Friday, March 28, 2014
Wednesday, March 19, 2014
- An erosion of society's perception of what is a private matter;
- 24-hour news cycles;
- The relative decline of more thorough print media; and
- The internet (and the explosion of linked high-speed outlets for the dissemination of falsehoods.)
Wednesday, March 12, 2014
Sunday, March 2, 2014
- A standard of business conduct which reflects the fiduciary obligations to clients;
- Provisions requiring all advisers’ and supervised persons’ compliance with applicable federal securities laws;
- Protection of material non-public information of both the adviser’s securities recommendations, and client securities holdings and transactions;
- Periodic reporting and reviewing of access persons’ personal securities transactions and holdings;
- Advisor’s approval before an access person can invest in an IPO or private placement;
- Duty to report violations of the code of ethics;
- A written acknowledgment that all supervised persons received the code of ethics; and
- Recordkeeping provisions.
- Prior written approval before access persons can place a personal securities transaction (“pre-clearance”);
- Maintenance of lists of issuers of securities that the advisory firm is analyzing or recommending for client transactions, and prohibitions on personal trading in securities of those issuers;
- Maintenance of “restricted lists” of issuers about which the advisory firm has inside information, and prohibitions on any trading (personal or for clients) in securities of those issuers;
- “Blackout periods” when client securities trades are being placed or recommendations are being made and access persons are not permitted to place personal securities transactions.
- Reminders that investment opportunities must be offered first to clients before the adviser or its employees may act on them, and procedures to implement this principle.
- Prohibitions or restrictions on “short-swing” trading and market timing.
- Requirements to trade only through certain brokers, or limitations on the number of brokerage accounts permitted;
- Requirements to provide the adviser with duplicate trade confirmations and account statements; and
- Procedures for assigning new securities analyses to employees whose personal holdings do not present apparent conflicts of interest.
Friday, February 28, 2014
Thursday, February 20, 2014
The Securities and Exchange Commission regulates larger investment advisers under the Investment Advisers Act of 1940 (the “Act”). In a previous posting, we noted that perhaps the most significant provision of the Act is Section 206, which prohibits advisers from defrauding their clients and which has been interpreted by the Supreme Court as imposing on advisers a fiduciary duty to their clients. See Transamerica Mortgage Advisors, Inc. (TAMA) v. Lewis, 444 U.S. 11, 17 (1979) (“[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.”).
A number of obligations to clients flow from the fiduciary duty imposed by the Act, including the duty to act in the clients’ best interests, to fully disclose any material conflicts the adviser has with its clients, to seek best execution for client transactions, to provide only suitable investment advice, and to have a reasonable basis for client recommendations. See Registration Under the Advisers Act of Certain Hedge Fund Advisers, SEC Release No. IA-2333; Status of Investment Advisory Programs under the Investment Company Act of 1940, SEC Release No. IA-1623.
From these fiduciary obligations arises the duty to properly explain investments or an investment strategy to clients. Where a financial adviser provides advice about investments, “a fiduciary duty is breached when the client is encouraged to purchase an investment with a level of risk that is not appropriate for the client, or is not properly informed of the speculative nature of an investment.” Sakai v. Merrill Lynch Life Ins. Co., C-06-2581 MMC, 2008 WL 4193058 (N.D. Cal. Sept. 10, 2008) (citing Vucinich v. Paine, Webber, Jackson & Curtis, Inc., 803 F.2d 454, 460-61 (9th Cir.1986) (holding that broker had fiduciary duty to fully inform client of nature and risks of selling short, “in terms capable of being understood by someone of [client’s] education and experience.”)).
