Tuesday, April 30, 2013

"The Retirement Gamble" - The Producers Reverse Course and Embrace Wall Street's Claims

A documentary which was more than a little critical of the financial services industry, the PBS Frontline episode The Retirement Gamble, has generated a storm of controversy. Today, in a stunning reversal, the producers of the PBS’ Frontline episode have reversed their views and now agree with their critics (Wall Street firms and insurance companies). These producers now agree that the focus of the documentary on fees was misplaced.  The producers now embrace the view that higher fees and costs nearly always lead to better investments, as Wall Street currently attests.

Said the producers in a recent interview, “Most illuminating to us is the discovery of group annuity fees, often 1% a year or greater. Imagine the huge benefits such additional fees must be generating for investors in 401(k) accounts. We can only speculate at the many advantages investors must be accruing from such costly ongoing fees.”

This is not to say that economies of scale are not possible in 401(k) plans. In fact, several Wall Street executives were heard to say, in response to the PBS Frontline show: “Of course, there are economies of scale. The more Americans put into their 401(k) accounts, the greater our personal economies get. Our fees go up and up, and we rarely are pressured to cut them.”

Fortunately for the producers, in an interview at www.FiduciaryNews.com, a popular web site covering the retirement investment industry, Craig Morningstar, Chief Operating Officer at Dynamic Wealth Advisors in Scottsdale, Arizona was quoted as saying that “the show only covered 1/3 of the typical hidden fees.” The producers felt relieved, as they now have even greater belief that the even-higher-than-suspected fees must result in “SUPER INVESTMENTS.” The producers added, “We are so glad that we omitted discussion of the '28 hidden fees' which Neda Jafarzadeh, a Financial Analyst at NerdWallet Investing, San Francisco, observed were present, in the article posted at www.FiduciaryNews.com.  [For the entire article, visit http://fiduciarynews.com/2013/04/exclusive-interview-frontline-producer-explains-controversial-401k-documentary-the-good/]. All of these fees must ... must ... be good for investors."

Of course, the strong negative correlation found in academic research between higher fees and  long-term investment returns has not gone overlooked. The producers of the PBS Frontline documentary have agreed with Wall Street, “Statistics, of course, never  speak the truth. Active management must trump low-fee, low-turnover passive index investing. It’s just common sense. For if that were not the case, why would we spend all that money advertising actively managed, high-cost investment strategies?”

The lack of academic evidence supporting the superior returns of index funds over actively managed funds, on average, over time, has not deterred the producers. The producers now cite Christine Marcks, President of Prudential Retirement, who was asked in the documentary about the overwhelming evidence that exists on indexing beating expensive active investing. Her response, with a straight face, was, "Yeah, I haven't seen any research that substantiates that. I mean, it – I don't know whether it's true or not. I honestly have not seen any research that substantiates that." The fact that one of the largest providers of retirement plans in the country has not done due diligence on this issue, by examining the academic evidence, does not deter these tireless producers, who were heard to state: “When a Wall Street executive speaks, the public must believe her. We all know that we should place blind trust in Wall Street and the insurance companies, especially after the financial crisis of 2008-9 and the great actions taken by Wall Street firms thereafter to restore faith in the securities industry, by returning to high levels of profitability so soon while individual investors and small businesses continued to suffer.”

The producers of the PBS documentary are now working tirelessly on a sequel, “The Retirement Gamble II: Why We Should Ensure the Bonuses Paid to Wall Street’s Executives and Analysts, To Ensure Their Retirement Succeeds.” Stated one of the producers, “It is so important that at least a few Americans have a successful retirement. In that way the rest of us can applaud the success of the few, who took so much from us. We have to have someone to cheer about, when we are in our used trailer in Florida watching old PBS documentaries on over-the-air television, while sweltering in the oppressive heat because we cannot afford to run the air conditioning. Financial security is, of course, so over-rated; the anti-depressive effects of cheering on in retirement those early-retired Wall Street and insurance company employees who profited so much by their greed should not be underestimated.”

The producers are also relieved that 85% of “financial advisors” were found, in the original documentary, to not be fiduciaries. (As stated in the original PBS Frontline documentary, only 15 percent of advisers are “fiduciaries” — advisers who by law must operate with the best interests of the plan sponsor or plan participant in mind.) The producers stated: “We are so glad that there are so many choices available. We would never want to limit the many business models, nor reduce the number of non-trusted advisors from which we can choose. Wall Street and the insurance companies should be able to extract excessive fees and costs from us in many different ways ... Why? Because it's what they do best!”

The producers added: "Is it too much to ask that financial advisors act in the best interests of their clients? Yes, of course it is, for that would destroy the high extraction of rents which occurs by Wall Street from the overall U.S. economy. Isn't it great that over 35% of the profits generated by the U.S. economy now occur in the financial services sector ... and that doesn't even count the huge bonuses awarded to Wall Street's executives! We certainly don't want to disrupt the high profits of our Wall Street firms and executives, just for the sake of the expectation of a consumer that his or her advisor is acting in the consumer's best interest. Let's not sacrifice Wall Street profits for some nebulous 'principle'!"

Asked about the fiduciary standard, the producers now question their earlier promotion of a higher standard for all retirement plan advisors, stating: “Who cares about a standard that consumers can’t even spell?” When asked about the huge potential benefits, in terms of lower fees and costs, which would result for 401(k) and IRA investors if ERISA's strict fiduciary standard were to be applied, the producers replied, "We should never interfere with a centuries-old business model. The dinosaurs that are Wall Street's proud institutions need not face an extinction event, simply because consumers desire trusted advice."

Upon hearing of the PBS Frontline documentary producers’ “change of heart” and their embrace of all of the hype promulgated by Wall Street, some industry observers were more than a little perplexed. Then again, an explanation soon became apparent. It was overheard that the producers' next documentary would be funded by a generous donation from FINRA, SIFMA, FSI, and many broker-dealer firms and insurance companies, with huge salaries to be paid to the producers along the way. When questioned regarding their objectivity in response to these new sources of funding, the producers brushed aside such concerns. “Of course we need higher salaries. This permits us to save more for retirement, as we have and will continue to promote. Only in such way can we ensure the high extraction of rents from our retirement accounts by Wall Street. Even though Wall Street is paying us a lot to do this next documentary, we are certain they will get their money back, and then some, over time. It will all balance out."

This interviewer then questioned the producers. "What about the trust of individual Americans in our financial services system? Without trust, investors have and will flee the capital markets, depriving American business of much-needed capital, and driving up the cost of capital. This will impose a brake on U.S. economic growth, leading to lower standards of living for all Americans than what could have been obtained." The producers responded, "We are so glad that we never paid attention in our college Macroeconomics class."

Stay tuned for more in "The Retirement Gamble" documentary wars. Wall Street and the insurance lobby are gearing up for "the next big show," confident that their message of "high costs, high fees, speculative products, and ensuring the financial security of Wall Street firms and their executives by preserving archaic, conflict-ridden business models" will resonate conclusively in the halls of Congress.

Saturday, April 27, 2013

FINRA's Failure: It Is NOT a "Professional Regulatory Organization"

I was recently asked to provide the distinctions between a professional regulatory organization and a self-regulatory organization.  The distinction is a fine one, but an important one.

A PRO serves the public interest. An SRO, as we have seen through the prominent example of FINRA, only gives lip service to serving the public interest, while in reality it keeps the standards of conduct observed by its members ("suitability") so low as to permit the firms to extract excessive rents at the expense of the consumer.


FINRA (formerly known as NASD) fails the important test of serving the public interest. As Tamar Frankel, America’s leading scholar on fiduciary law as applied to the securities industry, wrote in 1965:  “NASD … [does] not, as do the professions, consider the public interest as one of [its] goals … Let us consider the attitude of the professions toward the public interest. The goal of public service is embedded in the definition of a profession. (Pound, The Lawyer from antiquity to modern times 5 1963). A profession performs a unique service; it requires a long period of academic training. Service to the community rather than economic gain is the dominant motive. We may measure the broker-dealer’s activities against these criteria … Although at least part of his trade is to give service, profit is his goal. The public interest is stated in negative terms: he should refrain from wrongdoing because it does not pay. This attitude is the crux of the matter, the heart of the difference between a profession and the broker-dealer’s activity … The industry emphasizes its merchandising aspect, and argues that the broker-dealer is subject to the duties of a merchandiser even when he is also acting is his advisory capacity … the NASD [has] proved incapable of establishing accepted standards of behavior for the activities of the trade … Past experience has proved that it is unrealistic to expect the NASD to regulate in the public interest ….” (Tamar Frankel, f/k/a Tamar Hed-Hoffman, “The Maloney Act Experiment,” 6 Boston College L.R. 186, 217 1965).

Nearly half a century has passed since Professor Frankel's article appeared, and FINRA's failure continues. In fact, FINRA's failure goes all the way back to 1942, when FINRA first adopted Rules of Conduct for its members which omitted any reference to the broker's fiduciary duty when in a relationship of trust and confidence with a client (despite, as my earlier blog post observed, the application of state common law fiduciary duties which existed at such time). 

Going back further, to 1945, FINRA (f/k/a NASD) stated: “The entire program of [our SRO] is based upon the principle of self-regulation and self-discipline.  We believe the standards of business ethics in the business are as high as in any other business or profession.  It is the purpose of NASD to keep them high and to seek improvement.” - N.A.S.D. News, published by the National Association of Securities Dealers, Volume VI, Number 1 (May 1945). Of course, anyone who believes that the failed standard called "suitability" is "as high as any other ... profession" is simply off their rocker. And, unfortunately, the basic requirements of the suitability standard have not changed since the Maloney Act of 1938 authorized the creation of the SRO now know as FINRA.

