Tuesday, March 12, 2019

SEC Chair Jay Clayton is Wrong: The Advisers Act Requires Much More Than Just Disclosure of a Conflict of Interest

It has been confirmed to me that SEC Chair Clayton and/or others at the SEC have been stating recently that:

  • The Advisers Act's fiduciary standard of conduct only requires disclosure, when a conflict of interest exists.
  • Proposed Reg BI, which would impose a "best interests" obligation on broker-dealers and their registered representatives (which, the SEC acknowledges, only imposes an obligation of disclosure when a conflict of interest exists), would essentially raise the standard for broker-dealers to near the same standard of conduct as exists for investment advisers.
WE MUST PUSH BACK ON THIS.

Realize that the SEC ignores its own precedent, and centuries of law, with these actions. SEC Chair Clayton seeks to redefine the English language. His actions will only weaken the law, foster distrust of financial advisers, and deter capital formation (as trust is essential to same, and high intermediation costs interfere with capital accumulation), which in turn will weaken the U.S. economy in the long term.

Also realize that Reg BI arose from a proposal by SIFMA and FSI (broker-dealer lobbying organizations), the SEC Chair Clayton (who represented broker-dealers in his law practice) has embraced. But it is a grave threat to the financial security of individual Americans, and does not impose any substantial restrictions on the conduct of brokers.”


The SEC’s current view of the fiduciary standard is NOT the same as the view it had prior to the current Administration.
  • The current SEC Chair seeks to water down the fiduciary standard to a meaningless disclosure standard.
Think about it … if disclosure was all that were required under a fiduciary standard, then there would be no need for a fiduciary standard!
  • Laws and regulations imposing disclosure obligations would be all that is required. No fiduciary duties would have ever come into existence, under the law.
The law’s imposition of a fiduciary standard recognizes that disclosures are ineffective, especially in advisor-client relationships where a great disparity in knowledge and power exists and public policy so dictates.

The Investment Advisers Act of 1940 was ALWAYS known to apply the fiduciary standard.
  • The SEC stated this in 1941! The language of the Advisers Act was always known to apply the fiduciary standard!
  • While not expressly stated in the Advisers Act, there does not mean that the fiduciary standard, being “implied” from the language of the Advisers Act, is less than a true fiduciary standard.
  • The fiduciary standard was only confirmed to exist by the U.S. Supreme Court in the SEC vs. Capital Gains decision in 1963. It did not arise for investment advisers at that time.
The SEC’s view of Capital Gains is incorrect.
  • The broker-dealer industry (and, acting through its attorneys, who write outlines on fiduciary duties for dual registrant firms), has recently taken the position that the Investment Advisers Act of 1940 only requires disclosure, and nothing more. This is based upon a misreading of SEC vs. Capital Gains. But the U.S. Supreme Court, in that case, stated that it “could go further.” But all the SEC charged, as to a breach of fiduciary duty, was violation of the obligation of disclosure of a conflict of interest. (Which is far easier to prove than other requirements of the fiduciary duty of loyalty, such as whether informed consent was obtained.)
  • “It is arguable -- indeed it was argued by ‘some investment counsel representatives’ who testified before the Commission -- that any ‘trading by investment counselors for their own account in securities in which their clients were interested . . .’ creates a potential conflict of interest which must be eliminated. We need not go that far in this case, since here the Commission seeks only disclosure of a conflict of interests ….”
The SEC has previously taken the position that disclosure is not enough when a conflict of interest is present - much more is required.
  • As stated in an SEC No-Action Letter:  “We do not agree that ‘an investment adviser may have interests in a transaction and that his fiduciary obligation toward his client is discharged so long as the adviser makes complete disclosure of the nature and extent of his interest.’ While section 206(3) of the Investment Advisers Act of 1940 (“Act”) requires disclosure of such interest and the client's consent to enter into the transaction with knowledge of such interest, the adviser's fiduciary duties are not discharged merely by such disclosure and consent. The adviser must have a reasonable belief that the entry of the client into the transaction is in the client's interest.  The facts concerning the adviser's interest, including its level, may bear upon the reasonableness of any belief that he may have that a transaction is in a client's interest or his capacity to make such a judgment.” Rocky Mountain Financial Planning, Inc. (pub. avail. Feb. 28, 1983).
  • It has long been the Commission’s position that the “an investment adviser must not effect transactions in which he has a personal interest in a manner that could result in preferring his own interest to that of his advisory clients.” SEC Rel. No. IA-1092, October 8, 1987, 52 F.R. 38400, citing Kidder, Peabody & Co., Inc., 43 S.E.C. 911, 916 (1968).
The U.S. Supreme Court has previously written about the fiduciary standard, generally, and in particular the fiduciary duty of loyalty:
  • For example, see Justice Douglas’s majority opinion in Pepper v. Litton, 308 U.S. 295, 311 (1939), wherein he stated: “He who is in such a fiduciary position cannot serve himself first and his cestuis second … He cannot use his power for his personal advantage and to the detriment of [the cestuis], no matter how absolute in terms that power may be and no matter how meticulous he is to satisfy technical requirements.  For that power is at all times subject to the equitable limitation that it may not be exercised for the aggrandizement, preference, or advantage of the fiduciary to the exclusion or detriment of the cestuis. Where there is a violation of those principles, equity will undo the wrong or intervene to prevent its consummation … Otherwise, the fiduciary duties … would go for naught: exploitation would become a substitute for justice; and equity would be perverted as an instrument for approving what it was designed to thwart.”
The State Securities Administers Disagree with the SEC, as well.
  • In their Feb. 19, 2019 supplemental comment letter to the SEC, they stated: “What is missing from the [REG BI] proposal and statements by SEC officials is a recognition that disclosure cannot and should not be characterized as sufficient to satisfy an adviser’s fiduciary duty and more especially the adviser’s duty of loyalty. Disclosure of conflicts aside, an adviser’s duty is to act in the best interest of his or her client. The analysis does not and should not stop once the question of whether disclosure of the conflict has been made to the investor.”
It is clear that under state common law the fiduciary standard of conduct requires much more than mere disclosure.
  • It has long been the SEC’s view that the fiduciary duty created by the Advisers Act encompasses state common law fiduciary obligations. Brandt, Kelly & Simmons, LLC, Admin. Proc. File No. 3-11672, 2004 WL 2108661 (SEC Sept. 21, 2004). In fact, a "federal fiduciary standard" only exists to the extent necessary to resolve conflicts among the states or adhere to express legislative dictates.
  • Breach of fiduciary duty claims against investment advisers are typically based upon state common law, as the federal Advisers Act does not possess a private right of action (except in limited circumstances).  Accordingly, maintaining consistency with state common law should be a major factor in how the federal fiduciary standard arising under the Advisers Act is applied. The interpretation of the fiduciary duties arising under the Advisers Act does not preempt,  and should not seek to eclipse, state common law for breach of fiduciary duty by an investment adviser, given the limited remedies afforded to clients under the Advisers Act itself. Rather, the effect should be complementary.
What Does the Fiduciary “Best Interests” Standard Require, When A conflict of Interest is Present?
  1. Full, complete, and affirmative disclosure of the conflict of interest (and its ramifications to the client)
  2. The adviser ensures client understanding of the disclosures made.
  3. The client provides informed consent.
    1. Not mere consent.
    2. No client would ever consent to be harmed!
  4. Even then, the courts further test the transaction – is it substantively fair to the client?

You cannot easily disclaim your fiduciary obligations, nor seek client waiver of same.
  • Concepts of “waiver” and “estoppel” have substantially less application when the fiduciary standard is applied. As a result, generally fiduciaries cannot disclaim away their fiduciary duties, nor may clients waive the core fiduciary duties.
Disclosures are completely ineffective in this area.
The SEC wants brokers and investment advisers to be virtually the same. They are not – they are, and should remain – opposites.
  • Brokers are salespeople. They sell products and securities. They are in arms-length relationships with their customers. Caveat emptor applies. The suitability standard applies, which negates in large part the duty of care most other providers of products and services possess under the law.
  • Investment advisers are fiduciaries. They are paid by the client. They represent the client. They act as the “purchaser’s representative.” They possess strong fidiuciary duties of due care, loyalty, obedience, utmost good faith, and others. They are in a fiduciary-entrustor relationship with the client. They must receive only reasonable compensation (preferably levelized, and agreed-to in advance).
Fees and costs matter. 
  • Brokers generally result in much higher fees and costs for investors, than investment advisers.
  • Compelling and substantial academic evidence leads to the conclusion that the higher the fees and costs, the lower the returns to investors.
  • In my experience, from reviewing hundreds and hundreds of client (and potential client) portfolios, fee-only (fiduciary) investment advisers typically are 30% to 70% less expensive, in terms of total fees and costs investors bear, than “full-service brokers.”
The fiduciary standard acts as a deterrent to, or restriction upon, greed.
  • At its core, the fiduciary standard mandates certain conduct (duty of care) and restricts or prohibits other conduct (duty of loyalty).
  • Public policy strongly supports the application of the fiduciary standard to the delivery of investment advice, as a restraint upon fraud, and for numerous other reasons. See my comment letter.
Small clients CAN BE - and ARE NOW - being served under fee-based (and fiduciary) accounts.
  • Brokers are stating (and the SEC is now repeating) that small clients can't be served except under a broker-dealer commission-based sales model.
  • What the broker-dealer community is really saying: “We can’t serve small investors unless we charge them exorbitant fees.”
  • Note that many, many brokerage firms have minimums - $100,000, $250,000, or greater! Many of the brokers who advocate that "small investors can't be served under a fiduciary standard" are the ones who have these minimums!
  • Investment advisers have been serving small investors for reasonable fees, for many years. Specific examples include:
    • Vanguard Personal Advisor Services - $50,000 minimum.
    • Schwab Intelligent Adviser – a “robo-adviser” (and there are many in this area) that has a $5,000 minimum.
    • Betterment – another robo-adviser, no minimum account size, investment advisory fees of only 0.40% to 0.25%/year
    • Garrett Planning Network – over 300 investment advisers around the country providing comprehensive financial planning advice (including investment advice) for reasonable hourly fees
    • X-Y Planning Network – 750 members and rapidly growing, with most chagrining a monthly subscription fee (some at $80/month, average is about $180/month).
    • And thousands more investment advisers (not in organizations or networks, and who are not robo-advisers) exist that accept small accounts to manage - for flat annual fees, for monthly subscription fees, or for a reasonable percentage of assets under management.
  • As the industry has shifted from about 10% fee-based accounts 20 years ago, to about 50% fee-based accounts (and 50% commission-based) currently, and with the aid of technology that streamlines operations, I anticipate investment advisory fees to continue to trend downward, and more and more investment advisers to work with small clients.
  • Fee-based advice is often much more comprehensive than commission-based advice. Look at this situation. A client is sold a $24,000 mutual fund (Class A shares) by a broker, which has a 5.75% commission. That is $1,380 in compensation paid to the broker – for a simple sale. I know many financial advisors who will prepare a full-blown financial plan for that amount – including recommendations to invest in low-cost Vanguard funds or ETFs (which, unlike the Class A shares sold by the broker, don’t carry the burden of 0.25% annual 12b-1 fees, which is nearly always additional compensation to the broker, in most instances, and often continue indefinitely while adding no benefit to the customer / fund shareholder!)
In my view, SEC Chair Jay Clayton will go down in history as the worst SEC Chair ever. He is pushing the SEC to water down the fiduciary standard, redefine "best interests" as something other than the fiduciary duty of loyalty, and who advances the positions that so many broker-dealers desire - i.e., to be "trusted advisors" without being truly held accountable for the advice that they provide.

How should we react to this travesty?

    A. VISIT OR WRITE YOUR MEMBER OF CONGRESS and YOUR SENATOR. Visit her/him when she/he returns to the district. Or fax a letter to the Member or Senator, or mail one. (Feel free to copy from this post.)

    B. Submit a comment letter to the SEC. Yes, it is past time. But you can still indicate your outrage.

We have a chance of stopping the SEC, if you act now.

Just as importantly, your actions today will also set the stage for correcting the SEC's actions, when we get a new SEC Chair ... and Jay Clayton returns to being an attorney for Wall Street firms.

And your actions will demonstrate to Members of Congress and Senators how important this issue is. Not only to our profession. But to our neighbors and friends, and their future financial security. To the level of trust possessed by consumers in financial advisors.

For betrayal of trust (as will happen under the illusion of "best interests" that Reg BI fosters) will in turn lead investors to flee the capital markets, thereby deterring capital formation. This issue is important for the future growth of the U.S. economy.

Act today. MAKE YOUR VOICE KNOWN.

Thank you.
Bear

Tuesday, February 19, 2019

12 Core Values To Consider

[This post is inspired by an article in Bob Veres' Inside Information publication, a rich resource for all those who provide financial and investment advice. In his Feb. 2019 issue, Bob relates "core values" that were shared by Tracey Beckes, who recently spoke at the AICPA PFP Summit. Some of the following "core values" are derived directly from this publication; others were contributed by this author.]

What values will guide your life? What principles will you follow?

There are many ways to list out your values. Here's a recent list I composed, that conveys not just values but how they should be practiced. Some additional resources are listed, to aid those to begin to explore these practices.

THE 3 WAYS IN WHICH WE SHOULD PERCEIVE THE WORLD AROUND US:
  1. Listen, to be fully present whenever another person is speaking, be it a peer, colleague, friend or family member. Aspire to become one of the best listeners in the world. [Search YouTube for videos about empathetic listening.]
  2. Be ever curious. Keep a beginner’s mind, and nurture the habits and attitudes that sustain a curious mind and an open heart. [Search YouTube for "How Important is it to be curious" - a short interview of Bill Gates.]
  3. Embrace change, to create a mindset that seeks and welcomes opportunities for yourself and the members of any team or organization of which you are a part. [Read the book, "Who Moved My Cheese?"

THE 3 COMMITMENTS WE SHOULD MAKE TO OURSELVES AND TO OTHERS:
  1. Seek mastery, to commit yourself to fully developing the skills, expertise and wisdom to excel in your profession. [And it all begins with excellent written and oral communication skills. See the YouTube video: "Communication Skills - How to Improve Communications Skills - 7 Unique Tips." Also see the YouTube video, "Big Talk" by Kalina.]
  2. Be confident. Self-confidence is a skill. [See the YouTube video, "The skill of self confidence, Dr. Ivan Joseph. And if you are not self-confident in the moment, fake it to you make it! Also, remember to not let others tear you down, and avoid excessive self-judgment as well.]
  3. Commit to radical responsibility. Make clear agreements with yourself, and with your peers and with others, and bind yourself to honoring those agreements. Practice, and master, self-control and grit - for they may well be the key factors in your success in life. [Watch the YouTube videos, "Sesame Street Tells You How to Get to Sunnier Days Financially," and "Grit: the power of passion and perseverance" by Angela Lee Duckworth.]

THE 3 PRACTICES WE SHOULD UNDERTAKE EACH DAY:
  1. Practice gratitude, openly express thankfulness for the richness of your life and the gift of others both great and small. [Search for videos on YouTube: Oprah Winfrey Gratitude Journal.] 
  2. Expand your comfort zone, by doing one thing each day that “scares you.” This is especially useful for introverts. [Watch the video: Marcus Taylor, Measuring Comfort Zones, on YouTube. Then watch, "100 days without fear" by Michelle Poler.]
  3. Ask “How Can I Help?” If we were to treat everyone, each day, like they were hurting, then we wouldn’t miss by much. We can find much happiness in helping others. [For just one example, search YouTube for: "Happiness is helping others" - posted by Haytham Ibrahim]

THE 3 CORE VALUES WE SHOULD EMBRACE AT ALL TIMES:

  1. Strive for positivitybecause being positive and happy promotes greater learning, greater achievements, and greater success, in all aspects of life. [Watch the video, The happy secret to better work, by Shawn Achor.] 
  2. Plan out and enjoy the journey. Live your life by design, not be default, to enjoy a happy and fulfilling life. [Watch these videos: "The Time You Have (in JellyBeans)", and any video about setting S.M.A.R.T. Goals.]
  3. Most important - act with integrity, because all successful relationships are built on trust. And trust, when violated, can never be fully restored. [While teaching integrity requires more than short videos allow, there are many benefits from integrity - for an indication, watch the YouTube video by Kevin Lott, "Integrity Gets You Everything!"]