“A fiduciary must provide a proper disclosure and explanation of the investment activity, and should warn a client to exercise caution if an investment presents a greater risk than tolerable, given the client’s goals and circumstances.” Id.; see also Gochnauer v. A.G. Edwards & Sons, Inc., 810 F.2d 1042, 1049-50 (11th Cir. 1987) (finding that where adviser assisted clients in establishing speculative option trading account, “[a] more studied opinion of the risks of option trading in light of the [clients’] then-existing investment objective was owed by [the adviser] to [his clients]. This he failed to do, in breach of his fiduciary duty.”); In re Old Naples Sec., Inc., 343 B.R. 310, 324 (Bankr. M.D. Fla. 2006) (stating that “failing to disclose and fully explain the risk of an investment to an investor can be a breach of the broker’s fiduciary duty.”); Rupert v. Clayton Brokerage Co. of St. Louis, Inc., 737 P.2d 1106, 1109 (Colo. 1987) (“A broker who becomes a fiduciary of his client must act with utmost good faith, reasonable care, and loyalty concerning the customer’s account, and owes a duty . . . to keep the customer informed as to each completed transaction, and to explain forthrightly the practical impact and potential risks of the course of dealing in which the broker is engaged.”).
A good example of the application of the fiduciary duty to explain comes from Faron v. Waddell & Reed, Inc., 930 S.W.2d 508 (Mo. App. E.D. 1996). Although this case involves a broker-dealer as opposed to an investment adviser, Missouri imposes an unambiguous fiduciary standard on broker-dealers. In Faron, the client approached a registered representative of the broker-dealer inquiring whether he could obtain money from a trust to purchase a new home. He asked whether it would “cost any money.” Id. at 510. After he consulted with the registered representative he felt assured he could get the money and the transaction would result in no cost to him. He did not specifically consider tax ramifications nor did he directly ask about tax consequences. He assumed Waddell & Reed was lending the money to him to use, at no cost. However, instead of a loan the transaction actually consisted of a redemption of mutual funds. Id. He obtained the $250,000 from Waddell & Reed, returning the same amount within the required 21 days. The client’s accountant discovered the tax liability in the amount of approximately $32,000 while preparing an income tax return. The accountant brought it to the attention of the client, who brought suit against Waddell & Reed.
The trial court granted summary judgment for Waddell & Reed, finding that Waddell & Reed had no duty to provide tax information because none was requested. On appeal, the court noted:
In Missouri, stockbrokers owe customers a fiduciary duty. This fiduciary duty includes at least these obligations: to manage the account as dictated by the customer's needs and objectives, to inform of risks in particular investments, to refrain from self-dealing, to follow order instructions, to disclose any self-interest, to stay abreast of market changes, and to explain strategies. Implicit in these obligations is a duty to disclose to the customer material facts.Id. at 511 (emphasis added).
The court of appeals found that Waddell & Reed was privy to information and had expertise not yet proven on summary judgment to be equally or reasonably available to the client. In particular, the registered representative was aware of details of the transaction which consisted of a redemption of mutual funds, while the clients understood the transaction to amount to a short-term loan. Id. Waddell & Reed had a duty to manage the account according to the client’s expressed needs and objectives, to bridge finance by use of trust assets with “no loss whatsoever,” if possible, or to inform the client of the costs. Id. The client communicated his concerns about possible costs associated with the proposed transaction to the registered representative. The client was not told how the transaction would occur but was told it would not cost any money. The court of appeals concluded that what was meant by “costs” in the discussions between the parties remained uncertain. This implicated an unresolved question of fact, making summary judgment for Waddell & Reed inappropriate. Id.
In sum, the fiduciary duty standard requires that the client be properly informed of the nature of an investment or investment strategy. What is necessary in order to meet this standard will depend on the facts and circumstances of each case. A more in depth explanation of the risks of an investment or investment strategy will be necessary where the client’s related education and experience is minimal. Similarly, a more detailed explanation of strategy will become necessary where the strategy being implemented is more speculative in nature. Whether the fiduciary duty to explain has been met will usually be a question of fact to be decided by the judge, jury, or arbitrator after hearing all of the evidence.
Friday, February 14, 2014
PS: NASAA has “sections” divided into 5 subject matter areas; one of the five is the investment adviser section and another is the broker-dealer section. But while the sections are separate on paper, they work very closely together – especially the investment adviser and broker-dealer section.