1. Breach of Fiduciary Duty
Brian S. Hamburger, JD, AIFA®, CRCP
Managing Director
August 9, 2009
NASAA Investment Adviser Training Workshop

2. Farther from Fiduciary Duty
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3. Farther from Fiduciary Duty

4. Farther from Fiduciary Duty
$15 million (in 1920s dollars)
$400 million
$7 billion
$1.2 billion
$50 billion

5. Farther from Fiduciary Duty

6. Farther from Fiduciary Duty
“Only when the tide goes out do you discover who’s been swimming naked.”
Warren Buffet

7. Farther from Fiduciary Duty
“breach”[breech]:
(noun): a failure to perform some promised act or obligation
(verb): break or act contrary to (a law, promise, etc.)
Your Honor, he stole control in violation of his fiduciary duty. I should get to drive, or be compensated for the loss of control.

8. Defining the Fiduciary Duty
Fiduciary duty is the first principle of the investment adviser — because the duty comes not from the SEC or another regulator, but from common law. Some people think "fiduciary" is a vague word that's hard to define, but it's really not difficult to define or to understand. Fiduciary comes from the Latin word for "trust." A fiduciary must act for the benefit of the person to whom he owes fiduciary duties, to the exclusion of any contrary interest.
Remarks of Lori Richards Former Director of OCIE U.S. Securities and Exchange Commission

9. Defining the Fiduciary Duty
Essential Elements
Duty of Care
Duty of Loyalty
This “fiduciary” thingy really complicates pillaging a corporation.

10. Defining the Fiduciary Duty
SEC. v. Capital Gains Bureau, 375 U.S. 180 (1963)
“The Investment Advisers Act of 1940 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.”
“Nor is it necessary in a suit against a fiduciary, which Congress recognized the investment adviser to be, ...”
“Courts have imposed on a fiduciary an affirmative duty of "utmost good faith, and full and fair disclosure of all material facts," as well as an affirmative obligation "to employ reasonable care to avoid misleading“ [its] clients.”

11. Defining the Fiduciary Duty
What about state-registered investment advisers?
NASAA Model Rules do not mention fiduciary.
State regulators must look to their local securities act and rules thereunder as well as state case law to determine the scope of an adviser’s fiduciary duty under state law.
Example: Code of Maryland Regulations B states:
An investment adviser is a fiduciary and has a duty to act primarily for the benefit of its clients. While the extent and nature of this duty varies according to the nature of the relationship between an investment adviser and its clients and the circumstances of each case, an investment adviser may not engage in unethical business practices.

12. Defining the Fiduciary Duty
Prohibited practices Under certain state statutes
Lending money to or borrowing money from certain clients
Inducing trading in a client’s account that is excessive in size or frequency in view of the financial resources and character of the account
Charging excessive or unreasonable fees
Circulating advertising that is (1) misleading or (2) fails to comply with the Rule 206(4)-1 of the Advisers Act
Guaranteeing a client that a specific result will be achieved (gain or no loss) as a result of advice that will be rendered
Trading between the adviser’s (or representative’s) account and the client’s account without getting client consent.

13. Scope of the Fiduciary Duty
Legal standard of care
Commissioner Walter: universal fiduciary standard for all financial professionals
Commissioner Aguilar: Congress should mandate that all providers of investment advice should be fiduciaries
Chairman Schapiro: duty that exists on the investment advisory side does not exist, clearly, on the broker-dealer side, and Congress needs to pass a law to make this a uniform fiduciary duty
SIFMA: develop a standard between fiduciary and suitability
Financial Planning Coalition: establish a universal fiduciary standard
Richard Ketchum, Chairman and Chief Executive Officer of FINRA: establish a fiduciary standard that will fit with a variety of business models

14. Scope of the Fiduciary Duty
Dodd-frank bill
House version: Would have imposed a fiduciary duty towards customers on every financial intermediary who provides advice.
Senate version: Requested a study to determine the impact on applying a fiduciary standard to broker-dealers.
Final Bill (signed into law): Went with the Senate’s version and instructed the SEC to conduct a study regarding broader applicability of a fiduciary standard.
The SEC has opened a comment period to receive feedback; it will last 30 days from publication in the Federal Register. The SEC then has to submit its fiduciary report to Congress by January 21, 2011 and will then have the authority to promulgate a rule establishing a universal fiduciary standard.

15. Applying the Fiduciary Duty
Hypothetical #1: Due diligence
2010: Firm A and Firm B are considering purchasing Fund #1, which only has a track record of one year and one of its managers has a disciplinary event on his U4. Firm A relied primarily on industry reputation of the managers and a brochure it received in the mail. Firm B relies on the same information, but does some additional due diligence into the firm’s track record. Firm B is unsure about investing in a Fund with such a short track record and instead opts to invest client assets in Fund #2, which has a longer track record.
2015: Fund #1 has given Firm A’s clients a 100% return; Fund #2 has only given Firm B’s clients a 10% return, and it’s lagging the market.
2016: Firm B moves clients from Fund #2 to Fund #1, satisfied with the performance track.
2017: Fund #1 turns out to be a Ponzi scheme.

16. Applying the Fiduciary Duty

17. Applying the Fiduciary Duty
HYPOTHETICAL #2: CHERRY PICKING
IA traded in an omnibus account and allocated the trades once he could determine their profitability.
Profitable trades were generally directed to an account where the IA took a performance allocation; and away from a hedge fund the IA managed.
Profitable trades were allocated to the adviser’s personal accounts and the remainder to client accounts.
Portfolio manager placed orders for securities, but changed or delayed making allocations of the purchases and sales until after the order had been filled and the price of the security had been obtained, allocating more favorable trades to the proprietary hedge fund accounts. COO ignored red flags.

18. Applying the Fiduciary Duty
HYPOTHETICAL #3: Dually-registered representatives
IA representative is dually registered as an IAR and a registered representative of a broker-dealer.
IA representative may receive both advisory fee and commission or 12b-1 fee for making a trade.

19. Applying the Fiduciary Duty
You should search for those business practices that have the potential to sacrifice the interests on one set of customers in favor of the interest of another.
You should also identify any situations in which the firm could place its or its employees’ interest ahead of the firm’s customers.
Remarks of Stephen M. Cutler Former Director of Enforcement U.S. Securities and Exchange Commission

20. Brian S. Hamburger, JD, CRCP, AIFA®

21. Brian S. Hamburger, JD, AIFA®, CRCP
Alyssa M. Kolber, JD