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Who is a Fiduciary? Why it Matters and Tips for Financial Services Compliance and Risk Management

Change and uncertainty. These are two words that sum up the challenges facing the financial services industry. In recent years, the Securities and Exchange Commission (SEC), Department of Labor (DOL), and Financial Industry Regulatory Authority (FINRA) have focused on sweeping changes to the duties owed to clients, fee structures, potential conflicts of interest, and protecting senior investors, among other things. Companies and individuals in the financial services industry are constantly trying to keep up with new rules and regulations, potential changes to their business model, and a moving target when it comes to investigations and enforcement actions. In this article, we will discuss the most significant changes and why they matter. 

The Fiduciary Standard – Why it Matters


Historically, two primary models have been used to provide investment advice to individuals. The first model involved individuals working with a “broker,” referred to as a registered representative of a securities broker-dealer. Under this model, the broker makes a recommendation to a client (typically a recommendation to purchase a security of a fund) and the broker earns a commission for each securities transaction. This is a transaction-based model where the broker owes the client a duty of care to ensure the recommendation is “suitable.” The broker does not owe the client a “fiduciary duty” and the broker does not have any obligation to monitor the client’s brokerage account or offer ongoing advice to the client. The investment professional (and the associated broker-dealer) in this model is regulated by FINRA. The second model is slightly different. An individual who works with an “advisor[1],” referred to as an Investment Advisor (IA), receives investment advice (as opposed to securities transactions) through a Registered Investment Advisor (RIA) firm. Under this model, the advisor provides advice about how to “manage” a client’s overall investment portfolio and earns a percentage fee based on the size of the assets under his or her management (“AUM”). For example, an advisor could charge a 1% advisory fee on a $1,000,000 portfolio and earn a $10,000 fee each year for managing the portfolio. This relationship imposed a fiduciary duty on the advisor and required the advisor to provide ongoing advice. Advisors and RIA firms providing services under this model are regulated by the SEC (over $100M of AUM) or state securities regulators (under $100M of AUM).

In 2010, the Dodd-Frank Act directed the SEC to study and evaluate the effectiveness of the existing legal and regulatory standards of care applied to broker-dealers and investment advisers. In 2011, the Staff of the SEC submitted to Congress a detailed report, recommending a new uniform fiduciary standard of conduct for both broker-dealers and investment advisers when providing personalized investment advice to retail investors. After studying the existing legal and regulatory scheme, the Staff of the SEC concluded that customers do not understand the different standards of care and expect that an investment professional would always act in their best interest—regardless of whether the financial professional is a broker or an advisor. Consequently, the Staff of the SEC determined it appropriate to hold broker-dealers and investment advisers to the same standard when providing personalized investment advice to retail customers. In other words, the Staff recommended a uniform fiduciary standard of care.

As a result of the SEC’s delay in developing a rule that would impose a uniform fiduciary standard on brokers and advisors, President Obama, during the following February 23, 2015 address to the AARP, called on the DOL to update its rules that require retirement advisors to act in the best interest of their clients:

“Today, I’m calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests. It's a very simple principle: You want to give financial advice, you've got to put your client's interests first.”[2]

In response, on April 6, 2016, the DOL released its “Fiduciary Rule”, which imposes a “fiduciary duty” on individuals who provide advice to defined-contribution plans (401(k) plans, 403(b) plans, ESOPs, SEP plans), defined-benefit plans (pensions), and Individual Retirement Accounts (IRAs). The scope of the DOL rule was seen as a significant expansion of the then-existing definition of what would be considered “investment advice” and who would be potentially considered fiduciaries subject to the DOL’s rules and regulations.[3] After various delays and millions of dollars spent by the industry in an effort to comply, the rule was eventually struck down by the Fifth Circuit Court of Appeals on March 15, 2018.