Friday, January 11, 2019

Part 8 (Last in a Series) on the Regulation of Financial and Investment Advice:
Examining the Fiduciary Duties of Investment Advisers Under State Common Law

In 2018 the SEC published a draft of its interpretation of the fiduciary duties of investment advisers. Yet, in that draft they omitted several requirements - particularly in reference to the fiduciary duty of loyalty and what is required when a conflict of interest exist. The SEC's draft could lead investment advisers to believe their conduct is "o.k." - when in fact litigation (and arbitration) occurs as a result of state common law fiduciary claims - and only very rarely under the Advisers Act itself (as, generally, there is no private right of action under the Advisers Act).

Herein I set forth - in detail (no surprise there!) - the fiduciary duties of investment advisers, as discerned from both the SEC's proposed rule, but as augmented with state common law understandings of the fiduciary standard of conduct. Remember - the SEC sets the floor - not the ceiling. Advisers should conform their conduct to the higher standard. (And, when ERISA applies, even higher standards may be required - which are not set forth hereunder.)

Not all securities lawyers will agree with the elicitation of fiduciary standards I set forth below. In part, in my view, this is because of a (wishful) misinterpretation of SEC vs. Capital Gains Research Bureau, which I have previously written about. And this is due in part to a lack of realization of the limited role of waiver and estoppel in fiduciary relationships of this type. Debates will continue, no doubt, with dual registrant firms and their attorneys arguing for a weaker interpretation of the fiduciary standard, while others (such as myself) see the fiduciary standard as one that should not be weakened nor subject to "particular exceptions" (as the late Justice Benjamin Cardozo would have put it.)

This elicitation remains a work-in-progress. Much additional legal research can be undertaken to locate and provide additional authority for the propositions taken herein. 


