The SEC’s broadening of investment adviser obligations comes with hidden costs

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Amy Caiazza is a securities, fintech and blockchain partner in the Washington, DC, office of Wilson Sonsini Goodrich & Rosati. She is the leader of the firm’s fintech and financial services group, advising clients on regulatory and transactional matters involving securities and commodities laws.

Cutting-edge technology, from machine learning and AI to new payment rails, is transforming the world of financial services, including how fintech startups manage investor assets, assess the suitability of investments, and execute transactions.

However, recent attempts by the Securities and Exchange Commission to broaden its definition of fiduciary duties for investment advisers and the obligation of broker-dealers to act in customers’ best interest could create significant regulatory risks for those startups. This change is apparent in recently proposed rules that would sharply curtail the use of artificial intelligence and other technologies by broker-dealers and investment advisers.

A history of investment advisers’ fiduciary duties

Investment advisers have long been viewed as fiduciaries to their clients. Although the Investment Advisers Act of 1940 (the primary federal law regulating investment advisers) does not explicitly impose fiduciary duties on advisers, in 1963’s SEC v. Capital Gains, the Supreme Court found the law fundamentally based on the idea that advisers are fiduciaries.

Investment advisers who seek to innovate will need to tread carefully in this space to avoid missteps, which could have significant consequences for their viability.

In that case, the Court focused solely on whether the SEC could insist an adviser disclose practices raising conflicts of interest. While the Court acknowledged a separate argument that the potential conflicts of interest involved in the case should be eliminated rather than merely disclosed, the Court declined to rule on that issue, noting that the SEC had limited its request to disclosure — even though the conflict of interest in the case was significant.

Expansion in recent guidance

Over 50 years later, in 2019, the SEC issued an interpretive release asserting a much more expansive view of an adviser’s fiduciary duties. This standard encompasses a duty of care — which involves the duty to provide advice that is in the best interest of the client, to seek the best execution of a client’s transactions, and to provide advice and monitoring throughout the relationship — and a duty of loyalty, which involves either eliminating or providing full and fair disclosure of conflicts of interest.

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