Going back even further, FINRA (f/k/a NASD) commented upon the necessity of raising the standards of conduct, when the Chairman of the NASD early on opined: “[T]he time may come when we can arrive at a more professional status and we can give more of our attention as to who should be in the investment business ... The principal by-product [of formation of the SRO], which I don’t believe the founding fathers of this Association ever thought of, is that for the first time in history the securities dealer begins to see what he looks like and it hasn’t been altogether a pleasing sight.”  - statement of NASD Chairman Robert W. Baird in an address before the convention of the National Association of Securities Commissioners, as quoted in N.A.S.D. News, published by the National Association of Securities Dealers, Volume II, Number 1 (Nov. 15, 1941).  [Emphasis added.]  Of course, FINRA has failed miserably to attain "professional status" for the "securities profession," primarily because it has never raised its standards of conduct for its members and has never put the interests of the consumer first.

Why is a true Professional Regulatory Organization for financial planners and investment advisers important as a long-term goal? 

By maintaining and enhancing the professional standards of its members over time, the services of its members become more attractive to the public, fueling demand for the services of its members. The standards that are adopted must serve the public interest. They must be high enough to protect the consumer from the utilization of the professional's superior knowledge in a way adverse to the interests of the client. This is especially so in today's modern age, where the complexity of financial instruments, the ever-developing knowledge of investment strategies (both as to those shown to work and those shown to not work), and the emergence of new understandings with respect to risks faced by individual investors, demands that nearly all individual investors would be served by having a trusted, expert guide to navigate through the many shoals existing in the financial markets.

The key ingredient of a true profession is that the needs of the client always come first – i.e., a bona fide fiduciary standard is maintained. Without a bona fide principles-based fiduciary standard of conduct a true profession - bound to serve the public interest - cannot be created.

It should also be emphasized that members of a professional regulatory oganization must be individuals, not firms. Why? Because individuals, not bound to represent the commercial intersts of their firms when elected to membership of the professional organization, are far more likely to keep professional standards at high levels.


Permit me to contrast FINRA with my vision for a PRO for financial planners (including all those providing personalized investment advice):

Broker-dealer firms (i.e., business entities, which possess commercial interests)
Individuals (not firms) who are qualified to become members of the profession (see educational qualifications below; also, character requirements exist)
To protect its firms (and, by its charge, the public)
Primary mission is to protect the public. Also, to maintain a proper discipline of the members of the PRO accordance with the principles of the profession as a public calling. Also, to initiate and supervise, with the approval of the SEC and/or state securities regulators and/or other oversight body, appropriate means to insure a continuing high standard of professional competence on the part of the members of the PRO.
Initial Education
Series 6 or 7 licensure (for registered representatives)
4-year college degree from accredited institution is required, plus an advanced course of study in financial planning and investments; passage of comphrensive entrance exam is required for licensure to provide "personalized investment advice" to "consumers"
Continuing education
As necessary for licensure
30-80 hours of continuing education (CE) are required every two years, as determined by overseeing body
Standard of conduct applicable
Suitability + other specific rules; regulations are enumerated in FINRA’s “Rules of Conduct”
Principles-based bona fide fiduciary duties of due care, loyalty, and utmost good faith are applied at all times; principles are enumerated (while still quite broad) through “Professional Standards of Conduct” similar to the Model Rules of Professional Conduct for attorneys. While "scope of the engagement" can be defined, core fiduciary duties are incapable of "waiver" by the client.
Peer review upon receipt of a complaint
Initial investigation by PRO representative; Can initiate legal action to protect investors; can initiate disciplinary proceedings in certain cases where judgment of the member in adherence to his or her duties is not the issue; Otherwise, peer review of a complaint is required, and complaint is regarded as confidential until probable cause is found. Then hearing proceeds before a hearing officer; if an appeal is undertaken therefrom, the appeal is heard by a different peer review panel, and all decisions of such panel are published for purposes of educating members as to future actions.
Inspections and examinations
Periodic and upon receipt of a complaint
Generally, upon receipt of a complaint. However, periodic inspections occur of all firms relative to custody (i.e., ensuring safety of client investments) would occur, using a focused process designed to detect instances of actual fraud.
Governing body
FINRA, consisting of “public” members and industry members. However, most "public" members possess strong ties to member firms.
Board of Governors.  Initially, appointed individuals by state securities regulators (subject to SEC approval), consisting of professionals committed to the fiduciary standard. Transitioning to election over time (with elected members subject to state securities regulator and/or SEC approval)
Legal authority to control entrance into, and expulsion from, the organization
Act of Congress (Maloney Act) and SEC rules
Act of Congress + (for states to participate) legislative actions over time by state legislatures + federal/state enabling rules. Or, alternatively, authorizing legislation in specific states (usually accomplished through a "Model Act" which is first drafted, then adopted over time by the many states).
Funding sources
Fees imposed on securities transactions and on FINRA’s members, and additional revenue secured via fines
Professional annual membership fees only; all fines paid to U.S. Treasury and/or the states, to avoid the inevitable conflict of interest arising from using fines imposed upon members of the expenses of the professional organization. (Also, fines should not indirectly benefit the very persons who are fined, by providing revenue to the professional organization which, in turn, permits it to reduce its membership fees.)
Pro bono
Not required
Required: either hours of service to individuals and/or the community every year, or monetary donation to an organization that serves such purpose, in order to ensure access to the services of its members by all members of the 

Can You Legislate Morality?

A reader to my blog post on the fiduciary duty of brokers, already existing under state common law, writes: "You can't legislate morals."  Here's my reply:

I often here the phrase (often made by those opposed to the application of the fiduciary standard) "You cannot legislate morality." In one sense this statement is true, in another sense this statement is not true.

The law - whether developed over the centuries through the "common law" (judicial decisions) or via legislative dictates (statutes) - reflects the morals of our society. The great jurist Oliver Wendell Holmes once wrote: " The law is the witness and external deposit of our moral life. Its history is the history of the moral development of the race. The practice of it, in spite of popular jests, tends to make good citizens and good men." The Path of the Law, by Oliver Wendell Holmes, Jr., 10 Harvard Law Review 457 (1897).

At times we deem it important enought to specify, through laws, that a breach of something "wrong" is grave enough to warrant either a prviate remedy (i.e., damages for breach of contract, or damages for a tort - such as breach of duty of due care) or a public remedy (fine, loss of licensure, imprisonment, etc.). In essence, the law sets forth minimum moral standards that everyone is expected to follow.

There are many instances where breach of fiduciary duties can result in fines (i.e., public discipline). Attorney disciplinary proceedings are just one example. In the professional setting, more often breaches of the duty of care result in a private cause of action, and professional disciplinary proceedings occur only after "probable cause" has been found through a review of the advisor's actions by his or her peers.

Hence, can we legislate "morality"? Yes, in the sense that we can define, in the law, principles-based standards which we expect of professional advisors, and all professional advisors are expected to adhere to these baseline standards.

No, we cannot legislate "morality," in the sense that we cannot assure that everyone adheres to such standards. Yet, of course, no enacted law provides such a guarantee.

Moreover, one aspect of integrity is doing what is "right" even if it meets minimum legal standards. This aspect of morality - subscribing to even higher standards than the law should require (as a minimum standard) - cannot and should not be legislated. But it should be encouraged as a "best practice" by professional societies.

I don't think it is too much to ask that all financial advisors and investment advisers adhere to a legal standard to "act in the best interests of their clients." This is clearly what consumers desire, and expect. It would resolve the great deal of confusion that consumers possess at present. It would help restore trust in our financial services system.

And I would observe, if we are to become a true profession, the baseline standard for the delivery of investment and financial advice must be grounded in a bona fide fiduciary standard of conduct.

