Trusted Experts or Order Takers

With the collapse of the financial markets in 2007 and 2008, individuals having accounts with securities firms found their life savings depleted and, while large financial institutions were negotiating federal bailouts, distressed investors who previously believed their finances were in balanced and safe portfolios looked to their brokers for an explanation. Frequently, the brokers had little to say.

People recalled the television and press advertisements, marketed on a grand scale, reminding the public that a broker-dealer and its registered representatives were to be looked to for their expertise, experience and advice in the complex financial markets. Trust and security were words frequently used in the advertisements. However, when ultimately required to defend their investment advice those same experts frequently responded that they were merely order takers and had no heightened obligations to their customers.

More often than not, in the eyes of the law, they were correct. Recognizing that the public had little understanding of the scope and role of their investment professionals, on July 21, 2010, President Barack Obama signed into law the DoddFrank Wall Street Reform and Consumer Protection Act of 2010,1 which, under Section 913 of Title IX, required the Securities and Exchange Commission (SEC) to conduct a study to evaluate: • The effectiveness of existing legal or regulatory standards of care (imposed by the commission, a national securities association, and other federal or state authorities) for providing personalized investment advice and recommendations about securities to retail customers; and • Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute.

Once the study was completed and recommendations were made, as part of the act Congress authorized the SEC to adopt rules covering any identified gaps or overlaps. On Jan. 21, 2011, the SEC released the results of the study to the public. In recommending the SEC implement a “uniform fiduciary standard of conduct for broker-dealers and investment advisors when providing personalized investment advice about securities to retail customers,” the study found that “retail customers do not understand and are confused by the roles played by investment advisers and broker-dealers, and more importantly, the standards of care applicable to investment advisers and broker-dealers when providing personalized investment advice and recommendations about securities.” The recommended “fiduciary standard” was to be “no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2).” Specifically, the study proposed the adoption of a rule providing that the standard of conduct for all investment professionals “shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.” Virtually immediately, Wall Street expressed its outrage with the recommendations. Many argued that voluminous laws and regulations already existed, and that enforcement of those laws should have been the focus of the report. Others expressed concern over the heightened costs of compliance. As the result of lobbying and other efforts creating resistance to the recommendations, the SEC has taken few affirmative steps toward enacting any rules or regulations in furtherance of the study.

With no ensuing regulations having been implemented by the SEC since the issuance of the study, and perceiving that the mandate was mired in a bureaucratic quagmire, in Feb. 2015 the White House Counsel of Economic Advisors issued its own independent report, finding that advice provided by brokerage firms for retirement accounts was subject to substantial conflicts of interest, which benefited the brokerage industry and cost the public approximately $17 billion per year. Based on this, the White House directed the Department of Labor (DOL) to adopt a rule mandating that brokerage firms abide by a fiduciary standard that would put the best interests of the customers above their own when providing advice on retirement savings. Thereafter, the SEC chair, Mary Jo White, while speaking at a Securities Industry and Financial Markets Association conference on March 17, 2015, stated it was her “personal view” that the SEC should also adopt a uniform standard. With no firm regulations yet in place, the question presented and to be explored remains: Should all brokers providing investment advice be held to a fiduciary standard? By way of background, in general, securities are sold to customers through two avenues: registered investment advisors (RIAs) and broker-dealers (BDs). RIAs, often fee based, are registered with the SEC, and are regulated under the Investment Advisors Act of 1940. BDs generally charge commissions on the sale of products and, if they have assets under management of $110 million or more, are regulated by the Securities Exchange Act of 1934 and rules imposed by the industry’s self-regulatory organization (SRO), the Financial Industry Regulatory Association (FINRA). Often, BDs give advice, but there is an exclusion under the advisor’s act that permits the providing of such advice as long as the advice is “solely incidental” to the brokerage services and the broker does not charge additionally for the advice.

