Module 9 Flashcards
ERISA 5 Part Test
Under this rule, an adviser is considered a fiduciary if:
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
NYSE Rule 405 States
A general partner or executive officer, or designated individual of a member firm, will: Use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted or carried by such organization and every person holding power of attorney over any account accepted or carried by such organization.
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.
FINRA Responsibilities
1.) Market Regulation
2.) Member Regulation
3.) Enforcement
4.) Dispute Resolution
5.) Advertising Regulation
Common Sources of Ethical Conflicts
1.) Monthly production expectations
2.) The client with unrealistic expectations
3.) Mismatch of client and investment professional
Standards of Advice
1.) Registered investment adviser (RIA) - Fiduciary standard
2.) Registered representatives (RRs) and agents - Suitability standard
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. A fiduciary must not only provide disclosure, but should also make sure that the client understands what is being disclosed.
SEC Regulation Best Interest (Reg BI)
Under Regulation Best Interest (Regulation BI), brokers will have a “general obligation” to “act in the best interest of a retail customer when making a recommendation for any securities transaction or investment strategy involving securities to a retail customer.” Broker-dealers “may not put financial interests ahead of the interests of a retail client when making recommendations.” In order to comply with Regulation BI’s general obligation best interest rule, broker-dealers are required to meet four key obligations:
1.) Disclosure
2.) Reasonable care
3.) Conflict of interest
4.) Compliance
Disclosure Obligation - Reg BI
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.
Care Obligation - Reg BI
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.
Conflict of Interest Obligation - Reg BI
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 Obligation - Reg BI
Broker-dealers must “establish, maintain, and enforce policies and procedures ‘reasonably’ designed to achieve compliance with Regulation Best Interest as a whole.”
Fiduciary Relationship
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” (SEC v. Capital Gains Research Bureau, 375 U.S. 180, 1963).
Duties of a Fiduciary
1.) Duty of loyalty
2.) Duty of care
3.) Duty to disclose
4.) Duty to diagnose
5.) Duty to consult
6.) Duty to keep current
Duty of Loyalty
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.
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.