Saturday, April 20, 2013

Shhh!!! Brokers Are (Already) Fiduciaries ... Part 1: The Early Days

Shhh!!!  Brokers Are (Already) Fiduciaries ...
Part 1: The Early Days
[This is the initial draft of a white paper being prepared on the status of brokers as fiduciaries when providing personalized investment advice. This draft is released, prior to additional revisions and completion, as a means of informing the debate regarding the SEC’s Request for Comments issued on March 1, 2013.]
“The relationship between a customer and the financial practitioner should govern the nature of their mutual ethical obligations. Where the fundamental nature of the relationship is one in which customer depends on the practitioner to craft solutions for the customer’s financial problems, the ethical standard should be a fiduciary one that the advice is in the best interest of the customer. To do otherwise – to give biased advice with the aura of advice in the customer’s best interest – is fraud. This standard should apply regardless of whether the advice givers call themselves advisors, advisers, brokers, consultants, managers or planners.”[1]
“The duty of loyalty requires an adviser to serve the best interests of its clients, which includes an obligation not to subordinate the clients’ interests to its own.”[2]
On March 1, 2013 the U.S. Securities and Exchange Commission issued a request for data and information regarding the “Duties of Brokers, Dealers, and Investment Advisors.”[3] The SEC desires this information to inform its rule-making processes under Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act[4] (“Dodd-Frank Act”), specifically as to whether and how to impose fiduciary standards upon brokers (i.e., registered representatives of broker-dealer firms). However, often lost in this debate is the fact that brokers providing personalized investment advice are already fiduciaries, possessing broad duties of due care, loyalty and utmost good faith to their clients, and it has been this way for over a century. This paper explores this topic, as to the jurisprudence and understandings which developed largely during the first half of the 20th Century. A later blog post will explore later developments.
The delivery of investment advice in the United States primarily occurs through broker-dealers or investment advisers.[5] It is generally believed that registered investment advisers[6] and their investment adviser representatives (hereafter collectively referred to as “RIAs” or “investment advisers”) are subject to a higher standard of conduct (fiduciary standard of conduct) than broker-dealers and their registered representatives (hereafter collectively referred to as “brokers”) (subject to the lower “suitability” standard and certain other specific rules) when engaging in activities involving the furnishing of investment recommendations and advice to clients.[7]
Yet, often lost in the “debate” regarding whether brokerage firms and their registered representatives should be required to be fiduciaries to their individual customers is the fact that – for nearly a century - courts across the country have found brokers to be fiduciaries through the application of state common law. Moreover, early statements from both the SEC and the National Association of Securities Dealers (NASD), now known as the Financial Industry National Regulatory Authority (FINRA), embraced the view that brokers – when providing personalized investment advice – were fiduciaries to their clients.
The Investment Advisers Act of 1940 (Advisers Act) was widely believed, at the time of its enactment and thereafter, to apply broad fiduciary standards upon investment advisers. However, the Advisers Act provides for an exemption of brokers from the definition of “investment adviser”[8] provided the advice provided by brokers is “solely incidental” to the conduct of the broker’s activities and no “special compensation”[9] is received. Yet, the Advisers Act, while providing a limited exception from the application of its registration requirements for brokers,[10] did not negate the potential status of brokers[11] as fiduciaries under state common law.[12]
This paper explores cases arising under state common law in which brokers and their registered representatives are held to broad fiduciary standards of conduct similar to those applicable to investment advisers,[13] and not the lower standard of suitability,[14] arising due to the nature of the advisory activities undertaken. This paper also explore the limits of disclosure as an effective means of consumer protection in this area, the Financial Industry National Regulatory Authority’s[15] (FINRA’s) longstanding failure to acknowledge and enforce the fiduciary standards of brokers who are in relationships of trust and confidence with their clients, the rise of trust-based selling, the use of titles denoting relationships of trust and confidence, and the consequences of dual registration.[16]
As a result of regulatory missteps over many decades, substantial consumer confusion now abounds as to the standard of conduct consumers can expect from their providers of investment advice.[17] Section 913 of the Dodd-Frank Act provides the SEC with the legal authority to correct this situation through the imposition of fiduciary standards upon broker-dealers. This paper concludes by suggesting a course of action which the SEC may follow in applying the fiduciary standard to the personalized investment advisory activities of brokers and their registered representatives, with specific attention paid to understanding and methods for the elimination and/or proper management of conflicts of interest which arise from current broker-dealer methods of compensation.[18]
What Does a “Confidential Relation” Exist, Thereby Meriting the Imposition of Fiduciary Status?
“A fiduciary relationship may exist under a great variety of circumstances. Reliance may engender a duty of loyalty. Where the confidence and trust of another is accepted and is the basis for the guidance of another's affairs, a duty of loyalty is required. A disloyal adviser could have and should have declined to give advice.”[19]
The fiduciary principle has its roots in antiquity.  It is clearly reflected in the provisions of the Code of Hammurabi nearly four millennia ago, which set forth the rules governing the behavior of agents entrusted with property.[20] Ethical norms arising from relationships of trust and confidence also existed in Judeo-Christian traditions,[21] in Chinese law,[22] and in Greek[23] and Roman[24] eras.
Time and again our courts have enumerated the fiduciary maxim: “No man can serve two masters.”[25] As stated early on by the U.S. Supreme Court, “The two characters of buyer and seller are inconsistent: Emptor emit quam minimo potest, venditor vendit quam maximo potest.”[26] As the U.S. Supreme Court has also opined, “the rule … includes within its purpose the removal of any temptation to violate them….”[27]
Through elaboration in English law and U.S. law, fiduciary law has evolved over the centuries to refer to a wide range of situations in which courts have imposed duties on persons acting in particular situations that exceed those required by the common law duties of ordinary care and fair dealing which exist in arms-length relationships.[28]  Fiduciary duties find their origin in a mix of the laws of trust law, tort law, contract law, and agency law.  And, through the gradual expansion of the situations in which fiduciary duties are required as our society evolves,[29] today fiduciary status attaches to many different situations.
The fact that control of property (as would exist in a trustee-beneficiary relationship) or the management of property (as in the grant of discretion over securities) is nonexistent does not mean that fiduciary status does not attach. There has long been recognition that the mere provision of advice may result in a fiduciary relationship.[30]
It is curious that so many financial intermediaries today are unaware of their fiduciary status, or those situations in which it might attach.  The many paths to fiduciary status include: (1) common law fiduciary status arising from a relationship of “trust and confidence” between the financial advisor and client; (2) application of the Investment Advisers Act of 1940 (“IAA”); (3) application of ERISA[31]; (4) limited fiduciary duties imposed upon brokers under agency law, relating to best execution and safeguarding of custodied assets, for brokerage accounts; (6) discretionary accounts, now leading to the application of the Investment Advisers Act of 1940 and its imposition of broad fiduciary duties; (5) de facto “control” amounting to “discretion” over a brokerage account, also leading to the imposition of broad fiduciary duties; (6) state statutory law and regulations in a few states (including those stating that financial planners are investment advisers); (7) express acceptance of fiduciary duties through contractual terms; (8) service as trustee, custodian; guardian, or conservator; and (9) acting as attorney-in-fact.
Agency law dictates that agents are subject to certain limited fiduciary duties to act on behalf of their principals. It is under agency law that many of the early cases find fiduciary obligations pertinent to the broker’s duty of best execution or holding the client’s funds as a custodian.[32]
However, the broad fiduciary duties of a broker toward his or her customer are more likely to be found by courts when a confidential relation exists, as may occur when personalized investment advice is provided. In the United States, our state courts have long applied broad fiduciary duties upon those in relationships of “trust and confidence” with entrustors.  As stated by one early 20th Century court:
In equity the court looks to the relationship of the parties -- the reliance, the dependence of one upon the other. Where a relationship of confidence is shown to exist, where trust is justifiably reposed, equity scrutinizes the transaction with a jealous eye; it exacts the utmost good faith in the dealings between the parties, and is ever alert to guard against unfair advantage being taken by the one trusted.[33]
But what is this “relationship of trust and confidence,” sometimes referred to as a “confidential relation,” which merits the imposition of the fiduciary standard of conduct? First, let us examine what a “confidential relation” under the law is not; we should not confuse the existence of a longstanding friendship or an intimate relationship with a “relationship of trust and confidence” under the law sufficient to impose fiduciary status upon one of the actors in such a relationship:
Friendly relations or even intimacy of relationship present an entirely different question from what is understood as a confidential relation in law. One may have confidence in another's integrity and honesty of purpose, and likewise believe that he will live up to any of his contracts, without having any confidential relations with such person that would void any agreement or transactions entered into between them, on the theory of constructive fraud or undue influence. We think the record shows that the Harrises did have confidence in the honesty and integrity of the Jacksons, and believed that the Jacksons would comply with any agreements into which they entered; but there is absolutely no testimony showing anything further, or that there were any confidential business relationships, or relationships existing between the Jacksons and the Harrises which would constitute a basis for a charge of constructive fraud. There must be something further than mere confidence in another's honesty and integrity to sustain the presumption of constructive fraud.[34]
For a “confidential relation” to occur under the law, there is typically the placement of trust by one person in another, often the result of asymmetric information or disparate skill. One court described the situation in which parties deal with each other from substantially different positions, resulting in the possibility of abuse of the superior position:
Confidential relation is not confined to any specific association of the parties; it is one wherein a party is bound to act for the benefit of another, and can take no advantage to himself. It appears when the circumstances make it certain the parties do not deal on equal terms, but, on the one side, there is an overmastering influence, or, on the other, weakness, dependence, or trust, justifiably reposed; in both an unfair advantage is possible.[35]
However, placement of trust in another, by a person in an inferior position, is not sufficient to impose fiduciary status. We trust most men with whom we deal. Trust must be justifiably reposedi.e., there must be something reciprocal in the relationship before the rule applying fiduciary status can be invoked. In other words, it is not just the placement of trust, but the acceptance of that trust by either words or conduct or both, which form the basis of the fiduciary relation. As stated by a federal court applying California law:
It is true that one party cannot create a legal obligation or status by pleading ignorance and inexperience to an opposing party in a business transaction. Those who have in the law's view been strangers remain such, unless both consent by word or deed to an alteration of that status. The communicated desire or intention of one to impose upon the other a different status, involving greater obligations, is ineffective, unless the other consents to the changed relation. It is true that consent may find expression in acts as readily as in words. But such consent cannot be implied from a bare procedure with the transaction, after one party has declared his or her inexperience and reliance upon the other. The knowledge of this state of mind in a party may be an important consideration in determining the existence of fraud, as indicating what effect might be anticipated from statements made; but it cannot establish a confidential legal status.[36] [Emphasis added.]
The 1933 case of Hancock v. Anderson[37] illustrates this principle of acceptance or consent to the fiduciary relation, in the situation where the customer of a banker was advised to enter into an extension and renewal of a first mortgage held by the customer. Subsequently the banker acquired an adverse interest by representing the holder of the second mortgage on the same property. While there had been a history of advice provided by the banker to the customer over the years with respect to the purchase of bonds, with respect to a later transaction involving a suggestion to reduce the principal amount of the customer’s first mortgage, the banker stated to the customer, “I am not in a position to advise you.”[38] The banker advised the customer to seek advice from another businessman with respect to the particular transaction at hand.[39] The court stated:
Trust alone, however, is not sufficient. We trust most men with whom we deal. There must be something reciprocal in the relationship before the rule can be invoked. Before liability can be fastened upon one there must have been something in the course of dealings for which he was in part responsible that induced another to lean upon him, and from which it can be inferred that the ordinary right to contract had been surrendered. If this were not true a reputation for fair dealing would be a liability and an unsavory one an asset. A sale of bonds made by the Bank of England can be set aside no more quickly than a sale made by a "bucket-shop" …
In Pomeroy's Eq. (3d ed.) section 902, it is said that when a contract is not in its nature essentially fiduciary, a trust, to be established, must be expressly reposed or necessarily implied …
It is said that a man cannot be at once agent for a buyer and seller, that loyalty to his trust is an elementary duty, and that where confidential personal relations exist a full and fair disclosure is imperative …
The presumption is that people who deal with each other, grown men and women, deal with each other as such, and this presumption is not destroyed by disparity in age nor by the ties of blood ….[40]
[Emphasis in original.]
In other words, a provider of investment advice must “consent to be bound” – by words or conduct – for fiduciary status to attach under state common law. In the sections which follow are explored the types of words, representations, or conduct which merit the imposition of broad fiduciary obligations upon brokers. It will be demonstrated that holding out as a trusted advisor, such as through the use of the title “financial advisor,” or by means of an invitation to accept and/or follow “objective” advice, is sufficient conduct to provide such “consent to be bound.”
Early Authorities:  Brokers as Fiduciaries