In practice, this means the charges must be commission-based and not asset-based. Initially, one profound difference between RIAs and BDs is that when a BD sells a security to a customer it is able to do so from its own inventory. Recognizing the inherent conflict of interest, RIAs are not permitted to do so. Additionally, with notable exceptions, the courts have generally found that although RIAs have a recognized fiduciary duty to their customers, brokers have no such heightened obligation unless the broker is acting on a discretionary basis. The New Jersey federal district court has followed the consensus of most other courts in holding that “a broker is in a fiduciary relationship with a client, where that client maintains an account with the broker in which the broker, not the client, retains discretion.” Discretion is generally found where the broker has been provided with a power of attorney to trade the account, or where there is otherwise found to be de facto control. Without a finding of discretion or other facts that would impose a fiduciary standard upon a BD, its obligation to a customer ends with the adherence to “just and equitable principles of trade and high standards of commercial honor,” which often is deemed satisfied by any trade that is “suitable” and is generally defined as making recommendations which are “consistent with the interests of its customer.” Additionally, BDs must avoid “acute” conflicts of interest. Commencing in the 1980s, and seeking to begin competition with RIAs, BDs began providing financial planning services. They eschewed the title of stockbroker in favor of those perceived as more erudite and trustworthy, such as financial advisors, financial consultants, financial representatives, and investment specialists. With this and other similar shifts, the lines between broker and investment advisor began to blur, and the public was unable to perceive any marked difference between an RIA and BD. This became particularly true since approximately 88 percent of all investment advisors were also registered representatives of BDs.

The study issued by the SEC found the public “find[s] the standards of care confusing, and are uncertain about the meaning of the various titles and designations used by investment advisers and broker-dealers.” Arguments Against Imposing a Uniform Fiduciary Standard A lesser remedy exists by ‘un-blurring’ the titles and roles. Many find that there is a strong benefit to the public in maintaining a segment of the market as pure ‘salespeople’ rather than ‘advisors.’ They see the roles as completely different, and necessary for efficiency. As one commentator remarked, “both my butcher and my nutritionist may give me guidance on what to eat—there is little confusion about the nature of the ‘advice’ from each.” He suggests that “if you know what you want to buy, get a salesperson to buy it from; and if you want advice, get it from a true advice-giver. You don’t expect credible and objective advice about alternative products from your butcher, and nor should you expect it from your broker, either.” The suggested solution is not to impose a uniform standard for two completely different roles but, instead, to leave the standards as they presently are promulgated and ensure the role and titles are made clear and certain in order to avoid public confusion. It is urged that this may be accomplished through the enforcement of the advisor act, and to return to the assurances that advice provided by BDs is ‘solely incidental’ to the sale of securities. The imposing of a fiduciary standard would limit consumer access to products and accounts. One of the security industry advocacy groups, the National Association of Plan Advisors, has advanced the position that a uniform fiduciary rule would limit the ability of most Americans to have access to financial advice. They argue that small investors would no longer have access to financial advisors and investment providers “they trust simply because they offer different financial products—like annuities and mutual funds—with different fees.” Similarly, another securities industry advocacy group, the Securities Industry and Financial Markets Association (SIFMA), in citing a 2010 report issued by Oliver Wyman, Inc., argues that due to account minimums that would be required under the new standards, many investors would not be able to maintain accounts.20 In testimony by SIFMA’s president and CEO, Kenneth E. Bentsen Jr., given before the DOL on Aug. 10, 2015, Bentsen noted that up to 50 percent of all account holders would have no access to the market if minimums on IRA accounts of $50,000 were imposed, due to the regulatory costs and compliance requirements involved. Moreover, he stated in that testimony that under the present framework and an alternative suggestion developed by SIFMA to that being proposed by DOL, “customers currently can and do choose the fee model that best suits their needs and trading behavior. Under the uniform standard initially proposed by the SEC and DOL, investors would be compromised through the loss of account options and products presently available to them. Compliance costs would escalate and investors would bear the burden. Concerns have been expressed that the costs to the industry would increase dramatically as a result of a uniform fiduciary standard, due to the many layers of heightened obligations that would be imposed upon the industry. It is perceived that under such a heightened standard the industry would be required to incur a far greater investment of time and resources in training, legal and compliance, risk management and oversight, account supervision, investment strategy and planning and the dissemination of additional disclosures. As but one example, some fear that ‘cold calls’ or mere initial customer discussions could be deemed ‘advice’ subject to a fiduciary obligation, turning what are now brief, simple encounters into lengthier exercises requiring much greater research, preparation and personnel, among other things. It is argued that these costs—in whole or in part—would be transferred to the customer, increasing account maintenance and causing harm to the public. Under the model utilized in the Wyman report, these increased costs would impact small investors ($200,000 and under) by 46 percent, affluent investors ($500,000) by 85 percent, and high net worth investors ($1 million) by 77 percent. Particularly for customers who do not need the investment advice and are merely looking for a vehicle to buy or sell products, this increased burden is considered unwarranted.

