Investment managers owe fiduciary duties to clients, including a duty of loyalty and a duty of care. A persistent question, with no clear answer, is what precisely is required by the duties of loyalty and care. In this paper, I argue that much of investment management regulation is a response by regulators to the uncertainty inherent in the fiduciary obligation. Regulators design investment management rules to guide investment managers regarding the proscriptions imposed by the duty of loyalty and the diligence required by the duty of care.

Regulators, acting through agency rulemaking and enforcement actions, attempt to specify what is required of investment managers in the context of exercising their fiduciary obligation to clients. With regard to rulemaking, the Investment Advisers Act of 1940 authorizes the US Securities and Exchange Commission (‘SEC’) to adopt rules to guard against fraud. The SEC has used this authority to prescribe detailed conduct rules for investment managers. In many cases, the SEC has outlined specific steps managers must take in carrying out their fiduciary responsibilities. Absent these steps, the SEC will consider a manager to have breached its fiduciary duty and to have engaged in fraudulent conduct under the Advisers Act.

The paper presents several illustrations of SEC rules that work in this way: requirements regarding the disclosure information, requirements regarding the voting of proxies for shares held by advisory clients, and requirements regarding compliance policies and procedures. In each case, the SEC has used its rulemaking authority to outline specific steps managers must take to fulfil their fiduciary obligation.

Regulators take a similar approach with regard to agency enforcement actions. The Advisers Act is the primary federal statute regulating investment managers. Although there is only a limited private right of action under the Act, the SEC and the US Department of Justice actively enforce the law. Moreover, under the Act, mere negligence is sufficient for fraud liability. Thus, if the SEC deems an investment manager’s conduct, or lack of conduct, to be inappropriate, the SEC can bring an enforcement action under the negligence provision of the Act’s antifraud section. With negligence as the standard, such cases often are not difficult to prove.

Moreover, the vast majority of SEC actions settle, resulting in a statement or Order reviewing the misconduct and explaining that it is inconsistent with the Advisers Act. SEC statements discussing settlements, while not as significant as litigated cases, are followed closely by members of the investment management bar, who counsel investment funds and managers. Such statements are also followed closely by industry groups, who prepare best practices and other industry guidelines drawn in large part from settled actions. The SEC, therefore, uses the weapon of an enforcement action to announce to the industry the level of conduct the SEC believes is consistent with investment managers’ fiduciary obligation.

As an illustration, the paper discusses a series of actions brought by the SEC for a practice called market timing. Market timing is the frequent purchase and sale of mutual fund shares with the intent to profit from arbitrage between the net asset value of the fund and the value of the fund’s underlying portfolio. Market timing can harm fund shareholders but it is not necessarily illegal. The SEC launched investigations into the practice and brought a series of settled cases alleging breach of fiduciary duty and a violation of the Advisers Act’s antifraud provision. These cases present a clear example of the SEC using its prosecutorial authority to explain why market timing was a breach of fiduciary duty and a violation of the Advisers Act.

Viewing investment management law as I propose leads to an important insight about fiduciary law, and it challenges an alternative view of the fiduciary obligation. Some writers claim that detailed conduct rules effectively displace fiduciary duties. By contrast, I argue that, far from being an alternative to fiduciary duties, investment management law and regulation serve to explicate what the fiduciary obligation entails. Rules prepared by regulators governing the investment management industry are not a substitute for a fiduciary duty; they compose the substance of the fiduciary duty.

Arthur B. Laby is Professor of Law and Co-Director of the Rutgers Center for Corporate Law and Governance.