All about Fiduciary Duties and Dodd Frank Act

Sophisticated Ladies And Fiduciary Duties After Dodd Frank

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, the (Dodd-Frank Act), which significantly changed the regulation of financial institutions and the financial services industry.

The Dodd-Frank Act contains a number of provisions that are intended to improve investor protection, prevent securities frauds and securities scams, and strengthen the regulation of broker-dealers. Two key provisions are summarized below:

• Broker-Dealer Fiduciary Duties. The SEC is required to undertake a study to determine if there are any gaps or shortcomings in the current supervision of and standards of conduct applicable to broker-dealers and retail investment advisers. This study must be completed by January 21, 2011. The SEC is given the authority to adopt a new fiduciary duty rule applicable to broker-dealers based on the results of the study. However, the Dodd-Frank Act itself does not adopt any such new duty.

• Point of Sale Disclosures. The law now gives the SEC the explicit authority to require broker-dealers to provide certain disclosures to retail investors before the purchase of an investment product or service by the investors. Such disclosures must include information about investment objectives, strategies, costs, and risks, as well as any compensation or financial incentive received by a broker-dealer or other financial intermediary in connection with the investor’s purchase of the product or service.

The issue of whether the SEC should impose fiduciary duties on broker-dealers and their representatives has generated a firestorm of controversy with Wall Street urging that the current system is just fine. That current system that Wall Street seeks to maintain is one in which the obligation of broker-dealers and their representatives is to provide a suitable recommendation to customers, and not the most suitable recommendation. On the other hand, if the SEC adopts a new fiduciary duty rule, that would mean that broker-dealers would have to join those individuals and entities defined as “investment advisors” under the law would have to act in the investors’ best interests in all its actions with the investor, including when making an investment recommendation to the investor. To clarify, currently investment advisors under the Investment Advisors Act have fiduciary duties but the basic guy down the street stockbroker does not.

The U.S. Supreme Court has held that Congress, through the Investment Advisers Act, recognized “the delicate fiduciary nature of an investment advisory relationship.” Because of this “federal fiduciary duty,” investment advisers have “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 clients.” That same Advisers Act creates an exception for “any broker or dealer whose performance of [advisory] services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation” for those services.

There are many reasons why applying the fiduciary standard to broker dealers is a compelling idea whose time has come. The strongest argument is that it fulfills the expectations of investors that was created by the broker dealer industry .Brokerage firms ads classify themselves as “wealth managers”, tout that investors may “place their trust” in such firms and “have relationships built on trust”, and that the firms will “provide strategies and plans for retirement”. These ads are not much different than the investment advisers’ ads which also contain the key words of management, trust and retirement plans and strategies. In response, investors believe that all financial advisors, regardless of the alphabet soup of initials following their names, have a duty to act in their best interests. Consumers clearly don’t understand that fine distinction. A recent survey found that two-thirds of Americans think brokers already have a fiduciary duty to their clients. When pollsters asked about “financial advisers,” the label many brokerage firms use for their salespeople, 76 percent of investors assumed that, surely, these professionals are fiduciaries. Therefore, the legal obligations on all financial advisors should be the same because investors expect those obligations to be the same.
Not surprisingly, studies have found that even sophisticated investors, those with professional degrees and high incomes, are very wary of financial advisors because of the more than a dozen high-profile securities fraud and securities scam cases reported over the past few years. The issue of trust is a big issue, especially for women who tend to be more “trusting,” because the financial meltdown revealed that Wall Street simply did not care about investors. Wall Street was not alone obviously, since banks did not care who they made loans to, rating agencies did not care about the ratings given to Wall Street’s derivatives and other products that “blew up” in the financial meltdown, and even Allan Greenspan did not care about the consequences of abdicating the Federal Reserve’s regulatory responsibilities in the ten years before he resigned.

Another reason why the fiduciary duties should be imposed on broker dealers is because the financial services industry has already blurred the lines. Many representatives of broker dealers are also investment advisors under the law who have fiduciary duties. This trend is expected to continue in the future as more and more stockbrokers become independent advisors who then open an account at a broker dealer where they buy and sell securities on behalf of their investor clients.

Attorneys for investors have been arguing that broker dealers and their representatives have fiduciary duties with mixed results in securities litigation and securities arbitration. First of all, unless an arbitration agreement so provides, there is no governing law in arbitration, i.e. neither federal nor state law necessarily applies. In those few cases which do get to court instead of arbitration, when the broker acts as merely an “order taker,” most courts find that no heightened relationship exists but that the broker has a duty to execute the order as requested. In other non-discretionary account relationships in which the broker makes recommendations concerning the purchase or sale of securities, the broker “is obliged to give honest and complete information” with respect to that recommendation. The latter relationship is governed by what is called the “suitability rule,” an industry standard that is sometimes confused with but is not a fiduciary duty. In either case, most courts find that the broker’s duty to the client, whatever the scope, ends after each transaction is completed . Therefore, the extension of the fiduciary duty rule to broker dealers and their representatives would bring uniformity to the law as well.

The argument against the fiduciary duty extension allegedly based on the advantage it would give to investors in proving securities fraud further emphasizes why the extension is necessary. A breach of fiduciary duty cause of action does not require reliance as an element. The elements of a cause of action for breach of fiduciary duty are: (1) the existence of a fiduciary duty; (2) the breach of the fiduciary duty; and (3) damage proximately caused by the breach. The reason reliance is not an element is that the reason the fiduciary attained that status is because there are those who are relying on that status, i.e. trusting that status. The damaged person is entitled to rely on the fiduciary status without proving the actual reliance. Similarly, whether or not the investors were contributorily negligent is not a defense because negligence is not a defense to an intentional tort such as breach of fiduciary duty.

Essentially, the law squarely focuses the burden on the fiduciary to prove the fiduciary’s actions were appropriate. Thus, the investment experience and knowledge of sophisticated ladies and gentlemen investors is not in dispute in fiduciary breach cases. On the other hand, the fact that the investors held onto the investment after having received all the correct material facts about the investment including the risks, costs, and how the financial advisor was to be compensated would be relevant in determining the amount of damages the investor suffered.

In conclusion, the extension of the fiduciary duty standard to the brokerage industry is long overdue. Investors should obtain what they already expect, that their financial advisor of whatever nomenclature should not only provide excellent customer service but act solely in the investors’ best interests.

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