Fiduciary Duty for Broker-Dealers and Agents

Written By: Phil Feigin

Could the states impose fiduciary duty on their own?

For more years than I care to remember, consumer groups, state securities regulators and investment advisers large and small have warned of the confusion wrought on investors by the differences between the duties owed them by investment advisers and broker-dealers. IAs are fiduciaries and thus have duties of care and loyalty to their clients, while broker-dealers (absent discretionary authority) are generally not held to a fiduciary standard, subject instead to the lesser suitability standard, i.e., the requirement that they recommend only investments that are “suitable” to their customers. With the array of euphemistic titles brokerage firms bestow on their agents, calling them anything but salesmen, and the blizzard of commercials in the media in which they declare themselves to be in the investor’s corner, it is easy to make the case as to confusion.

I, for one, tend to downplay the confusion factor. I am sure many investors are at least confused as to the duties they are owed by their financial providers. At the same time, I doubt any consumer who visits a Volkswagen dealer is going to be confused by the fact they are likely to be shown Volkswagens to the exclusion of all other brands. But I digress.

The confusion argument has compelled a great deal of dialogue over the last many years, and led to the SEC’s Congressionally mandated assignment in Dodd-Frank to study and consider adopting a uniform fiduciary standard for broker-dealers and investment advisers. For me, that would be like drafting a uniform standard for real estate salesmen and attorneys, but again, I digress.

Ever since, the same consumer groups, state securities regulators and investment advisers large and small have been exhorting the SEC to adopt such a uniform standard, meaning some form of fiduciary duty. Notwithstanding Capital Gains, fiduciary duty is traditionally a matter of state law. The concept is a rarity in federal securities law. The preemption that has befallen state securities law of late often leaves the states with no choice but to urge the SEC or Congress to do something as opposed to doing it themselves.

Under the National Securities Market Improvement Act (“NSMIA”) back in 1996, the states were preempted from imposing any broker-dealer regulatory requirements that departed from federal standards:

No law, rule, regulation, or order, or other administrative action of any State or political subdivision thereof shall establish capital, custody, margin, financial responsibility, making and keeping records, bonding, or financial or operational reporting requirements for brokers, dealers, municipal securities dealers, government securities brokers, or government securities dealers that differ from, or are in addition to, the requirements in those areas established under this chapter….

In my view, the thrust of the provision was to prohibit state securities regulators from imposing books and records, forms and similar requirements on broker-dealers and their agents that were different than those required under federal law. My question is “would this (or some other) language also preempt a state from amending the private liability section of the state securities law to provide a private remedy for any investor whose broker-dealer or agent fails to act as a fiduciary to that investor?” I don’t believe anyone can say at this point.

How can anyone know? The only way to test the premise would be for a state to enact such a provision and wait to see if a broker-dealer successfully defended arguing the imposition of fiduciary duty is preempted in NSMIA. Scrutinizing the language, I can conjure up only two potential bases for preemption of such a state imposition of private liability for failing to act as a fiduciary under the provision. The first is under the term “financial responsibility,” although I believe that would be a reach as this phrase is meant to refer more to requiring a brokerage firm to have adequate capital, custody and the customer protection rule under the Securities Exchange Act of 1934. The second possibility would be a “penumbra” to the provision argument, i.e., it is not actually stated in the law expressly, but a court would rule preemption to be found in the “general intent” of the language.

Rather than waiting for and continually urging the SEC to suffer the laboring oar in the controversy, one or more states could propose and enact legislation that would create private civil liability on their securities brokerage licensees and registrants for failure to provide fiduciary services. This would not be a “law, rule, [or] regulation” constituting any sort of procedural snag in the licensing or registration process, as requiring separate state-required forms, reports, testing and filings might present. It would merely be grounds for private civil liability, a matter of prescribing the rights and liabilities between contractual parties.

Rather than continuing to harp on the beleaguered SEC to do something, perhaps a state itself committed to the cause could stand up for what it believes in and serve in that federalism-hallowed role as laboratory for new ideas. Let a state give such a private remedy a try. It would certainly get everyone’s attention.


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