code of Ethics and Standards of Conduct)
Integrity "demands honesty and candor which may not be subordinated to personal gain or advantage" and "cannot co-exist with deceit or subordination of principle." (CFP Board). Integrity includes not only observing the letter of the law, but also the spirit of the law. Any investment professional who offers advice must possess integrity and use it as the ultimate arbiter of right and wrong behavior with respect to clients. Misrepresentations as to one's own capabilities or experience, or the potential of certain investments, would be violations of personal integrity. The CFA Institute likewise emphasizes the importance of integrity in its Code of Ethics by requiring its members to "act with integrity, competence, diligence, respect, and in an ethical manner when dealing with the public, clients, prospective clients, employers, employees, colleagues in the investment profession, and other participants in the global capital markets." It continues by stating that members must "place the integrity of the investment profession and the interests of clients above their own personal interests."
What are the main principals of The CFP Board Code of Ethics and Standards of Conduct?
Integrity, Objectivity, Competence, Confidentiality, Professionalism, Diligence
Duty to Consult (fiduciary)
Making a recommendation on the strength of one's "recollections" about the differences between these two fairly complex arrangements is clearly a violation of two related ethical duties: (1) the duty to diagnose the technical features and requirements of the recommendation (in this case, different retirement plans and their relative suitability to this investor) and (2) the duty to consult with others who have specialized knowledge of the issue (in this case, retirement plans). All major securities and financial firms provide a period of initial training for new investment professionals. They also maintain departments dedicated to specialized investment products: mutual funds, insurance, tax-advantaged investments, retirement plans, and so forth. The broad scope of an investment professional's initial training is often structured to cover just the basics in each of these areas, with the clear implication that specialists in these departments are to be consulted when discussions with clients get beyond the basics. If an investment professional has any doubts concerning an issue that goes beyond their personal competence, an expert in that area should be consulted. Because providing clients with comprehensive financial advice covers so many specialized areas such as retirement planning, tax planning, and estate planning, no one individual has the professional expertise to be fully competent in more than just a few areas. The failure to consult specialists when needed could be deemed a breach of ethical duties to the client and, in some cases, can be the basis of a liability case brought against the investment professional and the firm.
What are some of the important tasks of FINRA?
Market regulation, Member regulation, Enforcement, Dispute resolution, Advertising regulation/investment companies
What were some of the key concepts and requirements of the fiduciary standard proposed by the Department of Labor?
One key concept was that the new rules would have applied to anyone giving advice to a retirement investor about his or her retirement plan. If an adviser was giving advice to a retirement investor about his or her retirement account, including an IRA, then the adviser would have been considered a fiduciary and required to look out for the best interest of the client. Another major change would have been clients no longer being forced to waive 100% of their legal rights and accept mandatory arbitration.
What are some of the major findings in the RAND study commissioned by the SEC?
RAND contacted households and held focus groups to find out if investors understood the differences between broker-dealers and advisers. Both financial professionals and investors found the landscape to be complex and confusing. Many were unaware that broker-dealers and advisers were held to different standards, and there was a lot of confusion over credentials and job titles. The SEC in 2018 proposed that there be limitations on the use of the terms "advisor" or "adviser."
Registered investment adviser (RIA) fiduciary standard
RIAs are held to a fiduciary standard. This standard has been developed by case law since the landmark Supreme Court case ruling of SEC v. Capital Gains Research Bureau in 1963. This ruling found that Section 206 of the Advisers Act imposed a fiduciary duty on all RIAs. Under this standard, RIAs must act in the best interests of their clients. Disclosure of such things as compensation and conflicts of interest must be made in writing, and a contract is required. RIAs must abide by the brochure rule, which requires providing every client and potential client with a copy of the firm's Form ADV Part 2. Since 2010 there has been a requirement that Form ADV Part 2 be in a "plain English" narrative form, enabling clients to better understand what is being disclosed rather than being buried in legal jargon. A fiduciary must not only provide disclosure, but should also make sure that the client understands what is being disclosed. The heightened responsibility and expectations of being held to a fiduciary standard will mean that potential liability is higher than if one is just held to a suitability standard.
The Investment Advisers Act of 1940
The Investment Advisers Act of 1940 wrote into law the fiduciary duty owed by investment advisers to their clients. This act requires investment advisers to register with the SEC by filing Form ADV. It also contains certain prohibitions regarding advertising practices and certain requirements for disclosure. Currently, investment advisers with over $100 million AUM register with the SEC, and all other investment advisers register at the state level.