As a consequence of the DOL rule being struck down, the SEC decided to act. On April 18, 2018, the SEC proposed “Regulation Best Interest,” consisting of two proposed rules and an interpretation, in order “to address retail investor confusion about the relationships that they have with investment professionals and the harm that may result from that confusion.” (SEC Press Release 2018-68)[4] The new rules would require broker-dealers to act in retail customer’s best interest when recommending any security or investment strategy. At their core, the proposed rules are designed to “enhance investor protection” by applying consistent principals to both investment advisers and broker-dealers and requiring that investment professionals, regardless of name “provide clear disclosures, exercise due care, and address conflicts of interest.”[5]  The rule explains that people must “act in the best interest of the retail customer at the time a recommendation is made without placing the financial or other interest of the broker-dealer or natural person who is an associated person making the recommendation ahead of the interest of the retail customer.” (SEC Release No. 34-83062)[6] Additionally, the proposed rule seeks to clarify the obligations owed by investments advisers. To promote clarity, the Regulation Best Interest proposes the use of a new disclosure document, a customer/client relationship summary (“CRS”), outlining, in clear terms, the nature of the relationship between the investment professional and customer.

Under this new Regulation Best Interest, the first rule addresses a broker-dealer’s obligations. In this regard, a broker-dealer satisfies its duty to retail customers by complying with three obligations: (1) Disclosure Obligation—disclose key facts about relationship, including material conflicts of interest; (2) Care Obligation—exercise reasonable diligence, care, skill and prudence to understand the product, have reasonable basis to belief what is in a client’s best interest; and (3) Conflict of Interest Obligation—establishment, maintenance, and enforcement of policies and procedures designed to at identify, disclose, and eliminate, or at least mitigate, material conflicts of interest, including those arising from financial incentives. The second rule, relating to the CRS, requires the provision of a standardized, short-form (maximum four pages) disclosure highlighting differences between services offered, applicable standards, fees, and any conflicts of interest. As part of this CRS, the proposed rule would restrict broker-dealers and associated persons from using the terms “adviser” or “advisor” as part of the name or title in their interactions with retail customers. Finally, the rule interpretation reaffirms that investment advisers owe a fiduciary duty to their clients. When comparing Regulation Best Interest (which again would apply to brokers) to an investment adviser’s fiduciary obligation, there are two major differences: (1) advisers, not broker-dealers, have an ongoing obligation to monitor a retail customer’s account; and (2) while advisers must disclose conflicts of interest, a broker-dealer must mitigate or eliminate any material conflicts of interest.

Impact on Litigation/Arbitration

The impact on litigation and increased regulatory risk from the move toward a more universal fiduciary standard is playing out right before us. From the litigation perspective, a breach of fiduciary duty claim has consistently been the most asserted claim in FINRA arbitration actions, dating back to 2012 and well-before the DOL and SEC Regulation Best Interest.[7] These claims were often asserted under state law (either statutory or common law) or simply asserted without any legal justification. With the industry’s attempt to get ahead of the regulatory rule-making process, many firms have simply adopted a fiduciary standard themselves, proclaimed on their website and in their marketing materials that they “put a client’s interest first”, and/or changed their business model to better address the disclosure of potential conflicts of interest. These changes and narratives will create additional ammunition for plaintiff’s attorneys pursuing claims in litigation or arbitration and, presumably, claims for breach of fiduciary duty will likely be on the rise.

Regulators have also been aggressive in their approach to a firm’s handling of conflicts of interest. A primary example is the SEC’s recent focus on 12b-1 fees. On February 12, 2018, the SEC announced that the Division of Enforcement would agree not to recommend financial penalties against investment advisers who self-report violations of the federal securities laws relating to certain mutual fund share class selection issues and promptly return money to harmed clients.[8] Under Section 206 of the Investment Advisers Act of 1940, investment advisers are required to act in their clients’ best interests, including an affirmative duty to disclose all conflicts of interest. A conflict of interest arises when an adviser receives compensation (either directly or indirectly through an affiliated broker-dealer) for selecting a more expensive mutual fund share class for a client when a less expensive share class for the same fund is available and appropriate. That conflict of interest must be disclosed.[9] Under the SEC’s program, the Enforcement Division will recommend standardized, favorable settlement terms to investment advisers who self-report that they failed to disclose conflicts of interest associated with the receipt of 12b-1 fees by the adviser, its affiliates, or its supervised persons for recommending to advisory clients in a 12b-1 fee-paying share class when a lower-cost share class of the same mutual fund was available for the advisory clients. For people who do not self-report, the Division warns that it expects to recommend stronger sanctions in any future actions against investment advisers that engaged in the misconduct but failed to take advantage of this initiative.[10] In addition to the self-reporting initiative, the SEC has taken an aggressive approach in its examination of firms and its expectation that firms would assess all available options for the lowest cost fund available.

