• SEC staff issued an FAQ regarding consideration of diversity, equity, and inclusion factors by investment advisers when selecting or recommending other investment advisers in compliance with an adviser’s fiduciary duty.
• The FAQ raises more questions than answers.

On October 13, 2022, the Securities and Exchange Commission (SEC) staff issued an FAQ (a response to a frequently asked question) relating to investment adviser consideration of diversity, equity, and inclusion (DEI) factors.[1] In it, the staff stated that an investment adviser that recommends other investment advisers to, or selects other advisers for, its clients may consider DEI factors without violating its fiduciary duty, provided that the use of such factors is consistent with a client’s objectives, the scope of the relationship, and the adviser’s disclosures. Staff added that, “the adviser’s fiduciary duty does not mandate restricting such a recommendation or selection to investment advisers with certain specified characteristics, such as a minimum amount of assets under management or a minimum length of track record.”[2]

The staff FAQ responded to recommendations from the SEC Asset Management Advisory Committee (AMAC).[3] AMAC conjectured that many investment advisers use a narrow diligence checklist of exclusionary factors, such as minimum assets under management (AUM) and minimum length of track record, that eliminate nearly all investment advisers owned by women and people of color from consideration in the selection process for institutional asset management.[4] To address this concern, AMAC recommended the SEC or staff issue guidance to clarify that a wide variety of factors may be considered by advisers in their selection of other advisory firms and that the adviser’s fiduciary duty does not require exclusion of asset managers that  are diverse, newer to the industry, or do not have a certain level of AUM.

While AMAC’s intention is laudable, it would be difficult for an adviser, particularly one selecting asset managers for retirement assets, absent an explicit instruction from a client, to satisfy its fiduciary duty by recommending or choosing an asset manager with a limited track record or limited assets under management under most circumstances.[5] Additionally, the FAQ does not provide guidance as to the weight advisers can give to DEI factors as compared to more traditional factors like length of track record and AUM in its selection or recommendation of other advisers while still meeting their fiduciary duty to clients.

Perhaps this explains the SEC’s curious treatment of the FAQ. First, the FAQ was not accompanied by a public announcement. No hint to its issuance can be found on the SEC website. In fact, if not for a joint statement from Commissioners Crenshaw and Lizárraga, the existence of the FAQ would be unknown.[6] If it were not for the fact that the Commissioners provided a hyperlink to the FAQ page, it would be even more difficult, if not impossible to find by browsing the SEC’s website.  It is not, for example, included among the FAQs listed on the SEC’s FAQs page.[7] Indeed, Commissioner Lizárraga acknowledged that “the FAQ is difficult to find on our website and could have been accompanied by a public announcement alerting market participants of its existence.”[8]

Second, the staff issuing the FAQ is not identified. Generally, the staff of a particular division or office is identified as being responsible for an FAQ.[9] In this case, the FAQ only states that it was issued by SEC staff. Ordinarily, an FAQ relating to an investment adviser’s fiduciary duty would fall squarely within the purview of the Division of Investment Management. Neither Investment Management, however, nor any other division claimed credit for the FAQ.

Finally, adding to the intrigue is the location of the FAQ on the SEC website. The URL identifies a web page of the Division of Trading and Markets as the location for the FAQ—note the “tm” identifier following “.gov” in https://www.sec.gov/tm/staff-faq-relating-investment-adviser-consideration-dei-factors. Advisers looking for an FAQ or guidance regarding their fiduciary duty to clients in selecting or recommending other advisers would hardly think to look at the Trading and Markets section of the SEC website.

These irregularities, which avoid drawing attention to the FAQ’s existence, might cause a skeptic to conclude that the FAQ was issued not to provide market participants with regulatory guidance, but as a check-the-box exercise to implement a controversial recommendation from the now-defunct AMAC. Even if an adviser stumbled upon the FAQ, as noted above, it does not provide helpful guidance as to how an adviser can incorporate DEI factors into its selection or recommendation of other advisers consistent with its fiduciary duty to clients.

Investment advisers should be wary of overreliance on this FAQ. Staff FAQs have no legal force or effect and do not alter or amend applicable law, given that they represent the views of SEC staff, not the Commission. Choosing an investment adviser with a short track record or minimal AUM can open an investment adviser to significant liability in the event of subpar performance or an incident of defalcation, a problem this nonbinding FAQ is unlikely to solve, particularly in light of the fact that it contains no guidance on how to balance these competing concerns.

Unfortunately, this most recent staff FAQ raises more questions than it answers.

[1] See Staff FAQ Relating to Investment Adviser Consideration of DEI Factors (Oct. 13, 2022), https://www.sec.gov/tm/staff-faq-relating-investment-adviser-consideration-dei-factors.

[2] Id.

[3] See Recommendations for Consideration by the AMAC, SEC Asset Management Advisory Committee  Subcommittee on Diversity and Inclusion (July 7, 2021), https://www.sec.gov/files/spotlight/amac/amac-report-recommendations-diversity-inclusion-asset-management-industry.pdf.

[4] Id.

[5] As noted in the FAQ in a footnote, some advisers also may be subject to regulation by the Department of Labor and must consider such regulations as well when providing advice.

[6] See Commissioner Caroline A. Crenshaw and Commissioner Jaime Lizárraga, Statement on Staff’s FAQ Relating to Investment Adviser Consideration of DEI Factors (Oct. 13, 2022), SEC.gov | Statement on Staff’s FAQ Relating to Investment Adviser Considerations of DEI Factors.

[7] https://www.sec.gov/answers/faqs; see also https://www.sec.gov/divisions/marketreg/mrfaq.

[8] Commissioner Jaime Lizárraga, Raising the Bar on Diversity, Equity, and Inclusion (Oct. 13, 2022), https://www.sec.gov/news/speech/lizarraga-remarks-raising-bar-diversity-equity-and-inclusion-101322.

[9] See, e.g., Responses to Frequently Asked Questions Concerning Rule 606 of Regulation NMS (last modified June 3, 2022), https://www.sec.gov/tm/faq-rule-606-regulation-nms (FAQs issued by staff of the Division of Trading and Markets); Staff Responses to Questions About the Custody Rule (last modified Feb. 21, 2017), https://www.sec.gov/divisions/investment/custody_faq_030510 (FAQs issued by staff of the Division of Investment Management).