Federal courts look to state common law to determine whether brokers should be deemed fiduciaries and the scope of the fiduciary duties thereby imposed.[41] Indeed, it is from state common law that fiduciary principles arose. State common law, derived from judicial opinions over hundreds of years, melds together the state common law of trust law,[42] agency law,[43] some aspects of contract law, [44] and tort law[45] to define fiduciary relationships and to explore the duties that arose therefrom.
In early England, the term "brokers" was used by persons who engaged in the then-disreputable pawnbroker's business.[46]  “It was not until the latter part of the 17th century, when the East India Company came prominently before the public, that trading in stock became an established business in England.”[47] This new breed of brokers became known as "stockbrokers."[48]
Early evidence of fiduciary-like prohibitions imposed upon stockbrokers in England can be found in the fiduciary-like restriction imposed upon brokers in 1697 by the English Parliament in An Act to Restrain the Number and Ill Practice of Brokers and Stock Jobbers.[49] The statute, enacted in response to “unjust practices” which had evolved in the selling of stock,[50] was in existence for a little over ten years,[51] required brokerage firms and their employees to take a verbal oath to comply with the law, which required brokers to eschew compensation not permitted under the Act.[52]
At the beginning of the 20th Century, in “the United States the business of buying and selling stocks and other securities [was] generally transacted by Brokers for a commission agreed upon or regulated by the usages of” a stock exchange.”[53] Indicative of the known distinctions between brokers and dealers, an early Indiana law provided for the licensing of brokers but not for “persons dealing in stocks, etc., on their own account.”[54]
Moreover, stockbrokers were known to possess duties akin to those of trustees, including the duty of utmost good faith and the avoidance of receipt of hidden forms of compensation. As stated in the 1905 edition of an early treatise:
He is a Broker because he has no interest in the transaction, except to the extent of his commissions; he is a pledgee, in that he holds the stock, etc. as security for the repayment of the money he advances in its purchase; so he is a trustee, for the law charges him with the utmost honesty and good faith in his transactions; and whatever benefit arises therefrom enures to the cestui que trust.[55]
By the early 1930’s, the fiduciary duties of brokers (as opposed to dealers[56]) were widely known. As summarized by Cheryl Goss Weiss, in contrasting the duties of an broker vis-à-vis a dealer:
By the early twentieth century, the body of common law governing brokers as agents was well developed. The broker, acting as an agent, was held to a fiduciary standard and was prohibited from self-dealing, acting for conflicting interests, bucketing orders, trading against customer orders, obtaining secret profits, and hypothecating customers' securities in excessive amounts -- all familiar concepts under modern securities law. Under common law, however, a broker acting as principal for his own account, such as a dealer or other vendor, was by definition not an agent and owed no fiduciary duty to the customer. The parties, acting principal to principal as buyer and seller, were regarded as being in an adverse contractual relationship in which agency principles did not apply.[57] [Emphasis added.]
The non-imposition of fiduciary duties upon dealers was further explained by Matthew P. Allen:
At the time the ’34 Act was passed, broker-dealers performed clearly defined functions, which are defined under the Act: a ‘broker’ ‘effected transactions in securities for the accounts of others,’ while a ‘dealer’ bought and sold securities for his own account. Brokers filled a customer’s buy order by going into the market and purchasing designated securities ‘from an exchange specialist or an over-the-counter marketmaker.’ As such, courts treated brokers as agents of their principal customers before enactment of the ’34 Act, and thus applied fiduciary principles to impose duties of care and loyalty on stockbrokers. But ‘dealers’ filled a customer’s order by selling the customer securities from the dealer’s own inventory of securities. Thus a dealer and customer are acting at arm’s-length as buyer and seller, or principal to principal, and ‘were regarded as being in an adverse contractual relationship in which agency principles did not apply.’ So a dealer, acting as a principal rather than an agent, owed only ordinary duties of care to the customer, not fiduciary duties.[58] [Emphasis added.]
The fact that stockbrokers were known to be fiduciaries at an early time in the history of the securities industry (when acting as brokers and not acting as dealers) should not come as a surprise. To a degree it is simply an extension of the laws of agency. One might then surmise that, if the broker provides personalized investment advice, then a logical extension of the principles of agency dictates that the fiduciary duties of the agent also extend to those advisory functions, as the scope of the agency has been thus expanded.[59]
Yet, not all early commentators agreed that the fiduciary duties of brokers extended to their advisory functions. As Professor Arthur B. Laby recently observed:
One would expect a broker acting as an agent to be held to a fiduciary standard. According to both the Restatement (First) of Agency from 1933 and the Restatement (Second) from 1958, an agency relationship is a fiduciary relationship. Many early cases stated that broker-dealers owed fiduciary duties not because they served in an advisory capacity, but rather because they were entrusted as agents with the customer’s cash or securities and owed a duty to carry out the customer’s instructions in good faith and with due diligence. An influential study from this era entitled The Security Markets – prepared by a team of thirty economists and associates of the Twentieth Century Fund [in 1938] – stated that a broker acts as a fiduciary to a customer account when the broker has custody of the funds or securities in the account. Otherwise, a broker’s liability is limited to the proper execution of the customer’s orders.[60]
Indeed, there are numerous cases which apply fiduciary duties upon brokers due to their custody of customer’s cash or securities[61] or the existence of discretion over a customer’s account, either de jure discretion[62] or through the exercise of “control” (de facto discretion).[63] These types of cases, however, are not the primary focus of this article. Rather, this inquiry seeks out those decisions which impose fiduciary status upon brokers due, at least in part, to the advice which is provided and the resulting relationship of trust and confidence which thereby exists.
Even modern commentators have stated that the mere furnishing of advice by a broker, without more, does not give rise to a fiduciary relationship between a broker and its customer. As stated by one treatise:
The prevailing view is that the mere rendering of advice by a broker-dealer that is excluded from the definition of an investment advisers is not by itself sufficient to establish a fiduciary relationship with its customer. Most of the decisions hold that, in addition to the giving of advice, some other element must be present to establish a fiduciary relationship, such as discretionary authority, control of the account by the broker, or the reposing of trust and confidence in the broker by the customer. A fiduciary relationship is formed where a brokerage firm holds itself to its customer out as a fiduciary.[64]
When does, under state common law, an arms-length relationship between a broker and his or her customer become transformed into a fiduciary relationship? The answer requires an examination of the history of the stock brokerage function and early statutes and cases in which the fiduciary status of brokers was considered, when advice was provided.
In the 1934 case of Birch v. Arnold,[65] in a case which did not appear to involve the exercise of discretion by a broker, the relationship between a client and her stockbroker was found to be a fiduciary relationship, as it was one of trust and confidence. As the court stated:
She had great confidence in his honesty, business ability, skill and experience in investments, and his general business capacity; that she trusted him; that he had influence with her in advising her as to investments; that she was ignorant of the commercial value of the securities he talked to her about; and that she had come to believe that he was very friendly with her and interested in helping her. He expected and invited her to have absolute confidence in him, and gave her to understand that she might safely apply to him for advice and counsel as to investments … She unquestionably had it in her power to give orders to the defendants which the defendants would have had to obey. In fact, however, every investment and every sale she made was made by her in reliance on the statements and advice of Arnold and she really exercised no independent judgment whatever. She relied wholly on him.[66] [Emphasis added.]
The Massachusetts Supreme Court held that, in these circumstances, facts “conclusively show that the relationship was one of trust and confidence”[67] and therefore the broker could not make a secret profit from the transactions for which the advice was provided.
The Birch decision therefore rests not upon the finding of discretion (real or de facto) over the account, but rather results from the finding that advice was provide in a relationship in which trust and confidence was reposed. In the 2000 case of Patsos v. First Albany Corp., the Massachusetts Supreme Court discussed further the 1934 Birch case and other Massachusetts cases, noting that: “Read together, Vogelaar, Berenson, and Birch recognize that in Massachusetts a relationship between a stockbroker and a customer may be either a fiduciary or an ordinary business relationship, depending on whether the customer provides sufficient evidence to prove ‘a full relation of principal and broker.’"[68] The Patsos court then went on discuss the decisions of other state courts, and to contrast discretionary and non-discretionary accounts:
Courts in other States have not been of single mind whether fiduciary duties inhere in every relationship between a stockbroker and his customer … Other courts have suggested that a broker always owes his customer some fiduciary obligations …. because the relationship between a customer and stockbroker is that of principal and agent, the broker, as agent, has a fiduciary duty to carry out the customer's instructions promptly and accurately … There is general agreement, however, that the scope of a stockbroker's fiduciary duties in a particular case is a factual issue that turns on the manner in which investment decisions have been reached and transactions executed for the account …
Where the account is ‘non-discretionary,’ meaning that the customer makes the investment decisions and the stockbroker merely receives and executes a customer's orders, the relationship generally does not give rise to general fiduciary duties … For nondiscretionary accounts, each transaction is viewed singly, the broker is bound to act in the customer's interest when transacting business for the account, but all duties to the customer cease ‘when the transaction is closed’ … Conversely, where the account is ‘discretionary,’ meaning that the customer entrusts the broker to select and execute most if not all of the transactions without necessarily obtaining prior approval for each transaction, the broker assumes broad fiduciary obligations that extend beyond individual transactions.[69]
The Patsos court then went on to state that an account termed “non-discretionary (by written or oral agreement)” could become subject to the control of the stockbroker later, in which case the “trier of fact may still find that the broker assumed the fiduciary obligations associated with a discretionary account.”[70] This would be the equivalent of de facto discretion over an account, one way of finding broad fiduciary duties to exist. Then the Patsos court went on to explain when an advisory relationship, not involving actual nor de facto discretion (i.e., control over the account) may result in the assumption of broad fiduciary duties:
Other factors may also support a finding that a stockbroker has assumed general fiduciary obligations to a customer. A customer's lack of investment acumen may be an important consideration, where other factors are present. See, e.g., Broomfield v. Kosow, 349 Mass. 749, 755, 212 N.E.2d 556 (1965); Birch v. Arnold & Sears, Inc., 288 Mass. 125, 129, 136, 192 N.E. 591 (1934); Romano v. Merrill Lynch, Pierce, Fenner & Smith, 834 F.2d at 530, citing Clayton Brokerage Co. v. Commodity Futures Trading Comm'n, 794 F.2d 573, 582 (11th Cir. 1986) (trier of fact must consider "the degree of trust placed in the broker and the intelligence and personality of the customer"); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F. Supp. at 953, 954 (where customer is particularly young, old, or naive with regard to financial matters, courts are "likely" to find that broker assumed control over account).  An inexperienced or naive investor is likely to repose special trust in his stockbroker because he lacks the sophistication to question or criticize the broker's advice or judgment. Paine, Webber, Jackson & Curtis, Inc. v. Adams, supra at 517. This may be particularly true where the broker holds himself out as an expert in a field in which the customer is unsophisticated. See, e.g., Burdett v. Miller, 957 F.2d 1375 (7th Cir. 1992); Paine, Webber, Jackson & Curtis, Inc. v. Adams, supra at 517, citing Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Boeck, 127 Wis. 2d 127, 145-146, 377 N.W.2d 605 (1985) (Abrahamson, J., concurring) ("By gaining the trust of a relatively uninformed customer and purporting to advise that person and to act on that person's behalf, a broker accepts greater responsibility to that customer"). Social or personal ties between a stockbroker and customer may also be a consideration because the relationship may be based on a special level of trust and confidence. Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F. Supp. at 954.[71] [Emphasis added.]
The Court therefore explained the Birch holding, noting that even in cases of non-discretionary (de jure or de facto) brokerage accounts, “other factors” may lead to broad fiduciary duties imposed upon a broker. However, the Patsos Court noted that fiduciary duties in such instances are not imposed by courts lightly:
 “[A] business relationship between a broker and customer does not become a general fiduciary relationship merely because an uninformed customer reposes trust in a broker who is aware of the customer's lack of sophistication. Cf. Broomfield v. Kosow, supra at 755 (catalyst in transformation of business relationship into fiduciary relationship is defendant's knowledge of plaintiff's reliance upon him). In this respect, as others, our law is consistent with other States. See, e.g., Hill v. Bache Halsey Stuart Shields, Inc., supra at 824 ("A fiduciary duty . . . cannot be defined by asking the jury to determine simply whether the principal reposed 'trust and confidence' in the agent").”[72] [Emphasis added.]
Johnson v. Winslow (1935). Another early case points out that brokers possess fiduciary obligations – which were not possessed, in contrast, by dealers in securities. “[A] stock broker may also become a stock dealer toward his customer in any one transaction, even though he has acted as broker in other transactions … Where the course of dealings between the parties has established a relationship of customer and broker, the customer is justified in assuming that that relationship will continue, and will not become one of buyer and seller, unless he is notified by the broker of the latter's intention to change the relationship … A broker, on the other hand, must confirm the purchase or sale to his customer at the exact price at which he himself buys or sells. He is not permitted by law to make a secret profit; nor is he permitted to supply his own stock in fulfillment of a purchase made for a customer, or take for his own account stock which he has sold for a customer … In the instant case the plaintiff was a layman, and was not fully acquainted with all the technicalities of the street or dealings on the exchange. She had a right to assume that the relationship of customer and broker, a fiduciary, would protect her, to the end that in acting for her, they would do all in their power to protect her account with them, and that in so doing she would get the full advantage of the knowledge of the defendants as such brokers in the management and care of the account. This she had a right to assume, and this she was entitled to … The law is well settled that the fiduciary relationship between the customer and broker requires full faith and confidence be given to the acts of the brokers in the belief that they would at all times be acting for their customer in all his dealings, and the plaintiff had a right to assume and to rely upon the fact that they were acting for her benefit at all times during the existence of such relationship.” Johnson v. Winslow, Supreme Court of New York, New York County, 155 Misc. 170; 279 N.Y.S. 147 (1935).