The push toward a more uniform fiduciary duty demonstrates the importance of clients understanding and addressing:

  1. Policies and Procedures – firms should revisit their policies and procedures they have in place, reduce or disclose conflicts of interest, and ensure best execution of trades.
  2. Marketing/Sales Literature – firms should balance the language it wants to use for sales and marketing purposes with the understanding that this language could be used against the firm at trial or arbitration.
  3. Fee Structure – firms should increase their awareness around point of sale analysis of share classes and fees.[11]
  4. Exception Reporting – firms should review their exception reporting to determine if additional measures can be integrated in the firm’s processes to identify potential problems.

Attorneys handling litigation involving breach of fiduciary duty claims should be acutely aware of the recent push toward the uniform fiduciary duty, as well as regulators increased scrutiny on firms to disclose or reduce conflicts, especially those dealing with compensation and fees. 

Compliance and Risk Management: Tips Related to Annual Examination Priorities

No financial advisor wants to land in hot water with the SEC or state regulators. Advisors can get clues about regulators’ top concerns by looking at the SEC’s examination priorities for the coming year, which are published in January of each year by the SEC’s Office of Compliance Inspections and Examination (OCIE). As in past years, the 2018 examination priorities identified areas where there is increased risk of potential harm to investors, in particular, to seniors and retirement savers. Since January, OCIE has been targeting these risk areas during its examinations of SEC-registered investment advisors.

This paper provides an overview of the potential regulatory implications of OCIE’s examination priorities on an RIA firm. Depending on the amount of its regulatory assets under management, an RIA firm is regulated either by the SEC, or in general, any state where the firm has six or more clients. While this paper refers to the findings of the SEC in relation to SEC-registered firms, the findings are in most cases applicable to state-registered firms as well.  State-registered RIA firms should invest the time to know their state’s regulations, which may impose additional requirements on the firm.

Insufficient Policies and Procedures

Following its analysis of OCIE’s examination results of RIA firms during the period 2015 to 2017, the SEC determined that its most frequently cited violations of federal securities laws and regulations were for insufficient compliance policies and procedures, incomplete/untimely regulatory filings, misinterpretation of the custody rule, insufficient Code of Ethics, and books and records errors. Such compliance failures are often attributable to inadequate policies and procedures.

For example, the SEC found the following shortcomings in firms’ policies and procedures:

  • Firms purchasing “off-the-shelf” template policies and procedures, and not taking the time to tailor them to reflect the firm’s actual investment strategies (or failing to update changes to the firm’s investment strategies), types of clients, fees, and other aspects of the firm’s business
  • Firms not complying with the SEC requirement to conduct an annual review of the firm’s policies and procedures, or conducting an annual review but not assessing the adequacy and effectiveness of the policies and procedures, or not correcting problems identified during the annual review
  • Firms having policies and procedures that, while accurately reflecting the firm’s business, are not followed by the advisors who work for the firm, most often with respect to the policies and procedures that pertain to a firm’s marketing, its expenses, and its employees’ conduct


With respect to the custody rule, it is easy to understand how firms may be confused when completing Form ADV, especially if they’re exposed to information about both SEC and State registration requirements. Withdrawal of advisory fees from a client’s account is treated differently by the SEC than by state regulators. For example, the SEC has provided guidance that an SEC-registered firm that withdraws its advisory fee from a client’s account, and does not otherwise have custody of a client’s assets, may respond “no” to the question on Form ADV asking whether the firm has custody of its clients’ assets. A State-registered RIA firm, on the other hand, may be required to respond “yes” to this same question depending on that State’s regulatory requirements regarding custody.  However, a “yes” response to this question by State-registered RIA firms should not require (again, depending on that State’s regulatory requirements) the firm to undergo the requirement of a surprise exam conducted by an independent public accounting firm in instances where the firm actually maintains custody of its clients’ assets.