A FURTHER ELICITATION OF STATE COMMON LAW
FIDUCIARY STANDARDS OF CONDUCT, WHICH SHOULD GOVERN
THE DELIVERY OF INVESTMENT ADVICE
(Derived in part from the SEC’s proposed interpretation, but
supplemented and corrected with my own language and recitations to authority)
An investment adviser is a fiduciary, and as such is held to the highest standard of conduct and must act in the best interest of its client.[1]Its fiduciary obligation, which includes an affirmative duty of utmost good faith and full and fair disclosure of all material facts, is established under various federal laws and state common law and is important to the Commission’s investor protection efforts.[2]The Commission also regulates broker-dealers, including the obligations that broker-dealers owe to their customers. Investment advisers and broker-dealers provide advice and services to retail investors and are important to our capital markets and our economy more broadly. Broker-dealers and investment advisers may have different types of relationships with their customers and clients and have different models for providing advice, which provide investors with choice about the nature and extent[3]of advice they receive and how they pay for the services or products that they receive.
The Advisers Act establishes a federal fiduciary standard for investment advisers.[4]This fiduciary standard is based on equitable common law principles and is fundamental to advisers’ relationships with their clients under the Advisers Act.[5]The fiduciary duty to which advisers are subject is not specifically defined in the Advisers Act or in Commission rules, but reflects a Congressional recognition “of the delicate fiduciary nature of an investment advisory relationship” as well as a Congressional intent to “eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser – consciously or unconsciously – to render advice which was not disinterested.”[6]An adviser’s fiduciary duty is imposed under the Advisers Act in recognition of the nature of the relationship between an investment adviser and a client and the desire “so far as is presently practicable to eliminate the abuses” that led to the enactment of the Advisers Act.[7]It is made enforceable by the antifraud provisions of the Advisers Act.[8]Investment advisers also possess broad fiduciary duties arising under state common law, which is enforceable primarily through civil action brought against the investment adviser by the adviser’s client.
An investment adviser’s fiduciary duty under the Advisers Act comprises a duty of due care and a duty of loyalty,[9]although other duties may be surmised. Several commenters responding to Chairman Clayton’s June 2017 request for public input[10]on the standards of conduct for investment advisers and broker-dealers acknowledged these duties.[11]
This fiduciary duty requires an adviser “to adopt the principal’s goals, objectives, or ends.”[12]
This means the adviser must, at all times, serve the best interest of its clients and not subordinate its clients’ interest to its own.[13]
The federal fiduciary duty is imposed through the antifraud provisions of the Advisers Act. The duty follows the contours of the relationship between the adviser and its client, and the adviser and its client may shape that relationship through contract when the client receives full and fair disclosure and provides informed consent,and further provided the transaction is substantively fair to the client. Although the ability to tailor the terms means that the application of the fiduciary duty will vary with the terms of the relationship, the relationship in all cases remains that of a fiduciary to a client. In other words, the investment adviser cannot disclose or negotiate away, and the investor cannot waive, the fiduciary duty.[14]
A.    Duty of Due Care
As fiduciaries, investment advisers owe their clients a duty of due care.[15]
The Commission has discussed the duty of care and its components in a number of contexts.[16]The duty of care includes, among other things: (i) the duty to act and to provide advice that is in the best interest[17]of the client, (ii) the duty to seek best execution of a client’s transactions where the adviser has the responsibility to select broker-dealers to execute client trades, and (iii) the duty to provide advice and monitoring over the course of the relationship.
1.   Duty to Provide Advice With the Requisite Degree of Required Expertise, Due Diligence, and Skill.
The SEC has previously addressed an adviser’s duty of care in the context of the provision of personalized investment advice. In this context, the duty of care includes a duty to make a reasonable inquiry into a client’s financial situation, level of financial sophistication, investment experience, and investment objectives (which is referred to collectively as the client’s “investment profile”) and a duty to provide personalized advice that is suitable[18]for and in the best interest[19]of the client based on the client’s investment profile.
An adviser must, before providing any personalized investment advice and as appropriate thereafter, make a reasonable inquiry into the client’s investment profile. The nature and extent of the inquiry turn on what is reasonable under the circumstances, including the nature and extent of the agreed-upon advisory services, the nature and complexity of the anticipated investment advice, and the investment profile of the client. For example, to formulate a comprehensive financial plan for a client, an adviser might obtain a range of personal and financial information about the client, including current income, investments, assets and debts, marital status, insurance policies, and financial goals.[20]
An adviser must update a client’s investment profile in order to adjust its advice to reflect any changed circumstances. The frequency with which the adviser must update the information in order to consider changes to any advice the adviser provides would turn on many factors, including whether the adviser is aware of events that have occurred that could render inaccurate or incomplete the investment profile on which it currently bases its advice. For example, a change in the relevant tax law or knowledge that the client has retired or experienced a change in marital status might trigger an obligation to make a new inquiry.
An investment adviser must also have a reasonable belief that the personalized advice is suitable for the client based on the client’s investment profile. A reasonable belief would involve considering, for example, whether investments are recommended only to those clients who can and are willing to tolerate the risks of those investments and for whom the potential benefits may justify the risks.[21]Whether the advice is proper must be evaluated in the context of the portfolio that the adviser manages for the client and the client’s investment profile.
The cost (including fees and compensation) associated with investment advice and the recommended investments[22]is generally be one of many important factors – such as the investment product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions – to consider when determining whether a security or investment strategy involving a security or securities is in the best interest[23]of the client. Accordingly, the fiduciary duty does not necessarily require an adviser to recommend the lowest cost investment product or strategy.[24]The SEC has stated that an adviser could not reasonably believe that a recommended security is in the best interest of a client if it is higher cost than a security that is otherwise identical, including any special or unusual features, liquidity, risks and potential benefits, volatility and likely performance.[25]Furthermore, an adviser would not satisfy its fiduciary duty to provide advice that is in the client’s best interest by simply advising its client to invest in the least expensive or least remunerative investment product or strategy without any further analysis of other factors in the context of the portfolio that the adviser manages for the client and the client’s investment profile. A reasonable belief that investment advice is in the best interest of a client also requires that an adviser conduct a reasonable investigation[26]into the investment sufficient to not base its advice on materially inaccurate or incomplete information.[27]The Sec has brought enforcement actions where an investment adviser did not independently or reasonably investigate securities before recommending them to clients.[28]This obligation to provide advice that is suitable and in the best interest applies not just to potential investments, but to all advice the investment adviser provides to clients, including advice about an investment strategy or engaging a sub-adviser and advice about whether to rollover a retirement account so that the investment adviser manages that account.
Assessment of an investment adviser’s exercise of due care is undertaken by assessing both process and substance. In reviewing the conduct of an investment adviser in adherence to the investment adviser’s fiduciary duty of due care, the review would likely involve an analysis as to whether the decision made by the investment adviser was informed (procedural due care). The very word “care” connotes a process. Procedural due care is often met through the application of an appropriate decision-making process, and judged under the standard, not (necessarily) by the end result.  But it is not enough to just possess a process; the steps in the process cannot be constructed nor implemented recklessly; the exercise of sound judgment must occur during the creation of the process and then as each step of the process is undertaken.[29]
A review of an investment adviser’s exercise of due care also includes an assessment of the substance of the transaction or advice given (substantive due care).
In assessing the due care undertaken by the investment adviser, the investment adviser is judged as an expert, as the standard of due care is relational.[30]Industry association standards are often highly probative when further defining the standard of care.[31]
2.   Duty to Seek Best Execution
The SEC addressed an investment adviser’s duty of care in the context of trade execution where the adviser has the responsibility to select broker-dealers to execute client trades (typically in the case of discretionary accounts).  The SEC has stated that, in this context, an adviser has the duty to seek best execution of a client’s transactions.[32]In meeting this obligation, an adviser must seek to obtain the execution of transactions for each of its clients such that the client’s total cost or proceeds in each transaction are the most favorable under the circumstances. An adviser fulfills this duty by executing securities transactions on behalf of a client with the goal of maximizing value for the client under the particular circumstances occurring at the time of the transaction. Maximizing value can encompass more than just minimizing cost. When seeking best execution, an adviser should consider “the full range and quality of a broker’s services in placing brokerage including, among other things, the value of research provided as well as execution capability, commission rate, financial responsibility, and responsiveness” to the adviser. The determinative factor is not the lowest possible commission cost but whether the transaction represents the best qualitative execution. Further, an investment adviser should “periodically and systematically” evaluate the execution it is receiving for clients.
The Advisers Act does not prohibit advisers from using an affiliated broker to execute client trades. However, the adviser’s use of such an affiliate involves a conflict of interest that must be fully and fairly disclosed and the client must provide informed consent to the conflict. Even then, the use of the affiliated broker should be substantively fair to the client.
3.   Duty to Act and to Provide Advice and Monitoring over the Course of the Relationship
An investment adviser’s duty of care also encompasses the duty to provide advice and monitoring over the course of a relationship with a client.[33]An adviser is required to provide advice and services to a client over the course of the relationship at a frequency that is both in the best interest of the client and consistent with the scope of advisory services agreed upon between the investment adviser and the client. The duty to provide advice and monitoring is particularly important for an adviser that has an ongoing relationship with a client (for example, a relationship where the adviser is compensated with a periodic asset-based fee or an adviser with discretionary authority over client assets). Conversely, the steps needed to fulfill this duty may be relatively circumscribed for the adviser and client that have agreed to a relationship of limited duration via contract (for example, a financial planning relationship where the adviser is compensated with a fixed, one-time fee commensurate with the discrete, limited-duration nature of the advice provided).[34]
An adviser’s duty to monitor extends to all personalized advice it provides the client, including an evaluation of whether a client’s account or program type (for example, a wrap account) continues to be in the client’s best interest.
B. Duty of Loyalty
(1)    Generally.
The duty of loyalty, the most distinctive of the duties imposed upon a fiduciary,[35]requires an investment adviser to put its client’s interests first.
Under the fiduciary duty of loyalty, as developed over centuries of case law, there is a duty to not possess a conflict of interest, and also a duty to not profit off of the client.[36]In other words, fiduciaries owe the obligation to their client to not be in a position where there is a substantial possibility of conflict between self-interest and duty.[37]This is called the “no-conflict” rule, derived from English law. Fiduciaries also possess the obligation not to derive unauthorized profits from the fiduciary position. This is called the “no profit” rule, also derived from English law.[38]
Because an adviser must serve the best interests of its clients, it has an obligation not to subordinate its clients’ interests to its own.
(2)    Examples of Non-Subordination of Interests: Trade Allocations; Favoring Higher-Fee Clients.
For example, an adviser cannot favor its own interests over those of a client, whether by favoring its own accounts or by favoring certain client accounts that pay higher fee rates to the adviser over other client accounts.[39]
(3)    Not Preferring the Interests of One Client Over Another.
An investment adviser must not favor its own interests over those of a client[40]or unfairly favor one client over another.[41]
Accordingly, the duty of loyalty includes a duty not to treat some clients favorably at the expense of other clients. Thus, in allocating investment opportunities among eligible clients, an adviser must treat all clients fairly.[42]This does not mean that an adviser must have a pro rata allocation policy, that the adviser’s allocation policies cannot reflect the differences in clients’ objectives or investment profiles, or that the adviser cannot exercise judgment in allocating investment opportunities among eligible clients. Rather, it means that an adviser’s allocation policies must be fair and, if they present a conflict, the adviser must fully and fairly disclose the conflict such that a client can provide informed consent.
(1)    The Necessity to Seek to Avoid Conflicts of Interest.
An adviser must seek to avoid conflicts of interest with its clients.[43]
The “no-conflict rule” states, in essence, that fiduciaries owe the obligation to their client to not be in a position where there is a substantial possibility of conflict between self-interest and duty.[44]
The no-conflict rule is firmly embedded in the federal fiduciary standard. In SEC vs. Capital Gainsthe U.S. Supreme Court explained the no conflict rule and provided the rationale behind the prohibition on serving two masters:
This Court, in discussing conflicts of interest, has said: ‘The reason of the rule inhibiting a party who occupies confidential and fiduciary relations toward another from assuming antagonistic positions to his principal in matters involving the subject matter of the trust is sometimes said to rest in a sound public policy, but it also is justified in a recognition of theauthoritative declaration that no man can serve two masters; and considering that human nature must be dealt with, the rule does not stop with actual violations of such trust relations, but includes within its purpose the removal of any temptation to violate them .... In Hazelton v. Sheckells, 202 U.S. 71, 79, we said: ‘The objection . . . rests in their tendency, not in what was done in the particular case … The court will not inquire what was done. If that should be improper it probably would be hidden and would not appear.’[45]
In an ideal world, no conflicts of interest between an adviser and its clients would ever exist. Indeed, the avoidance of conflicts of interest was a principal reason behind the enactment of the Advisers Act:
The IAA arose from a consensus between industry and the SEC that ‘investment advisers could not 'completely perform their basic function — furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments — unless all conflicts of interest between the investment counsel and the client were removed.'[46]
It should again be noted that when an adviser is a fiduciary under ERISA, conflicts of interest must generally be avoided,[47]absent a class or other exemption from the prohibited transaction rules.
However, while avoidance of a conflict of interest is the best method to adhere to an investment adviser’s fiduciary duty of loyalty,[48]and even other securities laws or regulations require the avoidance of certain conflicts of interest (even in non-fiduciary relationships),[49]it must be acknowledged that not all conflicts of interest can be avoided. In this regard, the “best interests” fiduciary standard is not as strict as the “sole interests” fiduciary standard applicable under the trust law of many states (and under ERISA), in that conflicts of interest may exist at times. However, even when a conflict of interest exists, actions must be taken to ensure that the client is not harmed. In other words, the conflict of interest, even when affirmatively and fully disclosed, must be properly managed through a process that includes obtaining the client’s informed consent[50]and, even then, that the transaction remains substantively fair to the client.
In the large financial services firm of today, there exists multiple areas where conflicts of interest might arise. As a result, at least one commentator has incorrectly interpreted the SEC vs. Capital Gains decision as a “pragmatic recognition by the Court of the complexities of the operations of contemporary investment advisers.”[51]But, the fiduciary standard of conduct should be lessened in order to adapt to the functions of the marketplace; rather, the marketplace should conform to the fiduciary standard of conduct. Indeed, the fiduciary duty of loyalty is not abrogated merely because of the size or nature of the firm or its diverse activities. “The standard of conduct required of the fiduciary is not diminished by reason of its organizational structure.”[52]  
(2)    Procedures to Follow When a Conflict of Interest is Still Present.
Should a conflict of interest exist, the law provides for a multi-stage process[53]designed to ensure that the client’s best interests are not subordinated to those of the adviser. 
(A)  STEP ONE: Affirmative Disclosure of the Conflict of Interest, All Material Facts Relating Thereto, and the Ramifications to the Client.
Disclosure of a conflict alone is not alwayssufficient to satisfy the adviser’s duty of loyalty and section 206 of the Advisers Act.[54]However, disclosure of a conflict of interest is one part of a multi-stage process which, if effectively followed by an investment adviser, may result in a defense to the breach of the fiduciary duty of loyalty that arises from the existence of a conflict of interest. 
The disclosure of the conflict of interest, and material facts concerning same, must be specific to that conflict of interest. Communications that generallydisclose existing or potential conflicts of interest fail to provide clients with an appreciation of all material facts and are generally ineffective as a basis for a client’s informed consent.[55]
All material facts must be disclosed, when a conflict of interest is present. A material fact is “anything which might affect the (client’s) decision whether or how to act.”[56]A fact is considered material if there is a substantial likelihood that a reasonable investor would consider the information to be important in making an investment decision.[57]
A material conflict of interest is always a material fact requiring disclosure.[58]
The disclosure must be timely given. “[D]isclosure, if it is to be meaningful and effective, must be timely. It must be provided before the completion of the transaction so that the client will know all the facts at the time[59]that he is asked to give his consent.”[60]