The Investment Company Act of 1940
The Investment Company Act of 1940 subjects both the structure and the operations of mutual funds to detailed regulation. Mutual funds belong to a class of investment companies defined in the 1940 act as "management companies," which are further classified as either diversified or nondiversified. The act also requires mutual funds to maintain detailed books and records on the securities owned, to use a custodian to safeguard the securities, and to send semiannual and annual reports to both the SEC and shareholders. The act also requires that proceeds from redeemed shares be sent to shareholders within seven days of the redemption.
The RAND Study
The SEC commissioned RAND Corporation to do a study to better understand the current financial landscape. RAND contacted households and held focus groups to find out if investors understood the differences between broker-dealers and advisers, and found the landscape to be complex and confusing to both financial professionals and investors. Quoting RAND's Research Brief: Given such complexity, it is not surprising that typical investors are confused about the nature of the services offered by their financial professionals. Many of those surveyed, as well as focus group participants, did not understand the key distinctions between investment advisers and broker-dealers: their duties, the titles they use, the services they offer, or the fees they charge. They attributed part of their confusion to the dozens of titles used in the field, including generic titles such as financial adviser and financial consultant, as well as advertisements that claim "We do it all."
Duty to Disclose (fiduciary)
The duty to disclose all material facts and all conflicts of interest is dealt with extensively in government regulation and professional codes of conduct. For example, full disclosure on new issues is a requirement of the Securities Act of 1933—any company wanting to sell stock publicly must disclose its financials and any potential risks. The investment professional also is ethically bound to disclose any negative or risk factors involving investments being offered to participants in a 401(k) plan. For instance, emphasizing to an inexperienced investor the fact that interest and principal repayment on 30-year Treasuries is "backed by the full faith and credit of the U.S. government"—while failing to explain how the market value of these same securities fluctuates with changes in market interest rates—represents just such a failure to disclose. Disclosure is an important fiduciary duty, but disclosure in and of itself will not necessarily meet the fiduciary standard. The client's best interests must still come first. For example, if a client purchases an investment that pays a generous commission and ongoing fee to the adviser, the fact that the adviser disclosed the fee conflict in and of itself doesn't take the adviser off the hook. If there was another investment that essentially did the same thing but had much lower fees, then a fiduciary would recommend that alternative investment since it would be in the client's best interest to pay less and keep more returns .In addition, SEC Rule 10b-5, relating to the Securities Exchange Act of 1934, makes it unlawful to provide false or misleading statements in connection with the purchase or sale of a security.
suitability rule
The investment professional must have reasonable grounds for believing that a particular investment recommendation is suitable for the client in question on the basis of the client's overall financial situation, tax status, risk threshold, and investment objective
duty of loyalty (fiduciary)
The obligation to look first to the client's best interest is the fundamental duty owed to the client. It is sometimes called the "duty of loyalty" and requires that the client's interests be put ahead of one's own, and that all actions be made solely for the benefit of the client. In cases where the interests of the firm, the investment professional, and the client compete, fiduciary duty requires that the client's interest must come first. To say of certain transactions that "The firm made money, I made money, and two out of three ain't bad" is antithetical to the requirement of fiduciary care. Clear examples of individuals who must uphold the fiduciary duty to the customer include the pension manager, the investment manager, the custodian of a child's account, and the trustee of a college endowment. These persons are clearly in fiduciary positions in that they normally have discretion to act on behalf of another. The investment professional with discretion in an account is likewise in a fiduciary position. Under ERISA there can be various parties held to the fiduciary duty, including the company itself, the plan administrator, and the investment manager. Conflicts of interest must be recognized by all parties and should be mitigated as much as possible to make sure that the client's best interests always come first.
Duty to Diagnose (fiduciary)
The obligations to "know your customer" and to investigate the suitability of any products recommended as investments are complementary and fall within the ethical duty to diagnose. This ethical duty is supported by formal requirements. For example, the New York Stock Exchange (NYSE) stresses the importance of learning all the essential facts about a client and that client's account. The FINRA suitability rule requires a broker-dealer to have reasonable grounds for believing that a recommended investment is suitable for the particular client—suitable, that is, in terms of the client's other security holdings, financial situation, and needs. When an investment professional makes any recommendation—investment or otherwise—to a client, they do so in light of the current economic environment and the client's risk tolerance, financial circumstances, existing portfolio of assets, and stated goals. It is important to gather and analyze client information, and strive to learn all relevant facts in order to make suitable recommendations that are in the best interest of the client. As the investment professional prepares, implements, periodically reviews, and revises a client's investment plan and portfolio, they must be aware of any changes in the client's financial and/or tax situation, and in the larger economic environment.
