Key report, “Emphasized that an adviser cannot provide unbiased advice unless conflicts of interest were removed.”
Over the past several years, scholar Arthur Laby has been one of the most prolific researchers on the fiduciary duties of advisers and the meaning of the suitability standard of brokers-dealers. In his most recent law review article, Selling Advice and Creating Expectations:Why Brokers Should be Fiduciaries, (Washington Law Review: Vol. 87:707) Laby argues that a far stronger case (than the arguments currently provided) for brokers being held to a stringent fiduciary standard exists. It is, quite simply, that investors have “reasonable expectations” to receive fiduciary advice from brokers. Laby makes a timely and persuasive case that should become familiar to every securities regulator.
Laby also performs an additional public service in his paper by recalling for his readers, again, the origins of the Advisers Act of 1940; and specifically, what prompted its enactment. As rulemaking on fiduciary duties remains in the air in both the Department of Labor and the Securities & Exchange Commission, this vital nugget of securities regulation history needs to emblazoned on each agencies’ hard drive. This nugget: The ’40 Act was enacted in large part to quell “tipster organizations” who sold products, from disguising themselves as investment advisors, because, as Laby notes, “Such institutions were unable to provide objective advice,” and as Laby further notes a 1935 SEC report stressed, “An adviser cannot provide unbiased advice unless conflicts of interest were removed.”
Highlights of Laby’s article on the enactment of the ’40 Act are noted here.
Why Brokers Should be FiduciariesArthur B. LabyWashington Law Review: Vol. 87:707 2. Investment Adviser Regulation Was Enacted in 1940
(page 720)
….. Unlike the Securities Act and the Exchange Act, the Investment Advisers Act was not a response to crisis. By 1940, when the Advisers Act was passed, the Great Crash was over a decade old and the country was well past the statistical lows of 1933, which marked the nadir of the Great Depression.56 Nor was the Advisers Act a response to scandal in the investment advisory profession. The Advisers Act instead grew out of study and reflection.57
In 1935, the SEC embarked on a comprehensive analysis of investment trusts and investment companies, which was required by Congress in the Public Utility Holding Company Act of 1935. Among the thirteen volumes comprising the study was a slim report entitled, Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services.58 The Commission’s jurisdiction to investigate advisers was incidental to its authority to study investment trusts and investment companies.59 The investment counsel report was little more than a survey of advisory firms that responded to the Commission’s request for information.
The report identified two concerns bedeviling advisory firms. The first was that so-called “tipster” organizations were disguising themselves as legitimate advisory organizations.60 Certain firms providing advice were affiliated with investment banks or brokerage firms and, therefore, had a vested interest in recommending particular securities. Investment banks were securities merchants; they were paid based on the spread between their purchase price and the sale price to the customer. Such institutions were unable to provide objective advice.
As one adviser stated, “[A] merchant in securities to be sold at a profit is primarily concerned with moving the wares he has on the shelf that he will make money out of, and therefore is not in a position to give unbiased advice, which we have stated to be the function of the professional investment counsel.”61 The report emphasized that an adviser cannot provide unbiased advice unless conflicts of interest were removed. This concern over biased advice presages the current debate over whether to place a fiduciary duty on brokers and will be revisited shortly….
In 1940, the U.S. Senate held hearings on a bill to regulate investment companies and investment advisers.64 When the hearings were over, the Senate report identified at least two reasons for federal regulation. One was to protect the public from “fraud and misrepresentations of unscrupulous tipsters and touts,” and the other was to protect bona fide investment advisers from the “stigma” of associating with unscrupulous members of the profession.65 …
Unlike the Exchange Act, which focused on securities transactions, the Advisers Act focused on the relationship between an adviser and client. Advisers who testified before the Senate in 1940 emphasized the personal nature of the advisory relationship. One witness described the profession as “a personal-service profession [that] depends for its success upon a close personal and confidential relationship between the investment-counsel firm and its client. It requires frequent and personal contact of a professional nature between us and our clients. We must know them well.”71 Another stated, “The relationship of investment counsel to his client is essentially a personal one involving trust and confidence.”72 Even the Supreme Court has noted the “delicate fiduciary nature” of the investment advisory relationship.73
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