Disclosure must be affirmatively undertaken.The duty to disclose is an affirmative one and rests with the advisor alone.[61]As conveyed by a recent statement of SEC Staff, clients do not generally possess a duty of inquiry in such circumstances: “The [Commission] Staff believes that it is the firm’s responsibility—not the customers’ — to reasonably ensure that any material conflicts of interest are fully, fairly and clearly disclosed so that investors may fully understand them.”[62]
The fiduciary is required to ensure that the disclosure is received by the client; the “access equals delivery” approach adopted by the Commission in connection with the delivery of a full prospectus to a consumer[63]would not likely qualify as an appropriate disclosure by a fiduciary investment adviser to her or his client of material facts.
Actual disclosure must occur, rather than readiness to disclose.[64]Constructive knowledge of the conflict of interest by the client is insufficient.[65]
Disclosure must be sufficient to obtain client understanding. The fiduciary must be aware of the client’s capacity to understand, and match the extent and form of the disclosure to the client’s knowledge base and cognitive abilities.[66]
 As stated in an early decision by the SEC:
[We] may point out that no hard and fast rule can be set down as to an appropriate method for registrant to disclose the fact that she proposes to deal on her own account. The method and extent of disclosure depends upon the particular client involved. The investor who is not familiar with the practices of the securities business requires a more extensive explanation than the informed investor. The explanation must be such, however, that the particular client is clearly advised andunderstandsbefore the completion of each transaction that registrant proposes to sell her own securities.” [Emphasis added.][67]
The disclosure must not be combined with attempts to unduly influence or coerce the client. Informed consent cannot be obtained through coercion nor sales pressure.[68]
Any disclosure must be clear and detailed enough for a client to make a reasonably informed decision to provide informed consent to such conflicts and practices or reject them.[69]
An adviser must provide the client with sufficiently specific facts so that the client is able to understand the adviser’s conflicts of interest and business practices well enough to make an informed decision.[70]The ramifications of the conflict of interest must be disclosed, so that the client understands the significance of the conflict of interest as it bears upon the client’s affairs.[71]
The disclosure must be frank. As stated by Justice Benjamin Cardoza: “If dual interests are to be served, the disclosure to be effective must lay bare the truth, without ambiguity of reservation, in all its stark significance ….”[72]
The disclosure must be full[73]and forthright. Even reasonably anticipated conflicts of interest must be disclosed.[74]However, an adviser disclosing that it “may” have a conflict is not adequate disclosure when the conflict actually exists.[75]
(B)  STEP TWO: Understanding by the Client, and the Client’s Grant of Informed Consent.
Following receipt of the disclosures provided, the client must achieve an understanding of the conflict of interest and its ramifications to the client, as well as an understanding of material facts disclosed. With such understanding, the client must then provide informed consent.[76]
Early on the U.S. Securities and Exchange Commission, and the courts, acknowledged that in applying the fiduciary requirements of the Advisers Act a client must provide informed consent.[77]Informed consent provides the client with the opportunity, should the client so choose, to waive the conflict of interest[78]If a conflict of interest is not avoided and does exist in a fiduciary relationship,[79]mere disclosure to the client of the conflict, followed by mere consent by a client to the breach of the fiduciary obligation, does not suffice.[80]
Under the law, it is not sufficient to create either a “waiver” of the client nor does it “estop” the client from pursuing a claim for breach of fiduciary duty under state securities statutes.[81]
Nor is disclosure sufficient to constitute a waiver or estoppel state common law.[82]Nor is disclosure sufficient to constitute waiver or estoppel under the Advisers Act.[83]If this were the case, fiduciary obligations – even core obligations of the fiduciary[84]– would be easily subject to waiver.[85]
The client must provide informed consent, not mere consent, in order for the consent to cure the conflict of interest and the potential for damage causes by such conflict.
Why is the tougher standard of informed consent, rather than mere consent, imposed? “By prohibiting all self-interested transactions and profit taking without a beneficiary’s informed consent – regardless of a fiduciary’s intent and irrespective of whether the beneficiary has suffered actual harm—fiduciary law eliminates a fiduciary’s incentives to abuse her position for her own gain.”[86]
To be informed consent, theconsent of the client must be “intelligent, independent and informed.”Generally, “fiduciary law protects the [client] by obligating the fiduciary to disclose all material facts, requiring an intelligent, independent consentfrom the [client], a substantively fair arrangement, or both.”[87][Emphasis added.].
A client’s informed consent can be either explicit or, depending on the facts and circumstances, implicit. However, it is not consistent with an adviser’s fiduciary duty to infer or accept client consent to a conflict where either (i) the facts and circumstances indicate that the client did not understand the nature and import of the conflict, or (ii) the material facts concerning the conflict could not be fully and fairly disclosed.[88]
For example, in some cases, conflicts may be of a nature and extent that it would be difficult to provide disclosure that adequately conveys the material facts or the nature, magnitude and potential effect of the conflict necessary to obtain informed consent and satisfy an adviser’s fiduciary duty. In other cases, disclosure may not be specific enough for clients to understand whether and how the conflict will affect the advice they receive. With some complex or extensive conflicts, it may be difficult to provide disclosure that is sufficiently specific, but also understandable, to the adviser’s clients. In all of these cases where full and fair disclosure and informed consent is insufficient, the adviser to eliminate the conflict or adequately mitigate the conflict so that it can be more readily disclosed.
Assuming full, frank and affirmative disclosure of a conflict of interest and its ramifications for the client, and assuming the client provides full consent, only provides a limited defense for the fiduciary against breach of fiduciary duty if the proposed transaction is also substantively fair to the client, as will be discussed in the next section. In other words, disclosure and informed consent do not terminate the fiduciary character of the relationship. Rather, the fiduciary remains subject to fiduciary duties and remains obligated to act loyally and with due care.[89]
(C)  STEP THREE: THE PROPOSED TRANSACTION MUST BE AND REMAIN SUBSTANTIVELY FAIR TO THE CLIENT
Even if the procedural safeguards of full, complete and affirmative disclosure leading to client understanding and to the client’s grant of informed consent all occur, a remaining mandatory substantive requirement exists– that the fiduciary deal fairly with the client.[90]This is because no client would be presumed to authorize a fiduciary to act in bad faith.[91]As stated by one court:
One of the most stringent precepts in the law is that a fiduciary shall not engage in self-dealing and when he is so charged, his actions will be scrutinized most carefully. When a fiduciary engages in self-dealing, there is inevitably a conflict of interest: as fiduciary he is bound to secure the greatest advantage for the beneficiaries; yet to do so might work to his personal disadvantage. Because of the conflict inherent in such transaction, it is voidable by the beneficiaries unless they have consented. Even then, it is voidable if the fiduciary fails to disclose material facts which he knew or should have known, if he used the influence of his position to induce the consent orif the transaction was not in all respects fair and reasonable.
[Emphasis added.][92]
In other words, at all times, the transaction must be substantively fair to the client. This last requirement looks not at the procedures undertaken, but rather casts view upon the transaction itself. It requires that, even if the previous steps involving disclosure, client understanding, and informed consent are followed, at all times the proposed transaction must be and remain substantively fair to the client. If this is not so, the courts will set aside the transaction between the fiduciary and the client.[93]
For example, if an alternative exists which would result in a more favorable outcome to the client, this would be a material fact which would be required to be disclosed, and a client who truly understands the situation would likely never gratuitously make a gift to the advisor where the client would be, in essence, harmed. 
In the absence of integrity and fairness in a transaction between a fiduciary and the client or beneficiary, it will be set aside or held invalid.[94] As stated by Professor Tamar Frankel, for decades the leading scholar onthe application of fiduciary law to investment advisers, “if the bargain is highly unfair and unreasonable, the consent of the disadvantaged party is highly suspect. Experience demonstrates that people rarely agree to terms that are unfair and unreasonable with respect to their interests.”[95]
(4)  Understanding the Distinction: The “Best Interests” vs. “Sole Interests” Fiduciary Standards.
The fiduciary standard of conduct is a tough standard, often called “the highest standard under the law.” How the fiduciary standard of conduct is applied (when it is found to exist) is surprisingly uniform. Yet, distinctions do exist in some contexts, such as between the regulatory regimes of state common law and the Advisers Act (applying a “best interests” fiduciary standard) and the regulatory regime of ERISA (applying, generally, a “sole interests” fiduciary standard, enhanced with prohibited transaction restrictions, as modified through class or other exemptions).
The Advisers’ Act fiduciary standard of conduct is generally described as a “best interests” fiduciary standard of conduct. The Advisers Act has always adopted the “best interests” standard[96]  as a codification of state common law applicable to relationships based upon trust and confidence.
In contrast, the “sole interests” standard of conduct found in trust law and (with some modification) under ERISA, is generally believed to be somewhat stricter, particularly with regard to the fiduciary’s obligations with respect to conflicts of interest. Generally, under state common law in which a “sole interests” standard is applied (generally, in trustee-beneficiary relationships), any form of self-dealing is essentially prohibited.[97]  [ERISA therefore has stricter prohibitions against self-dealing, and also possesses additional restrictions in the form of the prohibited transaction rules.]
(5)  Application of the Procedures: Principal Trading.
Principal trading is expressly permitted in limited circumstances under Section 206(3) of the Investment Advisers Act of 1940. However, under the express language of the statute, principal trades can only occur with full disclosure to the client in writing before the completion of the transaction of the capacity in which the investment adviser is acting and obtaining the consent of the client to such transaction.[98]The “ultimate goal” of Section 206(3) is to “prevent trades which are disadvantageous to clients of fiduciary advisors.”[99]
As the courts have stated:
“‘[W]hen a firm has a fiduciary relationship with a customer, it may not execute principal trades with that customer absent full disclosure of its principal capacity, as well as all other information that bears on the desirability of the transaction from the customer's perspective.’… Other authorities are in agreement. For example, the general rule is that an agent charged by his principal with buying or selling an asset may not effect the transaction on his own account without full disclosure which ‘must include not only the fact that the agent is acting on his own account, but also all other facts which he should realize have or are likely to have a bearing upon the desirability of the transaction, from the viewpoint of the principal.’”[100]
In an address entitled “The SEC and the Broker-Dealer” by Louis Loss, Chief Counsel, Trading and Exchange Division, U.S. Securities and Exchange Commission on March 16, 1948, before the Stock Brokers’ Associates of Chicago, the fiduciary duties arising under the Advisers Act, as applied in the Arleen Hughesrelease, were elaborated upon:
The doctrine of that case, in a nutshell, is that a firm which is acting as agent or fiduciary for a customer, rather than as a principal in an ordinary dealer transaction, is under a much stricter obligation than merely to refrain from taking excessive mark-ups over the current market. Its duty as an agent or fiduciary selling its own property to its principal is to make a scrupulously full disclosure of every element of its adverse interest in the transaction.
In other words, when one is engaged as agent to act on behalf of another, the law requires him to do just that. He must not bring his own interests into conflict with his client's.  If he does, he must explain in detail what his own self-interest in the transaction is in order to give his client an opportunity to make up his own mind whether to employ an agent who is riding two horses. This requirement has nothing to do with good or bad motive. In this kind of situation the law does not require proof of actual abuse. The law guards against the potentiality of abuse which is inherent in a situation presenting conflicts between self-interest and loyalty to principal or client. As the Supreme Court said a hundred years ago, the law ‘acts not on the possibility, that, in some cases the sense of duty may prevail over the motive of self-interest, but it provides against the probability in many cases, and the danger in all cases, that the dictates of self-interest will exercise a predominant influence, and supersede that of duty.’  Or, as an eloquent Tennessee jurist put it before the Civil War, the doctrine ‘has its foundation, not so much in the commission of actual fraud, but in that profound knowledge of the human heart which dictated that hallowed petition, 'Lead us not into temptation, but deliver us from evil,’ and that caused the announcement of the infallible truth, that 'a man cannot serve two masters.'’
This time-honored dogma applies equally to any person who is in a fiduciary relation toward another, whether he be a trustee, an executor or administrator of an estate, a lawyer acting on behalf of a client, an employee acting on behalf of an employer, an officer or director acting on behalf of a corporation, an investment adviseror any sort of business adviser for that matter, or a broker. The law has always looked with such suspicion upon a fiduciary's dealing for his own account with his client or beneficiary that it permits the client or beneficiary at any time to set aside the transaction without proving any actual abuse or damage. What the recent Hughes case does is to say that such conduct, in addition ‘to laying the basis for a private lawsuit, amounts to a violation of the fraud provisions under the securities laws: This proposition, as a matter of fact, is found in a number of earlier Commission opinions. The significance of the recent Hughes opinion in this respect is that it elaborates the doctrine and spells, out in detail exactly what disclosure is required when a dealer who has put himself in a fiduciary position chooses to sell his own securities to a client or buys the client's securities in his own name …
The nature and extent of disclosure with respect to capacity will vary with the particular client involved. In some cases use of the term ‘principal’ itself may suffice. In others, a more detailed explanation will be required. In all cases, however, the burden is on the firm which acts as fiduciary to make certain that the client understands …. [Emphasis added.] 
C.  THE DUTY TO AVOID UNREASONABLE COMPENSATION.
A fiduciary must not receive unreasonable compensation.
D.  ADDITIONAL FIDUCIARY DUTIES.
 “A comprehensive list of an adviser’s fiduciary duties is not found in either the common law or the Advisers Act.  However, duties of care and loyalty are among the basic fiduciary duties advisers are generally held to owe their clients, at a minimum.
Some authorities also list a duty of obedience.
Still others refer to a duty to act in good faith.
Other authorities cite to a duty of disclosure.[101]
1.   Duty of Confidentiality.
The Restatement (Third) of Agency §8.05(2) states that an agent has a duty “not to use or communicate confidential information of the principal for the agent’s own purposes or those of a third party.” While some legal commentators regard the duty of confidentiality as a separate duty, others believe it to be a subset of the duties of due care and loyalty.
2.     Is There a Fiduciary Duty to Disclose (Absent a Conflict of Interest?)
Does there exist, under the state common law applying fiduciary principles, a general duty “to disclose” material facts? Generally, no. Rather, the disclosure of material facts is seen as an element of the defense of the fiduciary when a conflict of interest exists.  In other words, where a conflict of interest exists, a duty of disclosure of that conflict of interest arises, along with other duties – including the need to undertake such disclosure thoroughly and affirmatively, and the necessity of obtaining the client’s informed consent.
However, Sect. 206(3) of the Advisers Act does impose an obligation of disclosure when investment advisers enter into principal trades with their clients. But, even then, a broad obligation of disclosure is not expressly set forth in the Advisers Act.
Notwithstanding the foregoing, the Commission has implemented a wide variety of specific disclosure obligations, even in situations where no conflict of interest exists. For example, inseeking to meet its duty of loyalty, the Commission has opined that an investment adviser must make full and fair disclosure to its clients of all material facts relating to the advisory relationship.[102]
Full and fair disclosure of all material facts that could affect an advisory relationship, including all material conflicts of interest between the adviser and the client, can help clients and prospective clients in evaluating and selecting investment advisers. Accordingly, the SEC requires advisers to deliver to their clients a “brochure,” under Part 2A of Form ADV, which sets out minimum disclosure requirements, including disclosure of certain conflicts.[103]Investment advisers are required to deliver the brochure to a prospective client at or before entering into a contract so that the prospective client can use the information contained in the brochure to decide whether or not to enter into the advisory relationship.[104]
“In Australian law, there is no distinct and freestanding fiduciary obligation requiring a fiduciary to disclose information to their principal … Despite the fact that fiduciaries, qua fiduciaries, owe no obligation of disclosure, questions of disclosure are often central in cases entailing fiduciary relationships … Given the significance of questions of disclosure in fiduciary cases, it is important to be clear about the role that disclosure plays in fiduciary law. The editors of Meagher, Gummow and Lehane’s Equity Doctrines and Remediesdescribe that role in the following terms:
If a person occupying a fiduciary position wishes to enter into a transaction which would otherwise amount to a breach of duty, he must, if he is to avoid liability, make full disclosure to the person to whom the duty is owed of all relevant facts known to the fiduciary, and that person must consent to the fiduciary’s proposal.
In other words, a breach of fiduciary obligation — either the obligation not to be in a position of conflict of interest and duty or the obligation not to make unauthorised profits—may be averted or cured by the consent of the principal to whom the obligation is owed, and the principal’s consent will be effective only if the fiduciary has first disclosed to the principal any relevant material information. Rather than constituting the discharge of a fiduciary obligation, disclosure which leads to informed consent confers on a fiduciary immunity from liability for the consequences of actions that would ordinarily amount to breaches of fiduciary obligation. And the immunity-conferring function of disclosure and informed consent provides a complete explanation of the role of disclosure in fiduciary law.”[105]