Norris v. Beyer (1935). In another early case the customer, “untrained in business – she had been a domestic servant for years – was susceptible to the defendant's influence, trusted him implicitly ….”  The court stated: “We are persuaded from the facts of the case that a trust relationship existed between the parties … The [broker] argues that he was not a trustee but a broker only. This argument finds little to support it in the testimony. He assumed the role of financial guide and the law imposed upon him the duty to deal fairly with the complainant even to the point of subordinating his own interest to hers. This he did not do. He risked the money she entrusted to him in making a market for hazardous securities. He failed to inform her of material facts affecting her interest regarding the securities purchased. He consciously violated his agreement to maintain her income, and all the while profited personally at the complainant's expense. Even as agent he could not gain advantage for himself to the detriment of his principal.” Norris v. Beyer, 124 N.J. Eq. 284; 1 A.2d 460 (1938). [Emphasis added.]
Laraway v. First National Bank Of La Verne (1940). In another early case, in a time where banks often acted as the sellers of securities, the facts – which so often are paralleled in modern-day broker-customer relationships, are informative.  “Following the death of her husband and the receipt of his insurance money, she went to respondent bank, where she and her husband had done business. She went there for the purpose of investing the insurance money that she had received. She trusted respondent Boly, the cashier of the bank, whom she had known over a period of years, to advise and assist her in making the desired investments so that, as she said, she and her son might have some income upon which to live. Subsequently, when the investments defaulted in payment of interest, she went back to the bank to inquire the reason therefor. While the occurrence of such defaults might prompt her to question the soundness of respondent Boly's judgment, surely it was no ground for her to question the integrity of the same. She inquired the reason for the defaults in the payment of interest, and respondents, still concealing from her the fact that they had sold her bonds at par when the same were upon the market at prices much less than par, informed her both in conversations and by letter that the failure of the corporation did not necessarily mean she would lose her money, and that these reorganization plans were due entirely to the business depression. That appellant relied upon respondents' representations and believed in the integrity thereof is indicated by the fact that she continued to apply to respondent Boly for advice and continued to keep her account in the bank until … 1936 … We hold that the evidence in this case is reasonably susceptible of the conclusion that there existed a continuing confidential and fiduciary relationship between the parties ….” Laraway v. First National Bank Of La Verne, 39 Cal. App. 2d 718; 104 P.2d 95 (1940).
Early Statements and Actions by the U.S. Securities and Exchange Commission
In its 1940 Annual Report, the U.S. Securities and Exchange Commission noted: “If the transaction is in reality an arm's-length transaction between the securities house and its customer, then the securities house is not subject' to 'fiduciary duty. However, the necessity for a transaction to be really at arm's-length in order to escape fiduciary obligations, has been well stated by the United States. Court of Appeals for the District of Columbia in a recently decided case:
‘[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest.  He who would deal at arm's length must stand at arm's length.  And he must do so openly as an adversary, not disguised as confidant and protector.  He cannot commingle his trusteeship with merchandizing on his own account…’”
Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158, citing Earll v. Picken (1940) 113 F. 2d 150.
In 1941, the SEC opined in its Seventh Annual Report: “The preceding case [Hope & Co.] is one of a series of cases involving revocation of registration ordered by the Commission during the year in which fraud, arisirig out of an abuse of a fiduciary duty, has been alleged.  Other cases were: In the Matter of Commonwealth Securities, Inc.; In the Matter of Securities Distributors Corporation; In the Matter of Equitable Securities Company of Illinois; and In the Matter of Geo. W. Byron &: Co. In some of these cases, including Commonwealth Securities, Inc. and Securities Distributors Corporation, the registered broker or dealer had attempted to avoid fiduciary responsibility by use of words on the confirmation intend to indicate that in the particular transaction it had not acted in a fiduciary capacity, but, in such cases, the Commission held that the form of confirmation could not alter the fiduciary character of the relationship where this was clearly established from the other facts and circumstances surrounding the transaction. The case of Geo. W. Byron &: Co. involved transactions in which the firm acted as agent for both parties to the transaction and accepted commissions from each without the other's knowledge and consent, which constituted an abuse of thc fiduciary responsibility to which an agent is subject. In the Matter of Securities Distributors Corporation involved failure of a securities firm, while acting as a fiduciary, to disclose information in its possession which the customer would wish to have in deciding whether to enter into the transaction. In the Matter of Equitable Securities Company oj Illinois involved a fiduciary obligation arising from a relation of trust and confidence between the customer and the securities company. In the decision in In the Matter of Hope & Company the Commission held:
‘A broker-dealer exercising supervision over a discretionary account is; Of course, an agent and under the principles already discussed these transactions constitute a violation of the statutory provisions cited …’
and further held:
‘A broker is an agent and it is, of course, a general principle of law that an agent may not, in the absence of consent of the person whom he purports to represent, deal with such person as a principal. This is so irrespective of any injury or loss to the principal. It follows that when a broker-dealer represents to a customer that he is effecting a transaction as broker, and, without the knowledge or consent of the customer buys from or sell to the customer as a principal, he is making a misrepresentation of a material fact and is engaging in a fraudulent practice which violates Section 17(a) of the Securities Act, Section 15(c) of the Securities Exchange Act and Rule X-15Cl-2 thereunder.’
In this opinion the Commission quoted the following statement of the law by the Supreme Judicial Court of Massachusetts in Hall v. Paine [224 Mass. 62, 112 N. E. 153.]:
‘A broker's obligation to his principal requires him to secure the highest price obtainable, while his self-interest prompts him to buy at the lowest possible price … The law does not trust human nature to be exposed to the temptations likely: to arise out of such antagonistic duty and influence. This rule applies even though the sale may be at auction and in fact free from any actual attempts to overreach or secure personal advantage, and where the full market price has been paid and no harm resulted * * *’”
Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158.
The SEC summarized a court decision finding that the furnishing of investment advice by a broker was a “fiduciary function.”  The SEC stated: “In the Stelmack case the evidence showed that the firm obtained lists of holdings from certain customers and then sent to these customers analyses of their securities with recommendations listing securities to be retained, to be disposed of, and to be acquired … The [U.S. Securities and Exchange] Commission held that the conduct of the customers in soliciting the advice of the firm, their obvious expectation that it would act in their best interests, their reliance on its recommendations, and the conduct of the firm in making its advice and services available to them and in soliciting their confidence, pointed strongly to an agency relationship and that the very function of furnishing investment counsel constitutes a fiduciary function.” – from the 1942 SEC Annual Report, p. 15, referring to  In the Matter of Willlam J. Stelmack Corporation, Securities Exchange Act Releases 2992 and 3254.
The SEC also “has held that where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer … [BD advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business … Where the relationship between the customer and broker is such that the former relies in whole or in part on the advice and recommendations of the latter, the salesman is, in effect, an investment adviser, and some of the aspects of a fiduciary relationship arise between the parties.” 1963 SEC Study, citing various SEC Releases.
The SEC has also opined: “[T]he merchandising emphasis of the securities business in general, and its system of compensation in particular, frequently impose a severe strain on the legal and ethical restraints.” – 1963 SEC Study
See also Arleen W. Hughes, Exch. Act Rel. No. 4048, 27 S.E.C. 629 (Feb. 18, 1948) (Commission Opinion), aff’d sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) (broker-dealer is fiduciary where she created relationship of trust and confidence with her customers);
Early FINRA (formerly known as NASD) Statements
Prior to FINRA’s creation the necessity for high standards of conduct for brokers was noted in the courts: “The ethical standards of the exchange are perforce the ethical standards of its members. Its standards rise no higher and sink no lower than their standards. It is the member who must create and maintain high standards if he would permanently succeed, because his is a fiduciary relation to his customers. So that if the practices of any proposed customer are distasteful to the broker member he must correct such practices, not the exchange.”  Pirnie, Simons & Co., Inc. v. Whitney, 144 Misc. 812; 259 N.Y.S. 193; 1932 N.Y. Misc. LEXIS 1216 (Sup.Ct.NY, 1932).
In 1938 the Maloney Act authorized the creation of the self-regulatory organization for broker-dealers. By 1940 the NASD had been formed. In an opinion issued by this self-regulatory organization for broker-dealers, in only its second newsletter to members, the NASD pronounced that brokers were fiduciaries: “Essentially, a broker or agent is a fiduciary and he thus stands in a position of trust and confidence with respect to his customer or principal.  He must at all times, therefore, think and act as a fiduciary.  He owest his customer or principal complete obedience, complete loyalty, and the exercise of his unbiased interest.  The law will not permit a broker or agent to put himself in a position where he can be influenced by any considerations other than those to the best interests of his customer or principal … A broker may not in any way, nor in any amount, make a secret profit … his commission, if any, for services rendered … under the Rules of the Association must be a fair commission under all the relevant circumstances.” – from The Bulletin, published by the National Association of Securities Dealers, Volume I, Number 2 (June 22, 1940).
In a later newsletter, the NASD, in discussing the decisions of two cases, the NASD wrote that it was “worth quoting” statements from the opinions:  “In relation to the question of the capacity in which a broker-dealer acts, the opinion quotes from the Restatement of the law of Agency: ‘The understanding that one is to act primarily for the benefit of another is often the determinative feature in distinguishing the agency relationship from others. *** The name which the parties give the relationship is not determinative.’ And again: ‘An agency may, of course, arise out of correspondence and a course of conduct between the parties, despite a subsequent allegation that the parties acted as principals.’” - from N.A.S.D. News, published by the National Association of Securities Dealers, Volume II, Number 1 (Oct. 1, 1941).
The self-regulatory association for broker-delears has also noted that a dealer in securities was not a fiduciary, but rather a merchant, stating: “A member when acting as a dealer or principal in a transaction with a customer is acting essentially as a merchant, buying or selling securities for himeself, for his own account, and like all merchants, hoping to make a profit of the difference between the price at which he buys or has bought for himself and the price at which he sells for himself.   A member when acting as a dealer or principal is thus not subject to the common law principles of agency which apply to a broker, but a dealer must at all times make it clear to his customer that he is acting as a dealer or principal, if that is the fact.  He must be ever careful in such transactions not to make misrepresentations, directly or indirectly, with respect to the particular security being purchased or sold, and he must buy from or sell to his customer at a price which is fair….” – from The Bulletin, published by the National Association of Securities Dealers, Volume I, Number 2 (June 22, 1940). [Emphasis added.]
The (Non-)Impact of the Investment Advisors Act of 1940
In the 1930’s, investment advisers (often called “investment counselors” at the time) were “viewed as providing investment advice and counsel to what were perceived as largely less knowledgeable retail customers. Investment advisers therefore were envisioned as having superior knowledge than, and thus greater responsibility for, their customers.”[73]
When the Investment Advisers Act of 1940 was enacted, early cases and speeches from the U.S. Securities and Exchange Commission (SEC) clearly stated the SEC’s belief that the new legislation imposed fiduciary status upon all those required to register as investment advisers (or representatives thereof).
In the seminal case 1963 of SEC v. Capital Gains the U.S. Supreme Court confirmed this longstanding understanding, when it construed Advisers Act Sections 206(1) and (2) as establishing a federal fiduciary standard governing the conduct of advisers.[74]
More recently, the SEC has expressed its view that Sections 206(1) and (2) of the Investment Advisers Act of 1940 sections 206(1) and (2) incorporate the common law principles of fiduciary duties.[75]
The application of fiduciary duties has important implications for investment advisers. While investment advisors governed by the Investment Advisers Act of 1940 are not subject to the strict “sole interests” fiduciary standard imposed by trust law[76] and by ERISA (when investment advisers are not subject to ERISA’s provisions), they are required by the courts to act in the “best interests” of their advisory clients. Under the “best interest” fiduciary standard, an adviser may possess certain conflicts of interest and thereby benefit from a transaction with or by a client, but the transaction must be fully disclosed in a manner which ensures client understanding, and client must provide informed consent to the proposed transaction, and even then the transaction must remain substatively fair to the client (i.e., the client should not be harmed). In addition, a broad range of other fiduciary duties are imposed upon investment advisers.
However, it should be emphasized that the Advisers Act, while providing an exemption from the application of the Advisers Act to broker-dealers in certain circumstances, did not overturn state common law principles which had already held that brokers (and their registered representatives), when in a relationship of trust and confidence with their client, are also fiduciaries. Brokers may have been exempted under the Advisers Act from registration as investment advisers; but this exemption did not, either expressly or by inference, negate the fiduciary status of brokers when they developed relationships of trust and confidence with their clients.
Nor did either various federal securities acts of the 1930’s and 1940 preempt state common law. In fact, it should be noted that that breach of fiduciary duty arising under state common law is now the most commonly asserted complaint by consumers in arbitration proceedings against brokers and dual registrants, and has been for the past five years.
Today brokers providing personalized investment advice nearly always, as will be shown in a subsequent blog post, intentionally and through various "trust-based sales" techniques form relationships of trust and confidence with their clients. Stay tuned.