Code of Ethics, Books and Records

As for Code of Ethics, common mistakes include a firm not identifying as an “access person” an employee, partner, or director who has access to client accounts, and failing to include the Code of Ethics in Part 2A of Form ADV, or not stating in the ADV that the Code of Ethics is available upon request. Common errors in books and records are attributable to insufficient, inaccurate, and/or inconsistent information, such as the omission of one or more of the firm’s advisory agreements, outdated fee schedules and client lists, or contradictory information relating to a firm’s business model as described on the firm’s website, in its advertisements, and in its disclosures.

More Concerns

In addition to the common compliance failures mentioned above, the SEC announced that it will continue to pay attention in 2018 to the following areas:

  • Risks to retail investors. Here, the SEC is paying close attention to the increasingly popular electronic investment advice platforms, i.e., robo-advice, offered by many firms.
  • Risks to retirement accounts of public employees and the conflicts of interest sometimes associated with these accounts, such as pay-to-play, undisclosed gifts, and entertainment practices. Related to this is the SEC’s focus on senior investors, who historically have been particularly susceptible to manipulation and fraud. To prevent such abuses, the SEC has been examining services that are directed at seniors and assessing whether the firm has implemented processes to prevent the financial exploitation of seniors.
  • Market-wide risks. The SEC has a mandate to not only protect investors but to protect the fair, orderly, and efficient operation of the markets. Here, the SEC is interested in reviewing a firm’s policies and procedures that are intended to prevent a cyber-attack and, if the firm were to become the victim of a cyber-attack, how the firm would respond.
  • Share class recommendation. The SEC has stated publicly that an advisory firm fails to uphold its fiduciary duty when it causes a client to purchase a more expensive share class of a fund when a less expensive share class is available. Here, the SEC has been focusing on policies and procedures regarding the mutual fund share class selection process, the due diligence conducted by the advisor before recommending a share class, and the firm’s compliance oversight of share class recommendations.

Firms should take advantage of the SEC’s stated examination priorities to conduct an ongoing review of their compliance programs to identify deficiencies and gaps, then revise its policies and procedures to address the deficiencies and gaps before the firm undergoes a regulatory examination. Firms would also benefit from taking any client complaint seriously and doing everything within reason to prevent a client who files a complaint with the firm from escalating that complaint to the SEC or a state securities regulator.

Why it Matters

Recent changes to the regulatory landscape have created uncertainty in the financial services industry, in particular with respect to the standard of care that a financial services professional owes to a client when conducting brokerage transactions versus providing investment advice. The continued push toward a fiduciary duty and investor protection is an inevitable upward trajectory—in rule-making, regulatory enforcement, and litigation—and should be an important reminder to financial services professionals, and the firms that employ them, to always consider how investors will either benefit from, or be harmed by, their actions.

For additional information about how these rules and regulations may impact your firm’s operations, contact Michael P. Shaw, Partner in the Corporate Department of Niles, Barton & Wilmer, LLP with over 25 years of experience as an in-house corporate and regulatory attorney in the securities and insurance industries. He serves the legal, compliance and enforcement defense needs of registered investment advisers, broker-dealers, hedge funds, private equity firms, and insurance agencies. 

For additional questions regarding the information provided in this article, contact Brian P. Nally, Esq., Reminger Co., L.P.A. or Michael P. Shaw, Esq., Niles, Barton & Wilmer LLP

[1] “Advisor” and “Adviser” are used interchangeably throughout this article. The meaning is the same.  
[2] (President Barack Obama, Feb. 23, 2015).
[4] SEC Press Release 2018-68.
[5] Ibid.
[6] SEC Release No. 34-83062.
[9] Ibid.
[10] Ibid.
[11] For example, regulators have spent significant time analyzing the share classes purchased in 529 accounts and have criticized the use of C-Shares in 529 accounts for younger beneficiaries (under the age of 10) and A-Shares in 529 accounts with older beneficiaries (above age 10). See e.g.,

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