[1]SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963) (“SEC v. Capital Gains”). See also infra notes 26 - 32 and accompanying text; Investment Adviser Codes of Ethics, Investment Advisers Act Release No. 2256 (July 2, 2004); Compliance Programs of Investment Companies and Investment Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003) (“Compliance Programs Release”); Electronic Filing by Investment Advisers; Proposed Amendments to Form ADV, Investment Advisers Act Release No. 1862 (Apr. 5, 2000). We acknowledge that investment advisers also have antifraud liability with respect to prospective clients under section 206 of the Advisers Act.
[2]See SEC v. Capital Gains.
[3]I do not concur that broker-dealers and investment advisers always possess “different types of relationships with their customers and clients and have different models for providing advice.” For reasons explained herein, brokers can – are often are – held to broad fiduciary duties of due care, loyalty, and utmost good faith. Moreover, the Commission’s attempt to distinguish between continual, versus episodic, delivery of advice is not in accord with what actually occurs for many, if not most, customers of “full-service” broker-dealer firms. Accordingly, I have suggested these deletions from the SEC’s introduction.
[4]Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17 (1979) (“Transamerica Mortgage v. Lewis”) (“§ 206 establishes federal fiduciary standards to govern the conduct of investment advisers.”) (quotation marks omitted); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 471, n.11 (1977) (in discussing SEC v. Capital Gains, stating that the Supreme Court’s reference to fraud in the “equitable” sense of the term was “premised on its recognition that Congress intended the Investment Advisers Act to establish federal fiduciary standards for investment advisers”); SEC v. Capital Gainssupranote 2; Amendments to Form ADV, Investment Advisers Act Release No. 3060 (July 28, 2010) (“Investment Advisers Act Release 3060”) (“Under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,” citing Proxy Voting by Investment Advisers, Investment Advisers Act Release No. 2106 (Jan. 31, 2003) (“Investment Advisers Act Release 2106”)).
[5]See SEC v. Capital Gainssupranote 2 (discussing the history of the Advisers Act, and how equitable principles influenced the common law of fraud and changed the suits brought against a fiduciary, “which Congress recognized the investment adviser to be”).
[6]See SEC v. Capital Gains.
[7]See SEC v. Capital Gains (“The Advisers Act thus reflects a congressional recognition ‘of the delicate fiduciary nature of an investment advisory relationship,’ as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser -- consciously or unconsciously -- to render advice which was not disinterested.” and also noting that the “declaration of policy” in the original bill, which became the Advisers Act, declared that “the national public interest and the interest of investors are adversely affected when the business of investment advisers is so conducted as to defraud or mislead investors, or to enable such advisers to relieve themselves of their fiduciary obligations to their clients. It [sic] is hereby declared that the policy and purposes of this title, in accordance with which the provisions of this title shall be interpreted, are to mitigate and, so far as is presently practicable to eliminate the abuses enumerated in this section” (citing S. 3580, 76th Cong., 3d Sess., § 202 and Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, Pursuant to Section 30 of the Public Utility Holding Company Act of 1935, on Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 28). See also In the Matter of Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (“Arleen Hughes”) (discussing the relationship of trust and confidence between the client and a dual registrant and stating that the registrant was a fiduciary and subject to liability under the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act).
[8]SEC v. Capital Gains, supranote 2; Transamerica Mortgage v. Lewis, supranote 10 (“[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.”).
[9]U.S. courts have in large part adopted the view of fiduciary obligations as resting upon “the triads of their fiduciary duty—good faith, loyalty or due care.” SeeIn re Alh Holdings LLC, 675 F.Supp.2d 462, 477 (D. Del., 2009). In the context of corporate directors’ fiduciary duties, dictum in Cede & Co. v. Technicolor, Inc., the Delaware Supreme Court announced for the first time that corporate directors owe a “triad” of fiduciary duties, including not only the traditional duties of loyalty and care, but a third duty of “good faith.” 634 A.2d 345, 361 (Del. 1993) (emphasis omitted). See, e.g.,Melvin A. Eisenberg, The Duty of Good Faith in Corporate Law, 31 Del. J. Corp. L. 1, 11 (2006) (“In short, the duty of good faith has long been both explicit and implicit in corporation statutes and implicit in case law. Recently, it has become explicit in case law as well.”); Hillary A. Sale, Delaware’s Good Faith, 89 Cornell L. Rev. 456, 494 (2004) (advocating the need for “a separate good faith duty” to address “those outrageous and egregious abdications of fiduciary behavior that are not simply the results of bad process or conflicts”).
But not all scholars believe that a separate duty of utmost good faith exists. See, e.g., Christopher M. Bruner, Good Faith, State of Mind, and the Outer Boundaries of Director Liability in Corporate Law, 41 Wake Forest L. Rev. 1131 (2006); Andrew S. Gold, The New Concept of Loyalty in Corporate Law, 43 U.C. Davis L. Rev. 457 (2009); Andrew C.W. Lund, Opting Out of Good Faith, 37 Fla. St. U. L. Rev. ___ (2010)
However, often the duty of “utmost good faith” is merged into the other two duties. For example, in the context of fiduciary duties arising for certain actors in corporations, one court explained: “A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.” Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362 (Del. 2006) at text surrounding footnote 26 (footnote omitted). This same court concluded that the duty of good faith is essentially a subset of the duty of loyalty.
[10]Public Comments from Retail Investors and Other Interested Parties on Standards of Conduct for Investment Advisers and Broker-Dealers, Chairman Jay Clayton (June 1, 2017), available at https://www.sec.gov/news/public-statement/statement-chairman-clayton-2017-05-31 (“Chairman Clayton’s Request for Public Input”).
[11]See, e.g.,Comment letter of the Investment Adviser Association (Aug. 31, 2017) (“IAA Letter”) (“The well-established fiduciary duty under the Advisers Act, which incorporates both a duty of loyalty and a duty of care, has been applied consistently over the years by courts and the SEC.”); Comment letter of the Consumer Federation of America (Sept. 14, 2017) (“an adviser’s fiduciary obligation ‘divides neatly into the duty of loyalty and the duty of care.’ The duty of loyalty is designed to protect against ‘malfeasance,’ or wrongdoing, on the part of the adviser, while the duty of care is designed to protect against ‘nonfeasance,’ such as neglect.”).
[12]Arthur B. Laby, The Fiduciary Obligations as the Adoption of Ends, 56 Buffalo Law Review 99 (2008). See also Restatement (Third) of Agency, §2.02 Scope of Actual Authority (2006) (describing a fiduciary’s authority in terms of the fiduciary’s reasonable understanding of the principal’s manifestations and objectives).
[13]Investment Advisers Act Release 3060 (adopting amendments to Form ADV and stating that “under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,” citing Investment Advisers Act Release 2106 supra note 10); SEC v. Tambone, 550 F.3d 106, 146 (1st Cir. 2008) (“Section 206 imposes a fiduciary duty on investment advisers to act at all times in the best interest of the fund and its investors.”); SEC v. Moran, 944 F. Supp. 286 (S.D.N.Y 1996) (“Investment advisers are entrusted with the responsibility and duty to act in the best interest of their clients.”). See also In re Prudential Ins. Co. of America Sales Prac., 975 F.Supp. 584, 616 (D.N.J., 1996) (“An essential feature and consequence of a fiduciary relationship is that the fiduciary becomes bound to act in the interests of her beneficiary and not of herself.”)
[14]Some commenters on Chairman Clayton’s Request for Public Input and other SEC requests for comment on the fiduciary standard of comment also stated that an adviser’s fiduciary duty could not be disclosed away. See, e.g., IAA Letter (“While disclosure of conflicts is crucial, it cannot take the place of the overarching duty of loyalty. In other words, an adviser is still first and foremost bound by its duty to act in its client’s best interest and disclosure does not relieve an adviser of this duty.”); Comment letter of AARP (Sept. 6, 2017) (“Disclosure and consent alone do not meet the fiduciary test.”); Financial Planning Coalition Letter (July 5, 2013) responding to SEC Request for Data and Other Information, Duties of Brokers, Dealers, and Investment Advisers, Exchange Act Release No. 69013 (Mar. 1, 2013) (“Financial Planning Coalition 2013 Letter”) (“[D]isclosure alone is not sufficient to discharge an investment adviser’s fiduciary duty; rather, the key issue is whether the transaction is in the best interest of the client.”) (internal citations omitted). See alsoRestatement (Third) of Agency, § 8.06 Principal’s Consent (2006) (“The law applicable to relationships of agency as defined in § 1.01 imposes mandatory limits on the circumstances under which an agent may be empowered to take disloyal action. These limits serve protective and cautionary purposes. Thus, an agreement that contains general or broad language purporting to release an agent in advance from the agent’s general fiduciary obligation to the principal is not likely to be enforceable. This is because a broadly sweeping release of an agent’s fiduciary duty may not reflect an adequately informed judgment on the part of the principal; if effective, the release would expose the principal to the risk that the agent will exploit the agent’s position in ways not foreseeable by the principal at the time the principal agreed to the release. In contrast, when a principal consents to specific transactions or to specified types of conduct by the agent, the principal has a focused opportunity to assess risks that are more readily identifiable.”); Tamar Frankel, Arthur Laby & Ann Schwing, The Regulation of Money Managers (updated 2017) (“The Regulation of Money Managers”) (“Disclosure may, but will not always, cure the fraud, since a fiduciary owes a duty to deal fairly with clients.”).
[15]See Investment Advisers Act Release No. 2106 (stating that under the Advisers Act, “an adviser is a fiduciary that owes each of its clients duties of care and loyalty with respect to all services undertaken on the client's behalf, including proxy voting,” which is the subject of the release, and citing SEC v. Capital Gains supra note 2, to support this point). See alsoRestatement (Third) of Agency, §8.08 (discussing the duty of care that an agent owes its principal as a matter of common law); The Regulation of Money Managers, (“Advice can be divided into three stages. The first determines the needs of the particular client. The second determines the portfolio strategy that would lead to meeting the client’s needs. The third relates to the choice of securities that the portfolio would contain. The duty of care relates to each of the stages and depends on the depth or extent of the advisers’ obligation towards their clients.”).
[16]See, e.g., Suitability of Investment Advice Provided by Investment Advisers; Custodial Account Statements for Certain Advisory Clients, Investment Advisers Act Release No. 1406 (Mar. 16, 1994) (“Investment Advisers Act Release 1406”) (stating that advisers have a duty of care and discussing advisers’ suitability obligations); Securities; Brokerage and Research Services, Exchange Act Release No. 23170 (Apr. 23, 1986) (“Exchange Act Release 23170”) (“an adviser, as a fiduciary, owes its clients a duty of obtaining the best execution on securities transactions.”).
[17]Scholars generally presume that the duty to act in the “best interests” of the client invokes, primarily, the fiduciary duty of loyalty. However, at times the term “best interests” is also utilized to describe the duty of due care. See, e.g., Julian Velasco, A Defense of the Corporate Law Duty of Care, 40 J. of Corporation Law 646, 649 (2015) [“the duty of care is necessary to let fiduciaries know that they have a legal duty to pursue the beneficiaries' interests with skill and diligence (i.e., carefully)”].
[18]The suitability standard applicable to broker-dealers has been applied to investment advisers. In 1994, the SEC proposed a rule that would make express the fiduciary obligation of investment advisers to make only suitable recommendations to a client. Investment Advisers Act Release 1406. Although never adopted, the rule was designed, among other things, to reflect the Commission’s interpretation of an adviser’s existing suitability obligation under the Advisers Act. The SEC has stated its belief that this obligation, when combined with an adviser’s fiduciary duty to act in the best interest of its client, requires an adviser to provide investment advice that is suitable for and applying the requisite level of expertise, due diligence and skill.
However, by no means is suitability the standard by which an investment adviser’s due care should be judged. Suitability remains only a small part of an investment adviser’s fiduciary obligation of due care. As the SEC has previously stated, investment advisers owe their clients the duty to provide suitable investment advice. SeeSEC's "Staff Study on Investment Advisers and Broker-Dealers - As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act" (Jan. 21, 2011), pp.27-8 (available at http://sec.gov/news/studies/2011/913studyfinal.pdf.),quotingSuitability of Investment Advice Provided by Investment Advisers, Investment Advisers Act Release No. 1406 (Mar. 16, 1994) (proposing a rule under the Advisers Act Section 206(4)'s antifraud provisions that would expressly require advisers to give clients only suitable advice; the rule would have codified existing suitability obligations of advisers). However, the due diligence burdens on an investment adviser under the duty of due care extend much further than the duties imposed under the suitability standard.
[19]Ross Jordan, Note, Thinking Before Rulemaking: Why the SEC Should Think Twice Before Imposing a Uniform Fiduciary Standard On Broker-Dealers and Investment Advisers, 50 U. Louisville L. Rev. 491(2012). [“The confusion surrounding the meaning of "acting in the client's best interest," or the best interest standard, is due to the SEC's inconsistent interpretation of an adviser's duty of care under the Advisers Act. As noted by Professor Barbara Black, following the holding in Capital Gains, the best interest standard was viewed as one part of an adviser's duty of loyalty to disclose conflicts of interest, as opposed to being part of an adviser's duty of care. However, after a while, the SEC began referring to the best interest standard in the context of the quality of an adviser's investment advice, instead of an adviser's disclosure obligations. Essentially, the Commission began describing the best interest standard as part of an adviser's duty of care-to manage the client's portfolio in the best interest of the client-rather than part of an adviser's duty of loyalty to disclose conflicts of interest.] [Citations omitted.]
[20]Investment Advisers Act Release 1406. After making a reasonable inquiry into the client’s investment profile, it generally would be reasonable for an adviser to rely on information provided by the client (or the client’s agent) regarding the client’s financial circumstances, and an adviser should not be held to have given advice not in its client’s best interest if it is later shown that the client had misled the adviser.
[21]The SEC noted that Item 8 of Part 2A of Form ADV requires an investment adviser to describe its methods of analysis and investment strategies and disclose that investing in securities involves risk of loss which clients should be prepared to bear. This item also requires that an adviser explain the material risks involved for each significant investment strategy or method of analysis it uses and particular type of security it recommends, with more detail if those risks are significant or unusual.
[22]It is well known that, on average, mutual fund returns are negatively related to fund expense ratios. [22]See Brad M. Barber, Terrance Odean, and Lu Zheng, Out of Sight, Out of Mind: The Effects of Expenses on Mutual Fund Flows(2003) (analyzing new money flowing into mutual funds from 1970 through 1999) (“Though there is no discernible relationship between performance and expenses for the majority of funds, investors clearly pay a large price for investing in funds with the highest expenses. These funds underperform by an economically large margin (26 to 37 basis points per month).” [Emphasisin original.]
Moreover, the presence of other fund costs – transaction and opportunity costs within the fund – also can lead to underperformance by stock mutual funds. While different academic studies debate the actual net impact of fees and costs, a substantial majority of the academic studies reveals that fees and costs, whatever form they take, negatively impact investors’ returns.  These academic conclusions run contrary to the understanding of many individual investors, who often assume that higher fund fees lead to improved performance. A Forbes Magazine survey found that eighty-four percent of the surveyed investors believed that higher fund expenses result in higher performance by the fund. Neil Weinberg, Fund Managers Know Best: As Corporations are Fessing Up to Investors, Mutual Funds Still Gloss Over Costs, Forbes Magazine, Oct. 14, 2002, at 220.
In essence, the higher the fees and costs of a mutual fund, the lower its likely returns will be (on average) when compared to other similar mutual funds. Mark Carhart finds that net returns are negatively correlated with expense levels, which are generally much higher for actively managed funds. Worse, Carhart finds that the more actively a mutual fund manager trades, the lower the fund's benchmark-adjusted net return to investors.  Carhart, Mark, “On persistence in mutual fund performance,” Journal of Finance 52, 57–82 (1997). A more recent paper also highlights the important of keeping costs low.  “The more rigorous academic studies find that annual expense ratios generally detract from fund performance (see, for example, Elton, Gruber, Das and Hlavka (1993), Gruber (1996), and Carhart (1997)). On average, fund managers are unable to recoup the expenses that funds pay via better performance. Wermers (2000) finds that the underlying equity holdings of equity mutual funds do outperform the market, but that cash drag, annual expenses and transaction costs more than offset this outperformance. These findings suggest that basing fund investment decisions at least partially on fees is wise. Lower cost funds have a smaller drag on performance that active managers must overcome. Taken to their logical conclusion, these results may suggest that index funds, accompanied by the lowest expense ratios in the mutual fund industry, are a more logical long-run investment choice than more expensive actively-managed funds.”  Karceski, Livingston, and O’Neal, “Portfolio Transaction Costs at U.S. Equity Mutual Funds” (2004), available at http://www.zeroalphagroup.com/news/Execution_CostsPaper_Nov_15_2004.pdf
Moreover, it is not just the annual expense ratio of a fund that matters; large portfolio transaction costs in a mutual fund can consume a large portion of the mutual fund’s potential gross returns. Professor Ian Domowitz considered the impact of mutual fund transaction costs and provided a hypothetical example of their impact.  “Consider, for example, an equally weighted global portfolio of stocks. Over 1996:3 through 1998:3, one-way total trading costs for this portfolio average 71 basis points (bps).  If the portfolio turns over twice a year, 285 bps in total costs are incurred. Average annual portfolio return over the period is 1228 bps. On this basis, trading costs alone account for 23 percent of returns.”  Domowitz, Ian, “Liquidity, Transaction Costs, and Reintermediation in Electronic Markets” (2001), available at http://www.smeal.psu.edu/ebrc/publications/res_papers/2001_04.pdf
[23]Most individual investors don’t know the fees and costs associated with their investments. For example, a 2004 survey by AARP found that “more than 80 percent of defined contribution pension participants would be categorized as self-reporting that they did not know how much they were paying in fees.”[23]
[24]However, the impact of fees and costs should not be overlooked, and should be considered a primary factor in choosing pooled investment vehicles, with a stronger weight afforded to this factor than other factors. Many have observed that fees and costs in pooled investment vehicles are the most important factor in determining future returns. See, e.g.,Russel Kinnel, Fund Fees Predict Future Success or Failure, Morningstar (May 5, 2016) (“If you've been following Morningstar's research for long, you know how important we think expense ratios are to the fund selection equation. The expense ratio is the most proven predictor of future fund returns. We find that it is a dependable predictor when we run the data. That's also what academics, fund companies, and, of course, Jack Bogle, find when they run the data.”)
As fiduciaries, investment advisers must weigh the expected benefits that may result from a higher-cost investment product. For example, two mutual funds may hold very similar assets, but a higher-cost tax-managed version of the fund may result in a greater net return for the client when taxes are considered. Or a higher-cost fund may provide an investor’s exposure to a different asset class (such as emerging markets) where the cost of operating the mutual fund may be generally greater, and exposure to the asset class may be desired due to such factors as higher returns and/or a lowering of risk (of which there exists many forms) for the portfolio as a whole.
Investment advisers should exercise a high degree of caution in utilizing past performance as a substantial factor in their selection, where the investment product possesses higher fees and costs. For example, it may be asked whether higher fees are justified when past returns (adjusting for style differences) of a selected fund are superior. Substantial academic evidence reveals that past performance is seldom, alone, a predictor of future long-term results for stock mutual funds. As one recent academic paper asserts, “more than half of the best funds are simply lucky … [and] only a tiny fraction of 2.1% of all funds yield truly positive alphas.” L. Barras, O. Scaillet, and R. Wermers, “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas” (2006).
[25]See discussion of the limited role disclosure plays, and the necessity for both informed consent and that the transaction be substantively fair to the client. Recommending a higher-cost share class of a mutual fund, when a lower-cost share class is available, would be a breach of the advisers’ fiduciary duties of due care and loyalty. The higher share class will possess lower returns for the client. Disclosure does not cure this breach of fiduciary duty, as explained elsewhere herein. No client would ever provide informed consent to be harmed. Clients who are informed, and who have achieved true understanding of the conflict of interest posed in this situation – and understanding of its impact upon the clients’ returns – would never consent to such a transaction. Clients are simply not so gratuitous to their investment adviser, at their own expense.