Thank you for the many responses to this blog post. I have also received several questions, which I answer below.

1ST ADDENDUM (4/21/2013):  A question was posed from a reader, as to whether future federal legislation would preempt state common law in this area. I respond:

The application of ERISA's strict "sole interests" fiduciary standard, through a re-proposal and subsequent adoption (as is likely) of the "Definition of Fiduciary" rule, will preempt state common law, as to qualified retirement accounts and IRA accounts.

However, I see no prospect in the next several years for federal or state legislation which will preempt the application of state common law to the delivery of personalized investment advice (outside of ERISA). There is no legislative proposal of which I am aware which would do so, and even if such proposal surfaced in Congress it is not likely to get far in the current political climate.

Under Dodd-Frank Act's Section 913, the SEC has been given authority to enact a regulation applying a fiduciary standard "not less stringent than" that in the Advisers Act to the personalized investment advice provided by brokers and their registered representatives. In this respect, the SEC would be issuing a regulation which simplifies the process (for both consumers and financial services providers) of determining when fiduciary duties attach. In other words, the SEC is given the opportunity to "draw the line" between sales and advice. However, neither Section 913 of Dodd-Frank, nor the SEC regulation which might result therefrom, is not believed to possess any preemptive characteristics. (There is no express preemption, and the various types of implied preemption do not appear to be applicable.)

It is, of course, known that SEC rule-making may influence the development of the common law, over long periods of time. This would not occur immediately, but over many years, if at all. However, just as Justice Benjamin Cardoza did nearly a century ago, I would expect the courts to resist any invitation to lower the fiduciary standard (if the SEC adopts a "weak" standard), as the courts continue to apply state common law fiduciary standards to the delivery of financial and investment advice. Why such resistance? Because judges and lawyers would be concerned that lowering the fiduciary standard in the context of the delivery of financial and investment advice might bleed into other professions in which the fiduciary standard is applied.

One concern for those who advocate for the fiduciary standard is that the SEC, if and when it issues a fiduciary standard for brokers, "get it right." A danger exists that the SEC's version of the fiduciary standard would not require all of the duties and obligations present under the state common law standard, or that it would permit a "waiver" of the fiduciary standard by the customer in circumstances in which state law fiduciary standards are incapable of waiver. If either of these results occur, continued confusion will result. Advisors might be misled by thinking that an action complies with SEC rules, even though their actions do not meet the requirements of state common law. Since the legal basis of "breach of fiduciary duty claims" asserted against brokers is state common law, if the SEC adopts a lower (or non-meaningful) version of a fiduciary standard for brokers, then brokers must still adhere to the (then-higher) fiduciary requirements arising out of state common law.