Arguments for Imposing a Uniform Fiduciary Standard A uniform fiduciary standard would provide heightened protection for investors. Much as the industry has its advocates, so do the investors. Organizations such as the Public Investors Arbitration Bar Association (PIABA) feel profoundly that the industry has demonstrated its inability to properly police itself, and that the imposition of a fiduciary standard to protect investors’ financial resources is an imperative. In its report of March 25, 2015, PIABA provides a litany of examples of BDs advertising their services as trusted financial advisors and confidants, and as placing the consumer’s interest paramount above all, yet when defending actions brought against them BDs have taken the legal position they owe little duty to the investor—and certainly not a fiduciary obligation. The report concludes, “Brokerage firms advertise that they put customers’ interests first, offer personalized advice and do all of this on an ongoing basis. In other words, they advertise that they are a fiduciary such as a doctor or lawyer. But, when a dispute arises with investors, brokerage firms consistently argue they have the duties of a used car salesman.” Proponents of the uniform standard state that investors would have transparency of fees and charges, and know that investment opportunities would first be offered to customers and not taken by the firm at the customers’ expense. Moreover, the duty may also impose monitoring of a customer’s account with the customer’s investment goals in mind, and not to act only when the account may be in peril. A fiduciary standard will create more fair and reliable fees and charges. Although the industry may argue that checks and balances are already in place through rules, a fiduciary standard would bring reliability to fee structures. Concerns of churning (transactions implemented only for the purpose of generating a commission) or neglect in a fixed-fee account would be addressed at a standard most favorable to the investor. Moreover, the rules are likely to result in greater transparency of complex and convoluted fee arrangements and hidden means of compensation. Consistency of standards. Although, as stated earlier, most states recognize there is no fiduciary duty for BDs acting without discretion, there are exceptions. California (joined by Missouri and South Dakota) imposes a fiduciary standard regardless of the type of account. Other states diverge internally. For example, most courts in New York have taken the position that without the existence of a discretionary account there is no fiduciary obligation. However, other courts within that same state opine differently. A single standard will likely produce more consistent and predictable results.

Some, like the former SEC Chair Arthur Levitt, state that the simple reality is a broker is necessarily a fiduciary under any analysis. He was quoted as saying a fiduciary duty should have been implemented “some time ago” because brokers are more than simply “order takers” and routinely provide investment advice. He summarized his position by stating, “I do not accept the notion that a broker is an order taker. If he’s a good broker, he’s much more than that.” The public will ultimately profit by the uniform standard. As compelling as the industry’s projections may be that there will be increased costs to BDs associated with a fiduciary standard, there are differences of opinion regarding the final impact. As previously stated, the DOL has taken the position that conflicts of interest in retirement accounts profit Wall Street and cost the public approximately $17 billion a year. A study entitled The Impact of the Broker Dealer Fiduciary Standard on Financial Advice came to markedly different results than those expressed in SIFMA’s Wyman report. It concluded, “Empirical results provide no evidence that the broker-dealer industry is affected significantly by the imposition of a stricter legal fiduciary standard on the conduct of registered representatives.” It predicted an additional “net welfare gain to society,” particularly to those “who are ill equipped to reduce agency costs on their own by more closely monitoring an adviser with superior information.” The study determined “results provide evidence that the industry is likely to operate after the imposition of fiduciary regulation in much the same way it did prior to the proposed change in market conduct standards that currently exist for brokers.” Perhaps more directly, PIABA summarized the finding by stating, “Actual data, as opposed to the rhetoric and hyperbole, demonstrates that the imposition of a fiduciary duty upon brokers has no meaningful impact on cost to investors or access to investment advice.” So Where Do We Stand? There is never a magic wand to ensure wholesale fairness and honesty when money is involved. Neither the financial industry nor the public, however, benefit from the ongoing uncertainty over what standards will prevail. If the SEC decides to promulgate a uniform fiduciary standard upon the broker-dealer industry, discussions can take place regarding precisely how those standards will be implemented. Investor groups such as PIABA will align with the SEC study and the DOL report. Wall Street, as expressed through SIFMA, will have its own position but, more than four years after release of the SEC study, it seems time to advance toward resolution of the issue.

Author’s Note – Following the completion of this article, the Financial Services Committee of the U.S. House of Representatives passed and sent to the full House a bill that would block proposed rulemaking by the U.S. Department of Labor that would expand the scope of the fiduciary duty. The impact of that rule would be limited to transactions in retirement accounts.

Bruce E. Baldinger is the managing member of The Law Offices of Bruce E. Baldinger, LLC in Morristown. He is a 1984 graduate of the University of Miami Law School and focuses his practice on commercial and securities litigation.

This article was originally published in the December 2015 issue of New Jersey Lawyer, a publication of the New Jersey State Bar Association, and is reprinted here with permission.

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