[26]While the duty of due diligence is a high one, it is not without boundaries.  For example, “ERISA imposes the highest standard of conduct known to law on fiduciaries of employee pension plans. Reich v. Valley National Bank of Arizona, 837 F.Supp. 1259, 1273 (S.D.N.Y.1993), quoting Donovan v. Bierwirth, 680 F.2d 263 (2nd Cir.1982); Kuper v. Iovenko, 66 F.3d 1447, 1453 (6th Cir.1988). However, this is not equivalent to a standard of absolute liability, as ERISA fiduciaries are only required to exercise prudence, not prescience or omniscience. Frahm v. Equitable Life Assurance Society of the United States, 137 F.3d 955, 960 (7th Cir.1998); DeBruyne v. Equitable Life Assurance Society of the United States, 920 F.2d 457, 465 (7th Cir.1990).”  Keach v. U.S. Trust Co. N.A., 313 F.Supp.2d 818, 863 (C.D. Ill., 2004).
Another case “addressed, in the context of determining liability under federal securities laws, whether an investment advisor has a duty to investigate the accuracy of statements made in an offering memorandum not prepared by itself and which its client relies upon in making an investment. The court declined to impose such a duty "when there is nothing that is obviously suspicious about those statements.”  Fraternity Fund v. Beacon Hill Asset, 376 F.Supp.2d 385, 413 (S.D.N.Y., 2005), citing Gabriel Capital, L.P. v. Natwest Finance, Incorporated, 137 F.Supp.2d 251, 262 (S.D.N.Y.2000).  ("An investment advisor is retained to suggest appropriate investments for its clients, but is not required to assume the role of accountant or private investigator and conduct a thorough investigation of the accuracy of the facts contained in the documents that it analyzes for the purpose of recommending an investment.”).  Id.at 263.  Of course, if a representation is made that the accuracy of documents will be verified, then such a duty of due diligence, voluntarily assumed by the investment adviser, will likely exist.  See Fraternity Fundat p.415 (“Here, however, Asset Alliance allegedly represented to Sanpaolo that it ‘ensure[d] that the portfolios’ marks are consistent with market values.’ By making this representation, Asset Alliance took on a duty to review and check Beacon Hill's prices.”).
[27]See, e.g., Concept Release on the U.S. Proxy System, Investment Advisers Act Release No. 3052 (July 14, 2010) (stating “as a fiduciary, the proxy advisory firm has a duty of care requiring it to make a reasonable investigation to determine that it is not basing its recommendations on materially inaccurate or incomplete information”).
[28]SeeIn the Matter of Larry C. Grossman, Investment Advisers Act Release No. 4543 (Sept. 30, 2016) (Commission opinion) (imposing liability on a principal of a registered investment adviser for recommending offshore private investment funds to clients without a reasonable independent basis for his advice).
[29]Sound criteria should be established to guide the investment adviser’s decision-making. For example, if an investment adviser were to adopt a process that ignores the relative fees and costs of the products to be recommended, substantive due care – in this instance – the exercise of informed and good judgment – has not been undertaken. While adherence to a proper process is necessary, at each step along the process the investment adviser is required to act prudently. In other words, the investment adviser must at all times exercise good judgment, applying his or her education, skills, and expertise to the issue at hand. Simply following a prudent process is not enough if prudent good judgment (and the investment adviser’s requisite knowledge, expertise and experience) is not applied as well, both in the creation of the process and at each stage of applying the process.
[30]The standard of prudence is relational, and it follows that the standard of care for investment advisers is the standard of a prudent investment adviser.  By way of explanation, the standard of care for professionals is that of prudent professionals; for amateurs, it is the standard of prudent amateurs. For example, Restatement of Trusts 2d § 174 (1959) provides: "The trustee is under a duty to the beneficiary in administering the trust to exercise such care and skill as a man of ordinary prudence would exercise in dealing with his own property; and if the trustee has or procures his appointment as trustee by representing that he has greater skill than that of a man of ordinary prudence, he is under a duty to exercise such skill." Case law strongly supports the concept of the higher standard of care for the trustee representing itself to be expert or professional.  SeeAnnot., “Standard of Care Required of Trustee Representing Itself to Have Expert Knowledge or Skill”, 91 A.L.R. 3d 904 (1979) & 1992 Supp. at 48-49.
[31]Expert witnesses in cases involving financial and investment advisers often turn to the standards adopted by various organizations, such as the Certified Financial Planner Board of Standards, Inc., the CFA Institute, and the AICPA’s Personal Financial Planning division. Generally, evidence of industry standards, customs and practices is “often highly probative when defining a standard of care.” 57A Am.Jur.2d Negligence § 185 (2002). Such evidence may be relevant and admissible to aid the trier of fact in determining the standard of care in a negligence action “even though the standards have not been imposed by statute or promulgated by a regulatory body and therefore do not have the force of law.” Ruffiner v. Material Serv. Corp., 506 N.E.2d 581, 584 (1987); Elledge v. Richland/Lexington School District Five, 534 S.E.2d 289, 291 (Ct. App. S.C. 2000).
[32]SeeCommission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Exchange Act Release No. 54165 (July 18, 2006) (stating that investment advisers have “best execution obligations”); Investment Advisers Act Release 3060 (discussing an adviser’s best execution obligations in the context of directed brokerage arrangements and disclosure of soft dollar practices). See alsoAdvisers Act rule 206(3)-2(c) (referring to adviser’s duty of best execution of client transactions).
[33]See SEC v. Capital Gains(describing advisers’ “basic function” as “furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments” (quoting Investment Trusts and Investment Companies, Report of the Securities and Exchange Commission, Pursuant to Section 30 of the Public Utility Holding Company Act of 1935, on Investment Counsel, Investment Management, Investment Supervisory, and Investment Advisory Services, H.R. Doc. No. 477, 76th Cong. 2d Sess., 1, at 28)). Cf.Barbara Black, Brokers and Advisers-What’s in a Name?, 32 Fordham Journal of Corporate and Financial Law XI (2005) (“[W]here the investment adviser’s duties include management of the account, [the adviser] is under an obligation to monitor the performance of the account and to make appropriate changes in the portfolio.”); Arthur B. Laby, Fiduciary Obligations of Broker-Dealers and Investment Advisers, 55 Villanova Law Review 701, at 728 (2010) (“Laby Villanova Article”) (“If an adviser has agreed to provide continuous supervisory services, the scope of the adviser’s fiduciary duty entails a continuous, ongoing duty to supervise the client’s account, regardless of whether any trading occurs. This feature of the adviser’s duty, even in a non-discretionary account, contrasts sharply with the duty of a broker administering a non-discretionary account, where no duty to monitor is required.”) (internal citations omitted).
[34]SeeLaby Villanova Article, supranote 36, at 728 (2010) (stating that the scope of an adviser’s activity can be altered by contract and that an adviser’s fiduciary duty would be commensurate with the scope of the relationship).
[35]“What generally sets the fiduciary apart from other agents or service providers is a core duty, when acting on the principal’s behalf, to adopt the objectives or ends of the principal as the fiduciary’s own.” Arthur B. Laby, SEC v. Capital Gains Research Bureau and the Investment Advisers Act of 1940, 91 Boston Univ. L.Rev. 1051, 1055 (2011).
[36]Under English law, from which American law is derived, the broad fiduciary duty of loyalty includes these three separate rules:
1)      The “No Conflict” Rule:A fiduciary must not place itself in a position where its own interests conflict with those of its client.
2)      The “No Profit” Rule: A fiduciary must not profit from its position at the expense of the client. This aspect of the fiduciary duty of loyalty is often considered a prohibition against self-dealing.  
3)      The “Undivided Loyalty” Rule:A fiduciary owes undivided loyalty to its client and therefore must not place itself in a position where his or her duty toward one client conflicts with a duty that it owes to another client.
These separate rules are alive and well in the United States.
[37]In the Matter of Dawson-Samberg Capital Management, Inc., now known as Dawson-Giammalva Capital Management, Inc. and Judith A. Mack, Advisers Act Release No. 1889 (August 3, 2000), citing SEC v.Capital Gains Research Bureau, 375 U.S. at 191-92.
[38]SeeCommission Guidance Regarding the Duties and Responsibilities of Investment Company Boards of Directors with Respect to Investment Adviser Portfolio Trading Practices, Release Nos. 34-58264; IC-28345 (July 30, 2008), at 23: “Second, investment advisers, as fiduciaries, generally are prohibited from receiving any benefit from the use of fund assets ….”
[39]The SEC has brought numerous enforcement actions against advisers that unfairly allocated trades to their own accounts and allocated less favorable or unprofitable trades to their clients’ accounts. See, e.g., SEC v. Strategic Capital Management, LLC and Michael J. Breton, Litigation Release No. 23867 (June 23, 2017) (partial settlement) (adviser placed trades through a master brokerage account and then allocated profitable trades to adviser’s account while placing unprofitable trades into the client accounts.).
[40]It has long been the Commission’s position that the “an investment adviser must not effect transactions in which he has a personal interest in a manner that could result in preferring his own interest to that of his advisory clients.”  SEC Rel. No. IA-1092, October 8, 1987, 52 F.R. 38400, citingKidder, Peabody & Co., Inc.,43 S.E.C. 911, 916 (1968).
[41]SeeInvestment Advisers Act Release 3060 (“Under the Advisers Act, an adviser is a fiduciary whose duty is to serve the best interests of its clients, which includes an obligation not to subrogate clients’ interests to its own,” citingInvestment Advisers Act Release 2106 supra note 9). See also Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011), available at https://www.sec.gov/news/studies/2011/913studyfinal.pdf(“913 Study”).
[42]See alsoBarry Barbash and Jai Massari, The Investment Advisers Act of 1940; Regulation by Accretion, 39 Rutgers Law Journal 627 (2008) (stating that under section 206 of the Advisers Act and traditional notions of fiduciary and agency law an adviser must not give preferential treatment to some clients or systematically exclude eligible clients from participating in specific opportunities without providing the clients with appropriate disclosure regarding the treatment).
[43]While this statement may appear harsh to some commentators, it is reflective of the vast disparity of knowledge and expertise between the investment adviser and the client, and also reflects the important public policy reasons that support the imposition of the fiduciary standard upon investment advisers. The investment adviser-client relationship is closely analogous to the attorney-client relationship.See, e.g.,Julia Smith, Out with “TCF” and in with “fiduciary”?, Butterworths Journal of International Banking and Financial Law (June 2012), P.344 [U.K.] [“On 23 February 2012, the FSCP proposed an amendment to the Financial Services Bill because: “Customers of banks should be owed the same fiduciary duty as those seeking the advice of a lawyer or an MP, with providers prohibited from profiting from conflicts of interest at the expense of their customers…The new Financial Conduct Authority (FCA) should be given powers to make rules to ensure that the industry would have to take their customers’ interests into account when designing products and providing advice.”]
Similar to the fiduciary duties imposed upon an attorney-at-law, the investment adviser’s fiduciary standard also treats the maintenance of conflicts of interest severely. “Conflicts of interest are broadly condemned throughout the legal profession because of their potential to interfere with the undivided loyalty that a lawyer owes to his or her client. The representation of adverse interests can likewise quickly erode the bond of trust between the attorney and his or her client.” Matthew R. Henderson, Chapter 7, “Breach of Fiduciary Duty,” Attorneys Legal Liability (2012), at p.7-8.
[44]In the Matter of Dawson-Samberg Capital Management, Inc., now known as Dawson-Giammalva Capital Management, Inc. and Judith A. Mack, Advisers Act Release No. 1889 (August 3, 2000), citing SEC v.Capital Gains Research Bureau, 375 U.S. at 191-92.
[45]SEC vs. Capital Gains. at p.___, fn. 50, citing United States v. Mississippi Valley Co., 364 U.S. 520, 550, n. 14
[46]Financial Planning Association v. Securities and Exchange Commission, No. 04-1242 (D.C. Cir. 3/30/2007) (D.C. Cir., 2007),citing SEC vs. Capital Gainsat 187.
[47]“When a conflict exists for fiduciaries of a retirement plan that is governed by ERISA, two distinct sets of ERISA requirements are implicated: (1) the rules governing breaches of fiduciary duty found in ERISA §404(a) and (2) the prohibited transaction rules in ERISA §§406(a) and (b) … Fiduciaries are obligated under ERISA’s fiduciary responsibility rules to (1) identify conflicts (or potential conflicts) that may impact the management of a plan; (2) evaluate those conflicts and the impact they may have on the plan and its participants; (3) determine whether the conflicts will adversely impact the plan; (4) consider protections that would protect the plan and participants from any potential adverse effect of the conflict (for instance, appointing an independent fiduciary to evaluate the investment or proposed service provider) and; (5) if the conflict adversely impacts the plan and its participants, change service providers, investments or other circumstances related to the conflict.
Although a conflict of interest may exist in connection with a proposed transaction, entering into the transaction may or may not be a breach of fiduciary duty – the determining factors are whether the fiduciary prudently evaluates the conflict, and acts solely in the interest of the participants and for the exclusive purpose of providing benefits. If material adverse impact on the participants cannot be avoided or properly mitigated, entering into the transaction would not be prudent and would trigger a fiduciary breach.
Furthermore, if a conflict of interest is precluded under ERISA's prohibited transaction rules, the fiduciaries cannot, as a matter of law, allow the plan to become a party to the transaction – even if the action were otherwise reasonable or profitable to the plan.”  C. Frederick Reish And C. Faucher, The Fiduciary Duty to Avoid Conflicts of Interest in Selecting Plan Service Providers (April 2009), available at http://www.reish.com/publications/pdf/whitepprmar09.pdf.
[48]“Avoidance is perhaps the best solution to conflict situations. Persons having a duty to exercise judgment in the interest of another must avoid situations in which their interests pose an actual or potential threat to the reliability of their judgment. Although avoidance of conflict situations is an important duty of decision-makers, a flat prescription to avoid all conflicts of interest is not only mistaken, but also unworkable. On the one hand, not all conflicts of interest are avoidable. Some conflict situations are embedded in the relation, while others occur independently of decision-maker’s will.” Fiduciary Duties and Conflicts of Interest: An Inter-Disciplinary Approach (2005), at p.20, available at http://eale.org/content/uploads/2015/08/fiduciary-duties-and-conflicts-of-interestaugust05.pdf.
[49]“The federal securities laws and FINRA rules restrict broker-dealers from participating in certain transactions that may present particularly acute potential conflicts of interest.  For example, FINRA rules generally prohibit a member with certain ‘conflicts of interest’ from participating in a public offering, unless certain requirements are met.  FINRA members also may not provide gifts or gratuities to an employee of another person to influence the award of the employer’s securities business.  FINRA rules also generally prohibit a member’s registered representatives from borrowing money from or lending money to any customer, unless the firm has written procedures allowing such borrowing or lending arrangements and certain other conditions are met.  Moreover, the Commission’s Regulation M generally precludes persons having an interest in an offering (such as an underwriter or broker-dealer and other distribution participants) from engaging in specified market activities during a securities distribution.  These rules are intended to prevent such persons from artificially influencing or manipulating the market price for the offered security in order to facilitate a distribution.”  SEC’s “Staff Study on Investment Advisers and Broker-Dealers - As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act” (Jan. 21, 2011), pp.58-9 (available at http://sec.gov/news/studies/2011/913studyfinal.pdf.) (Citations omitted.)  “FINRA rules also establish restrictions on the use of non-cash compensation in connection with the sale and distribution of mutual funds, variable annuities, direct participation program securities, public offerings of debt and equity securities, and real estate investment trust programs. These rules generally limit the manner in which members can pay for or accept non-cash compensation and detail the types of non-cash compensation that are permissible.”  Id.at p.68.
[50]SeeIn the Matter of Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948, at 4 and 8, stating: “Since loyalty to his trust is the first duty which a fiduciary owes to his principal, it is the general rule that a fiduciary must not put himself into a position where his own interests may come in conflict with those of his principal. To prevent any conflict and the possible subordination of this duty to act solely for the benefit of his principal, a fiduciary at common law is forbidden to deal as an adverse party with his principal. An exception is made, however, where the principal gives his informed consent to such dealings ….” 
[51]See, e.g.,comment letter of the Committee on Investment Management Regulation of the New York City Bar, dated June 26, 2018, stating in pertinent part: “[T]he Supreme Court rejected the idea proposed by some that an investment adviser must eliminate all conflicts of interest with its clients. That was a pragmatic recognition by the Court of the complexities of the operations of contemporary investment advisers, which provide many types of services and products to clients that implicate the adviser's resources and services but that could be deemed to give rise to actual or potential conflicts of interest.” For reasons set forth later in my comment letter, this conclusion is based upon a substantially incorrect interpretation of SEC vs. Capital Gains.
[52]Tuch, Andrew, “The Paradox of Financial Services Regulation: Preserving Client Expectations of Loyalty in an Industry Rife with Conflicts of Interest” (January 2008) (Australia) (noting “When an investment bank performs one of its traditional functions – underwriting securities offerings or providing financial advisory services to clients involved in mergers, acquisitions and other strategic transactions – it may under general law be a fiduciary of its client and thereby be required to avoid positions of conflict without its client’s informed consent. Yet the conglomerate structure of the firm may make conflicts of interest an inescapable feature of its doing business.”
[53]Under the Restatement (Third) of Agency, Section 8.06 allows an agent to obtain its principal’s consent to conduct by the agent that would otherwise be a breach of duty under one of sections 8.01 to 8.05. But, the agent is subject to various procedural restrictions in obtaining an effective consent from its principal. The agent must have “(i) act[ed] in good faith, (ii) disclose[d] all material facts that the agent knows, has reason to know, or should know would reasonably affect the principal’s judgment . . . and (iii) otherwise deal[t] fairly with the principal.” The consent also may not extend beyond “either a specific act or transaction, or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship.” Contained within Comment b to this section is the important qualification that:
an agreement that contains general or broad language purporting to release an agent in advance from the agent’s general fiduciary obligation to the principal is not likely to be enforceable. This is because a broadly sweeping release of an agent’s fiduciary duty may not reflect an adequately informed judgment on the part of the principal; if effective, the release would expose the principal to the risk that the agent will exploit the agent’s position in ways not foreseeable by the principal at the time the principal agreed to the release.
[54]See SEC v. Capital Gains(in discussing the legislative history of the Advisers Act, citing ethical standards of one of the leading investment counsel associations, which provided that an investment counsel should remain “as free as humanly possible from the subtle influence of prejudice, conscious or unconscious” and “avoid any affiliation, or any act which subjects his position to challenge in this respect” and stating that one of the policy purposes of the Advisers Act is “to mitigate and, so far as is presently practicable to eliminate the abuses” that formed the basis of the Advisers Act). Separate and apart from potential liability under the antifraud provisions of the Advisers Act enforceable by the Commission for breaches of fiduciary duty in the absence of full and fair disclosure, investment advisers may also wish to consider their potential liability to clients under state common law, which may vary from state to state.
[55]See, e.g., Andrew F. Tuch, Disclaiming Loyalty: M&A Advisors and Their Engagement Letters: In response to William W. Bratton & Michael L. Wachter, Bankers and Chancellors, 93 Texas L.Rev. 211, 220-1 (2015) (“Moreover, provisions that generally disclose existing and potential conflicts of interest may be ineffective in obtaining a client’s informed consent. These generalized disclosure provisions may fail to provide clients with a full appreciation of all material facts—as necessary to constitute effective consent. Confirming these doubts in a related context, the Law Governing Lawyersprovides that a “client’s consent will not be effective if it is based on an inadequate understanding of the nature and severity of the lawyer’s conflict ….”)
[56]Allen Realty Corp. v. Holbert, 318 S.E.2d 592, 227 Va. 441 (Va., 1984).
[57]TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Basic, Inc. v. Levinson, 485 U.S. 224, 233 (1988). See also SEC v. Steadman, 967 F.2d 636, 643 (D.C. Cir. 1992).
[58]The existence of a conflict of interest is a material fact that an investment adviser must disclose to its clients because it "might incline an investment adviser -- consciously or unconsciously -- to render advice that was not disinterested." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 191-192.