2ND ADDENDUM (4/21/2013): Another question from a reader: "In Part 2 of your paper, have things changed? Is the fiduciary standard still applied to registered representatives?" My response:

None of my research reveals that the state courts have altered their position on applying the fiduciary standard to brokers and their registered representatives when a relationship of trust and confidence exists. There does exist, however, some distinctions on when a relationship of trust and confidence is found.

What has occurred, as Professor Laby pointed out in his white paper, is that the SEC has backed off, in its rule-making, from the application of the fiduciary standard of conduct. It is still applied by the SEC in many enforcement cases, but the rhetoric of the SEC changed since 1970, as to when the fiduciary standard should apply, and how it should apply.

As I noted above, FINRA (formerly NASD) in 1942 failed to reflect in its Rules of Conduct for its member firms and their registered representatives that the fiduciary standard applies to their advisory activities. Over seven decades later, this failure persists. Perhaps FINRA's 2012 statement (in guidance over its changes to the suitability rule) stating that brokers have an obligation to act in the "best interests" of customers is a move toward recognition of its long-standing omission, and a step toward finally acknowledging in its Rules of Conduct the presence of the fiduciary duty as they relate to advisory activities. But this is only speculation on my part.

3RD ADDENDUM (4/21/2013): Another question from a reader: "I don't get it. My brokerage firm [a wirehouse\ never told me I was a fiduciary under these circumstances. Why didn't they?"

I'm sorry if the training you received on the issue of fiduciary, from your wirehouse brokerage firm, as to both when the fiduciary duty applies and what is required when it does, may have been inadequate. You inquire "why"? I can only speculate.

First, there is a debate within the legal (academic) community as to whether fiduciary duties can be waived. Some "contractualists" believe that fiduciary duties are only default rules, and hence a customer of a broker-dealer can agree that fiduciary duties don't apply. However, many, many legal scholars in this area disagree with the "contractualists" - noting that fiduciary status results from the application of not just contract law, but also a melding of trust law, agency law, and tort law as well. In recent years the "contractualist view" of fiduciary duties has been increasingly rebutted.

Indeed, under several cases arising under state common law, the courts have ignored the written agreement of the parties. Fiduciary duties are found to exist notwithstanding the terms of the customer-firm agreement. This follows the age-old principle under fiduciary law that "fiduciary duties are imposed by the law, not by the terms of the parties." In other words, fiduciary duties are applied to the relationship that actually exists, not what the parties state or agree as to what their relationship is (or is not). These decisions are in accord with the general legal views that core fiduciary duties are not "waivable." The legal concepts of "waiver" and "estoppel" have very limited application to a fiduciary-entrustor relationship.

Nevertheless, one reason why broker-dealer firms may not have adequately warned, in some instances, their registered representatives of the likely (in most instances) existance of a fiduciary relationship with their customers, would be reliance (mistaken, in my view) upon the contractualist view of fiduciary duties.

Second, I have read many outlines (presented at conferences) and articles written by attorneys who work as legal counsel for broker-dealer firms, insurance companies, and the like. These outlines seem to be "wishful thinking" in my view, as to when fiduciary duties are applied under state common law. For example, a recent case has been called an "anomoly" by some of these lawyers. Yet, in my view, the case is entirely consistent with the application of the fiduciary standard when a relationship of trust and confidence exists. The case is Western Reserve Life Assurance Company of Ohio vs. Graben, No. 2-05-328-CV (Tex. App. 6/28/2007) (Tex. App., 2007). Hence, it is possible that the compliance officers of broker-dealer firms may have been misled (unintentionally) on this issue, by legal counsel, who perhaps have not thoroughly explored the imposition of fiduciary duties under state common law, or who reach different conclusions than the conclusions I reach (although many legal scholars are in substantial agreement with my conclusions).

Third, another explanaton is possible, albeit more sinister. Breach of fiduciary duty is the most commonly asserted claim in FINRA customer-initiated arbitration proceedings, and has been for the past five years. Broker-dealer firms, which consistently fight the application of fiduciary standards in these proceedings (despite a trend toward losing these cases, more and more, from reports I here). It may be that broker-dealer firms are slow to react. Or, if one were to be cynical, it may be that broker-dealer firms see the claims process as just a "cost of doing business." Since arbitration largely shields the conduct of broker-dealer firms from public scrutiny, and the massive advertising budgets of the wirehouse overcome (over time) any negative publicity resulting from judgments against them, the large wirehouses might just see this as a "cost of doing business."

Unfortunately, from the standpoint of the individual registered representative (including dual registrants), the result of a breach of fiduciary duty complaint (and either its subsequent settlement or an adverse judgment) is much more severe, in terms of its consequences. Form U-4 must be amended, for all to see. If the registered representative is a dual registrant, or moves to become an investment adviser representative only., then disclosures must also be made on Form ADV, Part 2B. In addition to the public's ability to review these documents online, there are also rating agencies of both firms and individuals (such as Brightscope) are appearing, which gather information from such disclosures for consumers to see. Of course, past and current customers of the broker-dealer, as well as competitors, when provided knowledge of a transgression, may also disseminate that information.

A financial services professional's reputation is her or his most important asset. Each individual should guard that asset with great care. The professional's ability to earn a livelihood depends upon his or her reputation.

In summary, it is entirely possible that, since the wirehouse firms can largely overcome the existence of breach of fiduciary duty complaints (as a cost of doing business, and by advertising to change consumer opinion), and because they are so profitable under a non-fiduciary business model, these large broker-dealer firms simply don't want to inform their registered representatives of the risks present.

But, as stated above, other reasons exist, and my response to this question of "why" is somewhat speculative. If you have information which may better inform this response, please write to me.

A later blog post will explore developments affecting brokers providing personalized investment advice since the middle of the 20th Century. It will be demonstrated that the courts still apply fiduciary duties to brokers who provide personalized investment advice to their clients.
To receive notification of subsequent blog posts, please follow me on Twitter (@140ltd), or connect with me through LinkedIn.  Thank you. – Ron Rhoades.

P.S. - To write to me, please e-mail: RhoadeRA@AlfredState.edu.