Securities and Exchange Commission (SEC)
The primary federal regulatory authority is the SEC. Created by the Securities and Exchange Act of 1934, the SEC's mission is to protect investors and maintain integrity in the securities markets. As such, the commission requires public companies to disclose material information to the public so investors have a common source of information and therefore can decide for themselves if they want to invest in those companies. The SEC also oversees key participants in the securities world, including stock exchanges, broker-dealers, investment advisers, mutual funds, and public utility holding companies. Regarding investment advisers, those advisers managing clients' assets of $100 million or more (per the Dodd-Frank Act) register with the SEC (those with less than $100 million register with the state in which they conduct business), and the SEC requires investment adviser records, including electronic mail, be maintained for five years. The SEC interprets federal securities laws, amends existing rules, proposes new rules, and has enforcement authority against individuals and companies that violate securities laws.
The Fiduciary Duty
The word "fiduciary" comes from the Latin "fiducia," which means "trust." A fiduciary relationship exists whenever one person trusts in or relies upon another. More specifically, a fiduciary relationship arises whenever "confidence is reposed on one side, and domination and influence result on the other." In the case of fiduciary relationships involving investment advisers and clients, the U.S. Supreme Court has described the adviser's duty as "an affirmative duty of utmost good faith, and full and fair disclosure of all material facts"
The Securities Act of 1933
This act applies to most new, publicly issued securities. Its purpose is to require the "registration" of securities with the Securities and Exchange Commission (SEC) by providing full disclosure in the registration statement of the securities that the issuer or vendor was about to issue. If the SEC finds misleading, incomplete, or inaccurate information, it will delay the offering until the registration statement is corrected. All new issues must be accompanied by a prospectus All new issues must be accompanied by a prospectus, a detailed summary of the registration statement. The prospectus usually contains a list of directors and offices, their stockholdings, stock options, and salaries. It also includes a description of the company's properties and business, a description of the securities being offered for sale, and financial statements certified by independent accountants. In addition, it lists the underwriters, the purpose and use of the funds to be received from the offering, and any other reasonable information investors need before buying the securities. It also includes a general antifraud provision that prohibits deceit, misrepresentation, and other fraud in the sales of securities. Providing false or misleading information or failure to disclose all material facts relevant to an investment results in the violation of the act, for which officers of the company and other experts preparing the registration statement or prospectus can be sued. While this information is required to be accurate, the SEC does not guarantee its accuracy. Not all issues require registration.
Securities Acts Amendments of 1975 and May Day
This act directed the SEC to supervise the development of a national securities market. The assumption behind this act was that any national market would extensively use computers and electronic communications. It also prohibited fixed commissions on public transactions, which fosters greater competition and more efficient prices. May Day is the name given the to the day in 1975 when commission rates were no longer set by the NYSE and firms were free to set their own commission rates.
The Securities Investor Protection Act of 1970
This act established the Securities Investor Protection Corporation (SIPC) to oversee the liquidation of brokerage firms and to insure investors' accounts up to a maximum value of $500,000 (of which only up to $250,000 can be cash balances) in the case of bankruptcy of a brokerage firm. This corporation was set up in response to the problems encountered by brokerage firms in the late 1960s, when high volume caused a back-office paper crunch leading to bankruptcies and subsequent investor losses. While the SIPC insures brokerage accounts, it does not cover market losses suffered while waiting to get securities from a bankrupt brokerage firm. It also does not cover losses due to investment fraud and should not be thought of as the securities world equivalent of the Federal Deposit Insurance Corporation. The cost of this insurance is paid by members of SIPC. All brokers and dealers that are registered with the SEC and all members of national securities exchanges must be members of SIPC.
Gramm-Leach-Bliley Act of 1999 and Commodity Futures Modernization Act of 2000
This act is also known as the Financial Services Modernization Act, and it dealt with ways that financial institutions handle the private information of individuals. It is best known for repealing part of the Glass-Steagall Act of 1933, which prohibited financial institutions from consolidating and offering any combination of traditional commercial banking, investment banking (brokerage firms), and insurance. Some believe that this ultimately helped to contribute to the subprime mortgage meltdown and market financial crisis in 2008.