[59]Delivery of the investment advisers Part 2 of Form ADV may not result in timely disclosure, especially when the transaction occurs days, weeks, or months after the transaction is proposed to the client. “The adviser’s fiduciary duty of disclosure is a broad one, and delivery of the adviser’s brochure alone may not fully satisfy the adviser’s disclosure obligations.” SEC Staff Study (Jan. 2011), p.23, citingsee Instruction 3 of General Instructions for Part 2 of Form ADV; Advisers Act Rule 204-3(f); also citing see alsoRelease IA-3060. Note, as well, that the investment adviser must ensure client understanding; a client should not be presumed to have read and understood the disclosures contained in Part 2 of Form ADV.
[60]In the Matter of Arleeen W. Hughes, SEC Release No. 4048 (February 17, 1948), affirmed174 F.2d 969 (D.C. Cir. 1949).
[61]The burden of affirmative disclosure rests with the professional advisor; constructive notice is insufficient. See also British Airways, PLC v. Port Authority of N.Y. and N.J., 862 F.Supp. 889, 900 (E.D.N.Y.1994) (stating that the burden is on the client's attorney to fully inform and obtain consent from the client); Kabi Pharmacia AB v. Alcon Surgical, Inc., 803 F.Supp. 957, 963 (D.Del.1992) (stating that evidence of the client's constructive knowledge of a conflict would not be sufficient to satisfy the attorney's consultation duty); Manoir-Electroalloys Corp. v. Amalloy Corp., 711 F.Supp. 188, 195 (D.N.J.1989) ("Constructive notice of the pertinent facts is not sufficient."). A client of a fiduciary is not responsible for recognizing the conflict and stating his or her lack of consent in order to avoid waiver. Manoir-Electroalloys, 711 F.Supp. at 195.
[62]The Commission’s “Staff Study on Investment Advisers and Broker-Dealers - As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act” (Jan. 21, 2011), p.117.
[63]  SeeSEC Release No. 33-8998, “Enhanced Disclosure And New Prospectus Delivery Option For Registered Open-End Management Investment Companies,” (Jan. 13, 2009) (“The Commission is also adopting rule amendments that permit a person to satisfy its mutual fund prospectus delivery obligations under Section 5(b)(2) of the Securities Act by sending or giving the key information directly to investors in the form of a summary prospectus and providing the statutory prospectus on an Internet Web site.”)
The disclosure must be affirmatively made (the “duty of inquiry” and the “duty to read” are limited in fiduciary relationships) and must be timely made – i.e., in advance of the contemplated transaction. [“Where a fiduciary relationship exists, facts which ordinarily require investigation may not incite suspicion (see, e.g., Bennett v. Hibernia Bank,164 Cal.App.3d 202, 47 Cal.2d 540, 560, 305 P.2d 20 (1956), and do not give rise to a duty of inquiry (id., at p. 563, 305 P.2d 20). Where there is a fiduciary relationship, the usual duty of diligence to discover facts does not exist. United States Liab. Ins. Co. v. Haidinger-Hayes, Inc., 1 Cal.3d 586, 598, 83 Cal.Rptr. 418, 463 P.2d 770 (1970), Hobbs v. Bateman Eichler, Hill Richards, Inc., 210 Cal.Rptr. 387, 164 Cal.App.3d 174 (Cal. App. 2 Dist., 1974).)
[64]As stated in an early case applying the Advisers Act:  “It is not enough that one who acts as an admitted fiduciary proclaim that he or she stands ever ready to divulge material facts to the ones whose interests she is being paid to protect. Some knowledge is prerequisite to intelligent questioning. This is particularly true in the securities field. Readiness and willingness to disclose are not equivalent to disclosure. The statutes and rules discussed above make it unlawful to omit to state material facts irrespective of alleged (or proven) willingness or readiness to supply that which has been omitted.” Hughes v. SEC, 174 F.2d 969 (D.C. Cir., 1949).
[65]The burden of affirmative disclosure rests with the professional advisor; constructive notice is insufficient. See also British Airways, PLC v. Port Authority of N.Y. and N.J., 862 F.Supp. 889, 900 (E.D.N.Y.1994) (stating that the burden is on the client's attorney to fully inform and obtain consent from the client); Kabi Pharmacia AB v. Alcon Surgical, Inc., 803 F.Supp. 957, 963 (D.Del.1992) (stating that evidence of the client's constructive knowledge of a conflict would not be sufficient to satisfy the attorney's consultation duty); Manoir-Electroalloys Corp. v. Amalloy Corp., 711 F.Supp. 188, 195 (D.N.J.1989) ("Constructive notice of the pertinent facts is not sufficient.").  A client of a fiduciary is not responsible for recognizing the conflict and stating his or her lack of consent in order to avoid waiver.  Manoir-Electroalloys, 711 F.Supp. at 195.
[66]See, e.g.,Julia Smith, Out with “TCF” and in with “fiduciary”?, Butterworths Journal of International Banking and Financial Law (June 2012), P.344 [U.K.] [“In order to obtain B’s fully informed consent: (1) A must make full and frank disclosure of all material facts which might affect B’s consent (New Zealand Netherlands Society Oranje Inc v Kuys[1973] 1 WLR 1126 at 1132) and the extent of disclosure required depends upon the sophistication and intelligence of B (Farah Construction Pty Ltd v Say-Dee Pty Ltd[2007] HCA 22 at [107] to [108]). (2) A must disclose the nature as well as the existence of the conflict (Wrexham Assoc Football Club Ltd v Crucialmove Ltd[2007] BCC 139 at [39]).] (3) The burden of establishing informedconsent lies on the fiduciary (Cobbetts LLP v Hodge[2009] EWHC 786).
Consent is only informed if the client has the ability to fully understand and evaluate the information. For example, many complex products (such as CMOs, structured products, options, security futures, margin trading strategies, some alternative investments, and the like) may be appropriate only for sophisticated and experienced investors.  It is not sufficient for a firm or an investment professional to make full disclosure of potential conflicts of interest with respect to such products. The investment adviser, therefore, must make a reasonable judgment that the client is fully able to understand and evaluate the product and the potential conflicts of interest that the transaction presents. Fiduciary law reposes this burden to ensure client understanding primarily upon the adviser, not the client.
[67]In re the Matter of Arleen Hughes, SEC Release No. 4048 (1948).
[68]There must be no coercion for the informed consent to be effective. The “voluntariness of an apparent consent to an unfair transaction could be a lingering suspicion that generally, when entrustors consent to waive fiduciary duties (especially if they do not receive value in return) the transformation to a contract mode from a fiduciary mode was not fully achieved. Entrustors, like all people, are not always quick to recognize role changes, and they may continue to rely on their fiduciaries, even if warned not to do so.” Tamar Frankel, Fiduciary Duties as Default Rules, 74 Or. L. Rev. 1209.
[69]SeeArlene Hughes (in finding that registrant had not obtained informed consent, citing to testimony indicating that “some clients had no understanding at all of the nature and significance” of the disclosure).
[70]SeeGeneral Instruction 3 to Part 2 of Form ADV. Cf. Arleen Hughes, supra note 13 (Hughes acted simultaneously in the dual capacity of investment adviser and of broker and dealer and conceded having a fiduciary duty. In describing the fiduciary duty and her potential liability under the antifraud provisions of the Securities Act and the Exchange Act, the Commission stated she had “an affirmative obligation to disclose all material facts to her clients in a manner which is clear enough so that a client is fully apprised of the facts and is in a position to give his informed consent.”
[71]The extent of the disclosure required is made clear by cases applying the fiduciary standard of conduct in related professional advisory contexts, such as the duties imposed upon an attorney with respect to his or her client: “The fact that the client knows of a conflict is not enough to satisfy the attorney's duty of full disclosure.”In re Src Holding Corp., 364 B.R. 1 (D. Minn., 2007).  "Consent can only come after consultation — which the rule contemplates as full disclosure.... [I]t is not sufficient that both parties be informed of the fact that the lawyer is undertaking to represent both of them, but he must explain to them the nature of the conflict of interest in such detail so that they can understand the reasons why it may be desirable for each to [withhold consent].")Florida Ins. Guar. Ass'n Inc. v. Carey Canada, Inc., 749 F.Supp. 255, 259 (S.D.Fla.1990) [emphasis added],quoting Unified Sewerage Agency, Etc. v. Jeko, Inc., 646 F.2d 1339, 1345-46 (9th Cir.1981)); “[t]he lawyer bears the duty to recognize the legal significance of his or her actions in entering a conflicted situation and fully share that legal significance with clients.” In re Src Holding Corp., 364 B.R. 1, 48 (D. Minn., 2007) [emphasis added].
[72]Wendt v. Fischer, 243 N.Y. 439, 154 N.E. 303 (1926). See also“Will the Investment Company and Investment Advisory Industry Win an Academy Award?” remarks of Kathryn B. McGrath, then-Director of the SEC Division of Investment Management, at the 1987 Mutual Funds and Investment Management Conference, citingScott, The Fiduciary Principle, 37 Calif. L. Rev. 539, 544 (1949). See alsoBogert on Trusts, Paul D. Finn, Fiduciary Obligations(1977); J.C. Shepherd, The Law of Fiduciaries(1981). See also Scott, The Fiduciary Principle, 37 Calif. L. Rev. 539, 544 (1949).
[73]Even in arms-length relationships, a ratification or waiver defense may fail if the customer proves that he did not have all the material facts relating to the trade at issue. E.g., Davis v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 906 F.2d 1206, 1213 (8th Cir. 1990); Huppman v. Tighe, 100 Md. App. 655, 642 A.2d 309, 314-315 (1994). In contrast, in fiduciary relationships the failure to disclose material facts while seeking a release has been held to be actionable, as fraudulent concealment. See, e.g., Pacelli Bros. Transp. v. Pacelli, 456 A.2d 325, 328 (Conn. 1982) (‘the intentional withholding of information for the purpose of inducing action has been regarded ... as equivalent to a fraudulent misrepresentation.’); Rosebud Sioux Tribe v. Strain, 432 N.W. 2d 259, 263 (S.D. 1988) (‘The mere silence by one under such a [fiduciary] duty to disclose is fraudulent concealment.’)” (Id.)
[74]The Commission has stated that disclosure must occur not only of conflicts of interest, but also of potential conflicts of interest. See Release No. IA-1396, In the Matter of: Kingsley, Jennison, Mcnulty & Morse Inc. (Dec. 23, 1993).
[75]The SEC has brought enforcement actions in such cases. See, e.g., In the Matter of The Robare Group, Ltd., et al., Investment Advisers Act Release No. 4566 (Nov. 7, 2016) (Commission Opinion) (appeal docketed) (finding, among other things, that adviser’s disclosure was inadequate because it stated that the adviser may receive compensation from a broker as a result of the facilitation of transactions on client’s behalf through such broker-dealer and that these arrangements may create a conflict of interest when adviser was, in fact, receiving payments from the broker and had such a conflict of interest).
[76]As stated in an early decision by the U.S. Securities and Exchange Commission: “[We] may point out that no hard and fast rule can be set down as to an appropriate method for registrant to disclose the fact that she proposes to deal on her own account. The method and extent of disclosure depends upon the particular client involved. The investor who is not familiar with the practices of the securities business requires a more extensive explanation than the informed investor. The explanation must be such, however, that the particular client is clearly advised andunderstandsbefore the completion of each transaction that registrant proposes to sell her own securities.”  [Emphasis added.]   In re the Matter of Arleen Hughes, SEC Release No. 4048 (1948).
[77]Hughes v. SEC, No. 9853, COURT OF APPEALS OF DISTRICT OF COLUMBIA, 174 F.2d 969; 85 U.S. App. D.C. 56; 1949 U.S. App. LEXIS 2138; Fed. Sec. L. Rep. (CCH) P90,449, January 14, 1949, observing in pertinent part: “The acts of petitioner which constitute violations of the antifraud sections of statutes and of regulations thereunder are acts of omission in that petitioner failed to fully disclose the nature and extent of her adverse interest … The best price currently obtainable in the open market and the cost to registrant are both material facts within the meaning of the above-quoted language and they are both factors without which informed consent to a fiduciary's acting in a dual and conflicting role is impossible.” 
See alsoLeonard I. Rotman, Fiduciary Law279 (2005) (emphasizing the necessity of obtaining the principal’s express and informed consent before a fiduciary may enter into a self- or other-interested transaction).
See alsoEvan J. Criddle, Liberty in Loyalty: A Republican Theory of Fiduciary Law, 95 Tex.L.R. 993, 1009 (2017), stating in pertinent part: “[T]he no-conflict rule’s categorical prohibition against unauthorized conflicted transactions forces the investment manager to obtain the investor’s fully informed consent ex anteor face court-ordered rescission or disgorgement ex post.”
See alsoRobert H. Sitkoff, The Fiduciary Obligations of Financial Advisors Under the Law of Agency (2013): (“The duty of loyalty therefore prohibits A from misappropriating C’s property, and it regulates conflicts of interest in which the interests of A or a third party (such as another client) may be at odds with the interests of C.  A is prohibited from undertaking any conflicted action for which A does not first obtain C’s informed consent.”), and citing Restatement (Third) of Agency, §§8.02-8.04, §8.05(1), and §8.06.
[78]See Maplewood Partners, L.P. v. Indian Harbor Ins. Co., CASE NO. 08-23343-CIV-HOEVELER, UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF FLORIDA, 295 F.R.D. 550; 2013 U.S. Dist. LEXIS 103309, July 15, 2013 (In a case involving representation of multiple clients by an attorney: “A client can waive a conflict of interest upon informed consent ….).”
[79]In contrast, in arms-length relationships disclosure and consent creates estoppel, as customers generally possess responsibility for their own actions. This is fundamental to anti-fraud law, as applicable to arms-length relationships (“actual fraud”). Section 525 of the Restatement (Second) of Torts provides the general rule for fraudulent misrepresentation: “One who fraudulently makes a misrepresentation of fact, opinion, intention, or law for the purpose of inducing another to act or to refrain from action in reliance upon it, is subject to liability to the other in deceit for pecuniary loss caused to him by his justifiable reliance upon the misrepresentation.”
To prove common law fraud in most states, the plaintiff must show that
·       the defendant made a material false representation or failed to communicate a material fact, which had the effect of falsifying statements actually made;
·       the defendant did this intentionally (the defendant knew that the representation or omission constituted a falsehood) or recklessly (the defendant made the representation without regard to whether it was true or false);
·       the defendant intended that the plaintiff act on it; and
·       the plaintiff did, in fact, rely on the representation or omission to his or her detriment.
A representation is material if either a substantial likelihood exists that a reasonable person would attach importance to it in making a decision or the person who made the representation has reason to know that the plaintiff is likely to regard it as important in making a decision, even though a reasonable person would not so regard it.
Fraudulent misrepresentation by omission may be actionable if the defendant has a duty to the plaintiff to disclose material facts and fails to do so, and if this failure results in a false impression being conveyed to the plaintiff. A defendant can also be liable for failing to disclose new information that makes previously disclosed information misleading.
To be actionable, a fraudulent misrepresentation generally must concern fact rather than mere opinion, judgment, expectation, or probability. However, a fraud case can be based on a representation of opinion when one or more of the following occurred:
       the defendant knew that the facts on which the opinion was based were false;
       the defendant knew that the opinion was false;
       the opinion was based on the defendant’s special knowledge of information contained in it; and the defendant knew that the plaintiff was justified in relying on this special knowledge;
       the defendant claimed to have special knowledge of facts that would occur in the future; or
       the defendant had special knowledge superior to that of the plaintiff about value.
[80]“[D]isclosure is an effective response if it does not affect the decision-maker’s judgment process and if the beneficiary is able to correct adequately for that biasing influence. Psychological research shows that neither of these conditions may be met. Sometimes both parties may be worse off following disclosure.” Id., citingDaylian M. Cain, George Loewenstein, and Don A. Moore, “The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest” (2005) 34 Journal of Legal Studies 1 at 3.
[81]In dealing with the state securities statutes, state courts often disallow the defense of estoppel in order to preserve the protections afforded to retail consumers. See, e.g., Go2net, Inc. v. Freeyellow.com, Inc., 109 P.3d 875 (Wash. App., 2005), stating in pertinent part:
We are persuaded that the better rule is to bar the defenses of estoppel and waiver in an action alleging violation of a securities regulation. The flexibility of such defenses is inconsistent with our Act's foremost objective of protecting investors. The statute provides the clean and surgical remedy of rescission as the sole recourse for an investor who proves a violation. It would upset the balance struck by the statute to allow factfinders to evaluate the investor's conduct on a case-by-case basis to determine whether it excuses the violation. We hold that equitable defenses are not available in an action under the Securities Act of Washington and conclude the trial court properly dismissed Molino’s defenses of estoppel and waiver.
Id.at ____.
See also, e.g.,Covert v. Cross, 331 S.W.2d 576, 585 (Mo., 1960), stating:
The theory of estoppel the defendants sought to present 'would tend to nullify and defeat the very purpose of the statute, which is clearly penal in nature . . . The Act was passed to protect investors against their own weaknesses and to prevent the happening of such losses as are shown by this record.' 
Covert, 331 S.W.2d at 585.
The concerns expressed in Covert were cited and echoed by the dissent in the Illinois appellate court Logandecision, which likewise expressed the view that the adoption of an equitable estoppel defense severely undermines the legislation regulating the sale of securities:
The very person sought to be protected, the investor, is denied recovery while the individual violating the law escapes liability. This result neither serves to compensate the innocent purchaser nor does it deter future violations of the Blue Sky Law. In fact, the majority decision could prompt clever promoters of questionable investments to ignore the Blue Sky regulations and, instead, encourage an investor to participate in the management of the company so that an estoppel defense could later be established. Clearly, use of estoppel as a defense in the instant actions is inconsistent with the express terms of the statute, as well as the policy underlying our Blue Sky Law. This law should be strictly enforced, and legal exceptions kept to a bare minimum.
Logan,dissenting opinion at 293 N.W.2d at 364.
See alsoGowdy v. Richter, 314 N.E.2d 549, 557 (Ill. App., 1974) ('The penal character of the statute negates the utilization of in pari delicto or estoppel defenses.'), cited favorablyby Go2net, Inc. v. Freeyellow.com, Inc., 109 P.3d 875 (Wash. App., 2005).
A commentator further opines that the overall effect of allowing estoppel, even in limited circumstances, undermines the deterrent effect of the civil liability provisions:
Courts that allow the defense of estoppel lessen the blue sky laws' deterrent value and thus decrease compliance with the laws by hampering plaintiffs' chances of recovery.  Repeated successful use of the defenses will result in decreased compliance with the laws. Courts that disallow estoppel, on the other hand, increase deterrence by allowing for more successful suits and creating a 'general climate of fear of the statutory civil actions.'  To the extent that such courts increase deterrence, they further the primary goal of the laws.
Charles G. Stinner, Estoppel and In Pari Delicto Defenses to Civil Blue Sky Actions, 73 Cornell L. Rev. 448, 463 (1988)(footnotes omitted).
[82]The doctrine of estoppel springs from equitable principles, and it is designed to aid in the administration of justice where, without its aid, injustice might result. Levin v. Levin, 645 N.E.2d 601, 604 (Ind. 1994).
However, a breach of the fiduciary standard is “constructive fraud,” not actual fraud. To prove a breach of fiduciary duty, a plaintiff must only show that he or she and the defendant had a fiduciary relationship, that the defendant breached its fiduciary duty to the plaintiff, and that this resulted in an injury to the plaintiff or a benefit to the defendant. It is not necessary for the plaintiff to prove causation to prevail on claims of certain breaches of fiduciary duty. In other words, “reliance” is not a required element of a claim for constructive fraud (while reliance is required in a claim for actual fraud.)
In fact, it is the agent’s disloyalty, not any resulting harm, which violates the fiduciary relationship. Comment b to section 874 of the Restatement (Second) Of Tortsrecognizes that a plaintiff may be entitled to “restitutionary recovery,” to capture “profits that result to the fiduciary from his breach of duty and to be the beneficiary of a constructive trust in the profits.” In some circumstances, the plaintiff may recover “what the fiduciary should have made in the prosecution of his duties.” Restatement (Second) Of Torts§ 874 cmt. b (1979); see also 2 Dan B. Dobbs, The Law Of Remedies670 (2d ed. 1993) (noting that a fiduciary who wrongfully takes an opportunity, if “treated as a fiduciary for the profits as well as for the initial opportunity,” would “owe a duty to maximize their productiveness within the limits of prudent management and might be liable for failing to do so”).
Estoppel and waiver are not applied freely to operate as a defense to “constructive fraud” (breach of fiduciary duty). A breach of the fiduciary standard is “constructive fraud,”  not actual fraud.  The role of waiver and estoppel in fiduciary law is different in fiduciary relationships than in its application to arms-length relationships. Under state common law, for estoppel to make unactionable a breach of a fiduciary obligation due to the presence of a conflict of interest, it is required that the fiduciary undertake a series of measures, far beyond undertaking mere disclosure of the conflict of interest. This contrasts with the relative ease in which estoppel and waiver apply to arms-length relationships, in which mere disclosure and consent creates estoppel and a defense against “actual fraud” – for customers generally possess responsibility for their own actions. Prosser and Keeton wrote that it is a “fundamental principle of the common law that volenti non fit injuria– to one who is willing, no wrong is done.” W. Page Keeton et al., Prosser And Keeton On The Law Of Torts112 (5th ed. 1992); see also Restatement (Second) Of Torts§ 892A cmt. a (1977) (asserting that one does not suffer a legal wrong as the result of an act to which, unaffected by fraud, mistake or duress, he freely or apparently consents).
Traditionally, the fiduciary duty of loyalty has been treated with a high degree of reverence. Because violations of the fiduciary duty of loyalty often involve self-dealing, waivers of the duty of loyalty are permitted under state common law far less often then waivers of the duty of care. SeeDarren Guttenberg, Waiving Farewell Without Saying Goodbye: The Waiver of Fiduciary Duties in Limited Liability Companies in Delaware, and the Call for Mandatory Disclosure, 86 S.Cal.L.Rev. 869, 877 (2013).
[83]Sections 206(1) and 206(2) of the Advisers Act make it unlawful for any investment adviser to employ any device, scheme, or artifice to defraud, or to engage in any transaction, practice, or course of business that operates as fraud or deceit on clients or prospective clients. Those antifraud provisions may be violated by the use of a hedge clause or other exculpatory provision in an investment advisory agreement which is likely to lead an investment advisory client to believe that he or she has waived non-waivable rights of action against the adviser that are provided by federal or state law. See, e.g., In the Matter of William Lee Parks, Investment Advisers Act Release No. 736 (Oct. 27, 1980) and In the Matter of Olympian Financial Services, Inc., Investment Advisers Act Release No. 659 (Jan. 16, 1979). See also Opinion of General Counsel Roger S. Forster Relating to the Use of Hedge Clauses by Brokers, Dealers, Investment Advisers and Others, Investment Advisers Act Release No. 58 (Apr. 10, 1951).
The Commission has previously taken the position that hedge clauses that purport to limit an investment adviser’s liability to acts involving gross negligence or willful malfeasance are likely to mislead a client who is unsophisticated in the law into believing that he or she has waived non-waivable rights. SeeAuchinloss & Lawrence Incorporated, SEC Staff No-Action Letter (Feb. 8, 1974). This is true even if the hedge clause explicitly provides that rights under federal or state law cannot be relinquished. SeeOmni Management Corporation, SEC Staff No-Action Letter (Dec. 13, 1975) and First National Bank of Akron, SEC Staff No-Action Letter (Feb. 27, 1976). Such a hedge clause might read, in the context of an adviser-client contract for advisory services:
Non-Waiver of Rights: Notwithstanding the foregoing, nothing contained in this paragraph or elsewhere in this Agreement shall constitute a waiver by Client of any of its legal rights under applicable U.S. federal securities laws or any other laws whose applicability is not permitted to be contractually waived.
The Commissioned has stated that the use of hedge clauses in investment advisory agreements which purport to remove potential advisor liability for gross negligence or wilful malfeasance is not a per se violation of the anti-fraud provisions of the Advisers Act, but rather depends upon the facts and circumstances. In a case involving institutional investors, where the adviser represented to the Commission that institutional investors often dictated the terms of investment advisory contracts, the Commission opined:
We believe that whether an investment adviser that uses hedge clauses in investment advisory agreements that purport to limit that adviser’s liability to acts of gross negligence or willful malfeasance violates sections 206(1) and 206(2) of the Advisers Act would depend on all of the surrounding facts and circumstances. In making this determination, we would consider the form and content of the particular hedge clause (e.g., its accuracy), any oral or written communications between the investment adviser and the client about the hedge clause, and the particular circumstances of the client.7 For instance, when a hedge clause is in an investment advisory agreement with a client who is unsophisticated in the law, we would consider factors including, but not limited to, whether: (i) the hedge clause was written in plain English; (ii) the hedge clause was individually highlighted and explained during an in-person meeting with the client; and(iii) enhanced disclosure was provided to explain the instances in which such client may still have a right of action. In addition, we would consider the presence and sophistication of any intermediary assisting a client in his dealings with the investment adviser and the nature and extent of the intermediary’s assistance to the client.
Release No. IA-________, Heitman Capital Management, LLC (Feb. 12, 2007).
[84]An “irreducible core” of fiduciary duties exist, which are not subject to waiver by disclosure and consent under any circumstances. SeeA. Trukhtanov, The Irreducible Core of Fiduciary Duties (2007) 123 LQR 342.
[85]Note that the contractuarian view of fiduciary law has no place in fiduciary relationships in which there is a great superiority in knowledge held by the fiduciary. The contractualists’ theory of fiduciary law appears misplaced, at least in the context of advisory relationships. “[C]ontract law concerns itself with transactions while fiduciary law concerns itself with relationships.” Rafael Chodos, Fiduciary Law: Why Now! Amending the Law School Curriculum, 91 Boston U.L.R. 837, 845 (and further noting that “Betraying a relationship is more hurtful than merely abandoning a transaction.” IdSee alsoLaby, The Fiduciary Obligation as the Adoption of Ends, 56 Buff. L. Rev. 99, 104-29 (2008) (rejecting contractual approach as descriptive theory of fiduciary duties, and at 129-30 (arguing that signature obligation of fiduciary is to adopt ends of his or her principal). 
Rafael Chodoes further posits that there may be greater flexibility in contracting around fiduciary duties where the entrustor is an employer of a non-expert employee (i.e., in an employer-employee relationship) and has greater control and, presumably, knowledge than the employee. Even then, the “tendency of courts to construe fiduciary limitations narrowly and to be suspicious of provisions purporting to eliminate all fiduciary duties is understandable given the long tradition of treating business partners and managers as fiduciaries.” Chodos, at p.894 (further noting that: “This approach also is consistent with the general drafting principle that limitations on fiduciary duties are strictly construed.See, e.g., Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 171–72 (Del. 2002); Restatement (Third) Of AgencY § 8.06 (2006).”)Id.
Hence, greater emphasis on the contractual nature of fiduciary obligations may exist when contracting parties enter into a partnership agreement or a limited liability company operating agreement, given that most state statutes permit these parties, upon entry into the relationship, to negotiate (to a degree) the legal duties owed to one another. Yet, in relationships of an advisory-client nature, where there exists a vast disparity in knowledge between the advisor and the client, and where clients do not normally seek legal advice prior to entry into such relationships, the ability of the advisor to negate fiduciary duties by contract is properly more circumscribed.
Other scholars appear reject the contractualist theory of fiduciary duties more broadly. See, e.g.,Tamar Frankel, Fiduciary Duties as Default Rules, 74 Or. L. Rev. 1209 (1995) (“[C]ircumstances exist where fiduciary duties are not waivable for reasons such as doubts about the quality of the entrustors' consent (especially when given by public entrustors such as shareholders), and the need to preserve institutions in society that are based on trust. Further, non-waivable duties can be viewed as arising from the parties' agreement ex ante to limit their ability to contract around the fiduciaries' duties.  Under these circumstances fiduciary rules should generally be mandatory and non-waivable … I conclude that private and public fiduciaries should be subject to a separate body of rules and reject the contractarian view..”) Id. See also Scott FitzGibbon, Fiduciary Relationships Are Not Contracts, 82 MARQ. L. REV. 303, 305 (1999) (“This Article explores the nature of fiduciary relationships, shows that they arise and function in ways alien to contractualist thought, and that they have value and serve purposes unknown to the contractualists.”)
“Many courts deny the contractual approach.” Arthur Laby, Fiduciary Obligations of Broker-Dealers, 55 Villanova L.Rev. 701, 711 (2010).
[86]Evan J. Criddle, Liberty in Loyalty: A Republican Theory of Fiduciary Law, 95 Tex.L.R. 993, 1011 (2017), citing: See In re Primedia Inc. Derivative Litig., 910 A.2d 248, 262 (Del. Ch. 2006) (“[T]he duty of loyalty ‘does not rest upon the narrow ground of injury or damage to the corporation resulting from a betrayal of confidence, but upon a broader foundation of a wise public policy that, for purposes of removing all temptation, extinguishes all possibility of profit flowing from the breach of confidence imposed by the fiduciary relation.’” (quoting Guth v. Loft, Inc., 5 A.2d 503, 510 (Del. 1939))).
[87]Frankel, Tamar, Fiduciary Law, 71 Calif. L. Rev. 795 (1983).
[88]SeeArleen Hughes (“Registrant cannot satisfy this duty by executing an agreement with her clients which the record shows some clients do not understand and which, in any event, does not contain the essential facts which she must communicate.”) Some commenters on Commission requests for comment agreed that full and fair disclosure and informed consent are important components of an adviser’s fiduciary duty. See, e.g.,Financial Planning Coalition 2013 Letter, supra note 21 (“[C]onsent is only informed if the customer has the ability fully to understand and to evaluate the information. Many complex products … are appropriate only for sophisticated and experienced investors. It is not sufficient for a fiduciary to make disclosure of potential conflicts of interest with respect to such products. The fiduciary must make a reasonable judgment that the customer is fully able to understand and to evaluate the product and the potential conflicts of interest that it presents – and then the fiduciary must make a judgment that the product is in the best interests of the customer.”
[89]See, e.g., Andrew F. Tuch, Disclaiming Loyalty: M&A Advisors and Their Engagement Letters: In response to William W. Bratton & Michael L. Wachter, Bankers and Chancellors, 93 Texas L.Rev. 211, 217 (2015) (“When a fiduciary obtains its client’s informed consent for conduct that would otherwise breach a fiduciary duty, the consent shelters the fiduciary from liability for that conduct. However, it does not terminate the fiduciary character of the relationship. Rather, the fiduciary remains subject to fiduciary duties and thus generally obliged to act loyally within the scope of and for the duration of the relationship—but sheltered from liability for conduct to which its client consented.”)
[90]See Robert H. Sitkoff, The Fiduciary Obligations of Financial Advisors Under the Law of Agency (2013): (]T]here are mandatory rules within the fiduciary obligation that cannot be overridden by agreement. For example, the principal cannot authorize the fiduciary to act in bad faith. Even if the principal authorizes self-dealing, fiduciary law provides substantive safeguards, requiring the fiduciary to act in good faith and deal fairly with and for the principal …”
[91]SeeRobert H. Sitkoff, Economic Structure of Fiduciary Law, 91 Boston Univ.L.Rev. 1039, 1046 [“To be sure, there is a mandatory core to the fiduciary obligation that cannot be overridden by agreement. For example, the principal cannot authorize the fiduciary to act in bad faith.” and citingSee, e.g., UNIFORM POWER OF ATTORNEY ACT § 114(a) (2006); UNIFORM TRUST CODE § 105(b)(2) (2000); RESTATEMENT (THIRD) OF TRUSTS § 78, cmt. c(2) (2007); RESTATEMENT (THIRD) OF AGENCY § 8.06(1)(a), (2)(a) (2006).j]
[92]Birnbaum v. Birnbaum, 117 A.D.2d 409, 503 N.Y.S.2d 451 (N.Y.A.D. 4 Dept., 1986).
[93]In the absence of integrity and fairness in a transaction between a fiduciary and the client or beneficiary, it will be set aside or held invalid. Matter of Gordon v. Bialystoker Center and Bikur Cholim, 45 N.Y. 2d 692, 698 (1978) (2006 WL 3016952 at *29).
The relationship between an unfair or unreasonable transaction, and whether informed consent has occurred, is a close one. As stated by Professor Frankel, “if the bargain is highly unfair and unreasonable, the consent of the disadvantaged party is highly suspect. Experience demonstrates that people rarely agree to terms that are unfair and unreasonable with respect to their interests.” Frankel, Tamar, Fiduciary Duties as Default Rules, 74 Or. L. Rev. 1209.
[94]See Matter of Gordon v. Bialystoker Center and Bikur Cholim, 45 N.Y. 2d 692, 698 (1978) (2006 WL 3016952 at *29).
Note that in the attorney-client fiduciary relationship, which is similar to the investment-adviser fiduciary relationship in that fiduciary duties are imposed in recognition of the vast disparity of knowledge between the fiduciary and the client, not only are informed consent of the client and substantive fairness of the transaction required, but independent legal counsel must be sought before certain transactions can be entered into with clients. Attorneys are prohibited from entering into transactions with clients unless the client is clearly advised to seek independent legal counsel, and even then the business transaction must be substantively fair to the client. SeeABA Model Rules of Professional Conduct 1.8(a), stating: Rule 1.8 Conflict Of Interest: Current Clients: Specific Rules. (a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless: (1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing in a manner that can be reasonably understood by the client; (2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent legal counsel on the transaction; and (3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.
The Commission could adopt a similar rule – requiring that before any transaction is entered into for the purchase of a proprietary mutual fund, a security underwritten by an affiliate of the investment advisory firm, or certain other transactions, independent investment advice must be received. But this is not part of my recommendation at present.
[95]Frankel, Tamar, Fiduciary Duties as Default Rules, 74 Or. L. Rev. 1209, further stating: “Where the beneficiaries are all sui jurisand consent to the sale, it cannot be set aside if the trustee made a full disclosure and did not induce the sale by taking advantage of his relation to the beneficiaries or by other improper conduct, and if the transaction was in all respects fair and reasonable. On the other hand, the sale can be set aside if the trustee did not make a full disclosure, or if he improperly induced the sale, or if the transaction was not fair and reasonable ... In order to transform the fiduciary mode into a contract mode, four conditions must be met: (1) entrustors must receive notice of the proposed change in the mode of the relationship; (2) entrustors must receive full information about the proposed bargain; (3) the entrustors' consent should be clear and the bargain specific; (4) the proposed bargain must be fair and reasonable.” Id.
[96]  As to the “best interests” standard being present under the Advisers Act, see S.E.C. v. Moran, 922 F.Supp. 867, 895-6 (S.D.N.Y., 1996) (“the SEC alleges that by allocating Liberty stock to his personal and family accounts and requiring his clients to pay a higher price for the stock the next day, Moran Sr. and Moran Asset placed their own interests ahead of their clients thereby violating the fiduciary duty owed to those clients … Section 206 of the Advisers Act establishes a statutory fiduciary duty for investment advisers to act for the benefit of their clients, requiring advisers to exercise the utmost good faith in dealing with clients, to disclose all material facts, and to employ reasonable care to avoid misleading clients. Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17, 100 S.Ct. 242, 246, 62 L.Ed.2d 146 (1979); Burks v. Lasker, 441 U.S. 471, 482 n. 10, 99 S.Ct. 1831, 1839 n. 10, 60 L.Ed.2d 404 (1979); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 472 n. 11, 97 S.Ct. 1292, 1300 n. 11, 51 L.Ed.2d 480 (1977); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92, 84 S.Ct. 275, 282-83, 11 L.Ed.2d 237 (1963) … [T]he court interprets Section 206 to establish a fiduciary duty which in addition to applying to misrepresentations and omission, also requires the investment advisor to act in the best interests of its clients. See e.g., SEC v. Capital Gains Bureau, 375 U.S. at 195, 84 S.Ct. at 284-85 (‘Congress intended the Investment Advisers Act of 1940 to be construed like other securities legislation ‘enacted for the purpose of avoiding frauds,’ not technically and restrictively, but flexibly to effectuate its remedial purposes.’) ….”
[97]A more elaborate explanation of the difference between the “sole interests” standard and “best interests” standard can be found in Professor John Langbein’s article: “The sole interest rule prohibits the trustee from “plac[ing] himself in a position where his personal interest . . . conflicts or possibly may conflict with” the interests of the beneficiary. The rule applies not only to cases in which a trustee misappropriates trust property, but also to cases in which no such thing has happened—that is, to cases in which the trust “incurred no loss” or in which “actual benefit accrued to the trust” from a transaction with a conflicted trustee. The conclusive presumption of invalidity under the sole interest rule has acquired a distinctive name: the “no further inquiry” rule. What that label emphasizes, as the official comment to the Uniform Trust Code of 2000 explains, is that “transactions involving trust property entered into by a trustee for the trustee’s own personal account [are] voidable without further proof.” Courts invalidate a conflicted transaction without regard to its merits—“not because there is fraud, but because there may be fraud.” “[E]quity deems it better to . . . strike down all disloyal acts, rather than to attempt to separate the harmless and the harmful by permitting the trustee to justify his representation of two interests … I compare the trust law duty of loyalty with the law of corporations, which originally shared the trust law sole interest rule but abandoned it in favor of a regime that undertakes to regulate rather than prohibit conflicts … I recommend (in Section II.C) reformulating the trust law duty of loyalty in light of these developments. I would generalize the principle now embodied in the exclusions and exceptions, which is that the trustee must act in the beneficiary’s best interest, but not necessarily in the beneficiary’s sole interest. Overlaps of interest that are consistent with the best interest of the beneficiary should be allowed. What is needed to cure the overbreadth of the sole interest rule is actually quite a modest fix: reducing from conclusive to rebuttable the force of the presumption of invalidity that now attaches to a conflicted transaction.” Langbein, John H., Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest?. Yale Law Journal, Vol. 114, p. 929 (2005), available at SSRN: http://ssrn.com/abstract=696801
[98]Section 206 provides in pertinent part: “It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly – (3) acting as principal for his own account, knowingly to sell any security to or purchase any security from a client, or acting as broker for a person other than such client, knowingly to effect any sale or purchase of any security for the account of such client, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction. The prohibitions of this paragraph (3) shall not apply to any transaction with a customer of a broker or dealer if such broker or dealer is not acting as an investment adviser in relation to such transaction.”
[99]Comment letter of Mercer Bullard, Founder and President, Fund Democracy, and Barbara Roper, Director of Investor
Protection, Consumer Federation of America, Nov. 30, 2007, available at http://sec.gov/comments/s7-23-07/s72307-18.pdf, at
p.1.
[100]Geman v. S.E.C., 334 F.3d 1183, 1189 (10th Cir., 2003), quoting Arst v. Stifel, Nicolaus & Co., 86 F.3d 973, 979 (10th Cir.1996) (applying Kansas law) (quotingRestatement (Second) Of Agency§ 390 cmt. a (1958)).
[101]See, e.g., “Will the Investment Company and Investment Advisory Industry Win an Academy Award?” remarks of Kathryn B. McGrath, Director of the SEC Division of Investment Management, at the 1987 Mutual Funds and Investment Management Conference (“McGrath Remarks”), citingScott, The Fiduciary Principle, 37 Calif. L. Rev. 539, 544 (1949), at p.7: “The words ‘fiduciary duty’ refer to the duties, of first, obedience to the terms of one's trust, second, diligence and care in the carrying out of one's fiduciary functions, and third, undivided loyalty to the beneficiaries of one's trust.” Other authorities do not list the duty of obedience separately, but rather consider it within the framework of the other basic duties of care and loyalty.” Lorna A. Schnase, An Investment Adviser’s Fiduciary Duty (Aug. 1, 2010), at p.5, available at http://www.40actlawyer.com/Articles/Link3-Adviser-Fiduciary-Duty-Paper.pdf.  
[102]Investment Advisers Act Release 3060 (“as a fiduciary, an adviser has an ongoing obligation to inform its clients of any material information that could affect the advisory relationship”). See also General Instruction 3 to Part 2 of Form ADV (“Under federal and state law, you are a fiduciary and must make full disclosure to your clients of all material facts relating to the advisory relationship.”)
[103]Investment Advisers Act Release 3060; General Instruction 3 to Part 2 of Form ADV (“Under federal and state law, you are a fiduciary and must make full disclosure to your clients of all material facts relating to the advisory relationship. As a fiduciary, you also must seek to avoid conflicts of interest with your clients, and, at a minimum, make full disclosure of all material conflicts of interest between you and your clients that could affect the advisory relationship. This obligation requires that you provide the client with sufficiently specific facts so that the client is able to understand the conflicts of interest you have and the business practices in which you engage, and can give informed consent to such conflicts or practices or reject them.”).
[104]Investment Advisers Act rule 204-3. Investment Advisers Act Release 3060 (adopting amendments to Form ADV and stating that “A client may use this disclosure to select his or her own adviser and evaluate the adviser’s business practices and conflicts on an ongoing basis. As a result, the disclosure clients and prospective clients receive is critical to their ability to make an informed decision about whether to engage an adviser and, having engaged the adviser, to manage that relationship.”).
[105]Matthew Harding, Two Fiduciary Fallacies (2007).

Ron A. Rhoades, J.D., CFP® is an Asst. Professor of Finance at Western Kentucky University's Gordon Ford College of Business, where he serves as Director of its nationally recognized Personal Financial Planning program. This article represents his views, alone, and are not those of any institution, organization or firm with whom he may be associated. Follow Ron on Twitter: @280lmtd. To contact him, please email: Ron.Rhoades@wku.edu.