The USA Patriot Act of 2001
This act requires broker-dealers, among others, to have internal policies, procedures, and controls meet the "know your customer" mandate to combat terrorism and money laundering. Broker-dealers, in turn, may well ask their investment advisers to provide more detailed information about their clients. Advisers should look for red flags such as transactions that do not make sense for a client, numerous accounts held in different names or corporations for no apparent reason, and clients' lack of concern about investment objectives, risks, and investment costs. The adviser's requirements in complying with the act are still evolving, but the adviser should be aware of this act and its possible implications, including having formal policies in place to fight money laundering.
The Sarbanes-Oxley Act of 2002
This act set up the Public Company Accounting Oversight Board, which consists of five financially literate members, two of whom must be or have been certified public accountants. The board is to establish, or adopt, by rule, "auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers." It also must conduct inspections of accounting firms, conduct investigations and disciplinary proceedings, and impose appropriate sanctions. It requires a company's chief executive officer and chief financial officer each to certify the financial and other information contained in the issuer's quarterly and annual reports. The rules also require these officers to certify that they are responsible for establishing, maintaining, and regularly evaluating the effectiveness of the issuer's quarterly and annual reports about their evaluation and whether there have been significant changes in the issuer's internal controls or in other factors that could significantly affect internal controls subsequent to the evaluation. This law also makes it generally unlawful to extend credit to any director or executive officer. This act has precipitated the employment of chief compliance officers.
The Securities Exchange Act of 1934
This act, which established the Securities and Exchange Commission and gave it enforcement powers for this act, aimed to regulate securities transactions on both organized exchanges and in over-the-counter markets. This act forbids market manipulation, deception, misrepresentation of facts, and fraudulent practices. It requires most broker-dealers and transfer agents, clearing agencies, and self-regulatory organizations (including securities exchanges) to register with the SEC. In this way, the SEC supervises and regulates many aspects of exchanges. It also requires many issuers of securities to provide ongoing information about their business affairs by filing quarterly financial statements with the SEC, sending annual reports to shareholders, and filing 10-K reports (which have more financial information that the annual reports), with the SEC annually. Further, it made subject to law the trading activities of corporate directors and officers ("insiders"), who were viewed as principal villains in the market debacle of 1929. In the last two decades, the SEC has widened the interpretation of an insider to include anyone having information that was not public knowledge. This act also gave the Federal Reserve Board of Governors responsibility for setting margin requirements when buying securities.
Confidentiality (The CFP Board Code of Ethics and Standards of Conduct)
Two account representatives from the same firm were changing in the men's locker room of a popular downtown health club. One described the profitable morning he just had: the sale of a private placement partnership interest in a local shopping mall to a well-known figure in the business community. The next morning, the manager of the two investment professionals called them into his office. "One of my clients—a longtime friend of this firm—called to tell me that he and several others had overheard one of you publicly bragging at the health club about selling a partnership deal to his friend, Mr. Fred Wainwright!" The errant investment professional had grossly violated the obligation of confidentiality he owed his customer—once by bragging to his colleague and again by doing so in public. As all experienced investment professionals know, many people are more guarded in discussing their financial situation than in discussing their personal affairs. The unauthorized sharing of information with regard to their financial situation, experience, or objectives would represent, in their view, a betrayal of trust. Maintaining confidentiality is a key factor in building trust between the client and the certificant. To emphasize the importance of confidentiality, the CFP Board may take disciplinary action against a CFP certificant for breach of confidence with a client even in those cases in which no harm to the client occurs. Also, maintaining confidentiality means ensuring that any client information is closely protected. This includes proper security of stored information and the destruction of discarded information.
What are the two main choices that the SEC wants to maintain for customers under Regulation Best Interest?
Under Regulation BI, it is clear that the SEC wants to maintain two choices in the marketplace: a sales-based and an advice-based approach. Regulation Best Interest is an extension of the suitability standard that is already in place, and does not mention or cross the line into fiduciary advice.
What are the duties of fiduciary that an adviser must follow?
duty of loyalty duty of care duty to disclose duty to diagnose duty to consult duty to keep current
NYSE Rule 405
spells out the supervision and approval requirements for all new accounts, which is a function of management. But the obligation "to use due diligence to learn the essential facts" about each and every new customer (i.e., to "know your customer") is at the heart of industry self-regulation with respect to the activities of investment professionals. The "essential facts" here relate to the client's investment experience, net worth, other assets, income, investment objectives, and anything else that may have a bearing on the relationship between the investment professional, the firm, and the client.