* Program Director for the Financial Planning Program at Alfred State College, Alfred, NY; Chair of the Steering Group for The Committee for the Fiduciary Standard (www.thefiduciarystandard.org). The Committee, led by a volunteer Steering Group of practitioners and experts, seeks to help inform and nurture a public discussion on the fiduciary standard.  The Committee’s objective is “to ensure that any financial reform regarding the fiduciary standard: 1) meets the requirements of the authentic fiduciary standard, as presently established in the Investment Advisers Act of 1940; and 2) covers all professionals who provide investment and financial advice or who hold themselves out as providing financial or investment advice, without exceptions and without exemptions.” This article is submitted on behalf of The Committee for the Fiduciary Standard. Please submit any comments or suggestions regarding this publication to rhoadera@alfredstate.edu.  Thank you.
[1] James J. Angel, Ph.D., CFA and Douglas McCabe Ph.D., Ethical Standards for Stockbrokers: Fiduciary or Suitability? (Sept. 30, 2010).
[2] Staff of the U.S. Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Jan. 2011) (hereafter “SEC Staff 2011 Study”), available at www.sec.gov/news/studies/2011/913studyfinal.pdf, at p. 22.
[3] SEC Release No. 34-69013; IA-3558; File No. 4-606, Duties of Brokers, Dealers, and Investment Advisers (March 1, 2013), available at http://www.sec.gov/rules/other/2013/34-69013.pdf.
[4] Section 913 of the Dodd–Frank Wall Street Reform and Consumer Protection Act. Pub. L. 111-203, 124 Stat. 1376 (2010). Specifically, the SEC may extend the fiduciary standard to broker-dealers in situations involving “a natural person, or the legal representative of such natural person, who (A) receives personalized investment advice about securities from a broker, dealer or investment adviser; and (B) uses such advice primarily for personal, family, or household purposes.” 15 U.S.C. 80b–11(g)(2).
[5] Other regulated actors also provide investment advice, including the trust departments of banks and their trust officers, separate trust companies and their trust officers, and, on occasion, insurance agents with respect to sales of cash value life insurance products and various forms of annuities. This paper does not seek to address the regulation of these providers.
[6] Webster’s Revised Unabridged Dictionary (1913) defines “adviser” as “One who advises.” The term “advisor” is not found in this dictionary. However, the common practice in the United State is to use the spelling “advisor.” However, the text of the Investment Advisers Act of 1940 and regulations adopted thereunder use the spelling “adviser.” Both spellings are now generally deemed acceptable by many dictionaries.
[7] See, e.g., James J. Angel, On the Regulation of Advisory Services: Where do we go from here (Oct. 31, 2011), stating, “Advisers have a higher standard of care in that their recommendations must be in the best interest of the client, whereas broker recommendations are held to a slightly weaker suitability standard.”
[8] Advisers Act Section 202(a)(11) defines “investment adviser” to mean “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.” Advisers Act Section 202(a)(11)(C) excludes from the investment adviser definition any broker or dealer (i) whose performance of its investment advisory services is “solely incidental” to the conduct of its business as a broker or dealer; and (ii) who receives no “special compensation” for its advisory services. Accordingly, broker-dealers providing investment advice in accordance with this exclusion are not subject to the fiduciary duty imposed by the Advisers Act, but remain subject to the fiduciary duties imposed by state common law.
[9] The SEC staff noted the ways that brokers receive compensation in its 2011 Special Study: “Generally, the compensation in a broker dealer relationship is transaction-based and is earned through commissions, mark-ups, mark-downs, sales loads or similar fees on specific transactions, where advice is provided that is solely incidental to the transaction. A brokerage relationship may involve incidental advice with transaction-based compensation, or no advice and, therefore no charge, for advice.” SEC Staff 2011 Study, supra n. 2, at pp. 10-11. Interestingly, the SEC Staff did not note the fact that brokers also receive compensation which is in the form of asset-based compensation, similar to the “assets under management” fee structure of most investment advisers, such as 12b-1 fees and payment for shelf space. 12b-1 fees have been criticized by this author as possible “special compensation” and “investment advisory fees in drag.” See Ron Rhoades, “7 reasons why wirehouses shouldn’t milk the old business model,” RIABiz, Jan. 28, 2010 (available at http://www.riabiz.com/a/114009/7-reasons-why-wirehouses-shouldn39t-milk-the-old-business-model).
The U.S. Court of Appeals decision in Financial Planning Association vs. SEC, No. 04-1242  (D.C. Cir., March 30, 2007), possesses potentially far-reaching implications. Three times in that decision the Court emphasized that the term “investment adviser” was “broadly defined” by Congress.  Additionally, in discussing the exclusion for brokers (insofar as their advice is solely incidental to brokerage transactions for which they receive no special compensation), the U.S. Court of Appeals stated:
“The relevant language in the committee reports suggests that Congress deliberately drafted the exemption in subsection (C) to apply as written. Those reports stated that ‘investment adviser’ is so defined as specifically to exclude ... brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions) ….” [Emphasis added.]
As a result of this language, all arrangements in which broker-dealer firms and their registered representatives receive compensation other than commission-based compensation should be reviewed to see if the definition of “investment adviser” found in 15 U.S.C. §80b-2.(a)(11) applies: “Investment adviser” means any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities ….”
For example, does the receipt of 12b-1 fees by broker-dealer firms and their registered representatives, which by the SEC’s own admission are asset-based fees and relationship compensation, run afoul of the IAA when received by those outside investment advisory relationships with their customers. The written submissions to the SEC by many brokerage industry representatives acknowledge that 12b-1 fees are utilized in large part to compensate registered representatives for the fostering of an ongoing relationship between the registered representative and the investor, including the provision of advice over time with respect to a customer’s personal circumstances, and including financial planning, estate planning, and investment advice (not specific to any transaction). Moreover, the SEC has in the past acknowledged that, to meet the “compensation” test under the Advisers Act: “It is not necessary that an adviser's compensation be paid directly by the person receiving investment advisory services, but only that the investment adviser receive compensation from some source for his services.” SEC Release IA-770 (1981).
While industry representatives have argued that the 12b-1 fee “compensation” received by the broker-dealer firm is not paid by the customer directly, there is no qualification in the definition of investment adviser which says that compensation must be directly paid by an investor.  Moreover, there is a common law principle which attorneys were taught when they were in law school:  “You cannot do indirectly what you cannot do directly.”  In other words, “if it walks like a duck….”   While admittedly Class C shares in particular, and fee-based compensation in general, might at times better align the interests of investors with those of financial intermediaries, such an alignment is not the basis of any exclusion from the application of the IAA.  Given the significance of this issue, all ongoing payments to advice-providers deserve close scrutiny – including ongoing payments for shelf space, variable annuity product provider annual fees to broker-dealers, and – as stated above – 12b-1 fees.
12b-1 fees also may violate the Sherman Act and its anti-trust prohibitions, inasmuch as they negate the ability of a customer to effectively negotiate, in many instances, the compensation for advisory services. This issue, involving unlawful restraint of trade, is beyond the scope of this paper.
[10] As stated in the SEC Staff’s 2011 Report:
The Advisers Act excludes from the investment adviser definition any broker or dealer: (i) whose performance of its investment advisory services is “solely incidental” to the conduct of its business as a broker or dealer; and (ii) who receives no “special compensation” for its advisory services. To rely on the exclusion, a broker-dealer must satisfy both of these elements.
Generally, the ‘solely incidental’ element amounts to a recognition that broker-dealers commonly give a certain amount of advice to their customers in the course of their regular business as broker-dealers and that “it would be inappropriate to bring them within the scope of the [Advisers Act] merely because of this aspect of their business.” On the other hand, “special compensation” “amounts to an equally clear recognition that a broker or dealer who is specially compensated for the rendering of advice should be considered an investment adviser and not be excluded from the purview of the [Advisers] Act merely because he is also engaged in effecting market transactions in securities.” Finally, the Commission staff has taken the position that a registered representative of a broker-dealer is entitled to rely on the broker-dealer exclusion if he or she is providing investment advisory services to a customer within the scope of his or her employment with the broker-dealer.
SEC Staff 2011 Report, supra n.2, at pp. 15-16.
[11] The products and services offered by broker-dealers fall into two broad categories: brokerage services and dealer services. Generally, a broker is one who acts as an agent for someone else, while a dealer is one who acts as principal for its own account. A firm can act as both a broker and a dealer. The licensed employees of a broker-dealer are referred to as “registered representatives” and, until recent years, were often commonly referred to as “stockbrokers.”
[12] The SEC’s March 1, 2013 release acknowledges that brokers and their registered representatives may possess a fiduciary duty under state common law: “A broker-dealer may have a fiduciary duty under certain circumstances. This duty may arise under state common law, which varies by state. Generally, courts have found that broker-dealers that exercise discretion or control over customer assets, or have a relationship of trust and confidence with their customers, are found to owe customers a fiduciary duty similar to that of investment advisers.” [Emphasis added.]
See also 2011 SEC Staff Study, supra n.2, at pp.10-11. “While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts have found broker-dealers to have a fiduciary duty under certain circumstances. Moreover, broker-dealers are subject to statutory, Commission and SRO requirements that are designed to promote business conduct that protects customers from abusive practices, including practices that may be unethical but may not necessarily be fraudulent.” It should be noted that the views expressed in the Study were those of the staff and do not necessarily reflect the views of the Commission or the individual Commissioners.
See also A Joint Report of the SEC and the CFTC on Harmonization of Regulation (Oct. 2009), available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, stating: “While the statutes and regulations do not uniformly impose fiduciary obligations on a [broker-dealer (BD)], a BD may have a fiduciary duty under certain circumstances, at times under state common law, which varies by state. Generally, BDs that exercise discretion or control over customer assets, or have a relationship of trust and confidence with their customers, are found to owe customers a fiduciary duty similar to that of investment advisers … State common law imposes fiduciary duties upon persons who make decisions regarding the assets of others. This law generally holds that a futures professional owes a fiduciary duty to a customer if it is offering personal financial advice.Id. at pp.9-10. [Emphasis added.]
[13] Registered investment advisers are separately licensed under the Investment Advisers Act of 1940. Their licensed employees are referred to as “investment adviser representatives.” However, many financial services firms offer both broker-dealer and investment advisory services, which leads to the connotation of the firm (and its licensed employees who also possess both Series 6/7 and 65 licensure) as “dual registrants.” As of mid-October 2010, approximately 88% of investment adviser representatives were also registered representatives of a FINRA-registered broker-dealer.
[14] The suitability standard imposes both additional substantive (fairness) and procedural (disclosure) obligations upon broker-dealers, in addition to the requirements of good faith applicable to the performance of contracts between all those in arms-length relationships. The SEC and the U.S. Consumer Futures Trading Commission (CFTC) recent summarized the broker-dealers suitability obligation as follows:
Under the federal securities laws and SRO rules, broker-dealers are required to deal fairly with their customers. This includes having a reasonable basis for recommendations given the customer’s financial situation (suitability), engaging in fair and balanced communications with the public, providing timely and adequate confirmation of transactions, providing account statement disclosures, disclosing conflicts of interest, and receiving fair compensation both in agency and principal transactions. In addition, the SEC’s suitability approach requires BDs to determine whether a particular investment recommendation is suitable for a customer, based on customer-specific factors and factors relating to the securities and investment strategy. A BD must investigate and have adequate information regarding the security it is recommending and ensure that its recommendations are suitable based on the customer’s financial situation and needs. The suitability approach in the securities industry is premised on the notion that securities have varying degrees of risk and serve different investment objectives, and that a BD is in the best position to determine the suitability of a securities transaction for a customer. Disclosure of risks alone is not sufficient to satisfy a broker-dealer’s suitability obligation.
A Joint Report of the SEC and the CFTC on Harmonization of Regulation (Oct. 2009), available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, at p.9.
[15] The North American Securities Dealers Association (NASD) was founded in 1939 and was registered with the SEC in response to the 1938 Maloney Act amendments to the Securities Exchange Act of 1934, which allowed it to supervise the conduct of its members subject to the oversight of the SEC. See Maloney Act of 1938, 15 U.S.C. § 78o-3 (2006) (adding Section 15A to Securities Exchange Act of 1934 and establishing system of self-regulation for broker-dealers). FINRA succeeded to the regulatory functions of NASD in 2007.
[16] As stated in the SEC’s March 1, 2013 release: “Many financial services firms may offer both investment advisory and broker-dealer services … See Letter from Angela Goelzer, FINRA, to Lourdes Gonzalez, Assistant Chief Counsel, Securities and Exchange Commission (Nov. 16, 2012). Further, as of mid-November 2012, approximately 41% of FINRA-registered broker-dealers had an affiliate engaged in investment advisory activities. Id. Many of these financial services firms’ personnel may also be dually registered as investment adviser representatives and registered representatives of broker-dealers. As of October 31, 2012, approximately 86% of investment adviser representatives were also registered representatives of a FINRA-registered broker-dealer. Id.” SEC Release, supra n. 3, at p. 5 (footnote).
[17] See SEC Release No. 34-69013; IA-3558; File No. 4-606, Duties of Brokers, Dealers, and Investment Advisers (March 1, 2013) (“Today, broker-dealers and investment advisers routinely provide to retail customers many of the same services, and engage in many similar activities related to providing personalized investment advice about securities to retail customers. While both investment advisers and broker-dealers are subject to regulation and oversight designed to protect retail and other customers, the two regulatory schemes do so through different approaches notwithstanding the similarity of certain services and activities … Studies suggest that many retail customers who use the services of broker-dealers and investment advisers are not aware of the differences in regulatory approaches for these entities and the differing duties that flow from them.”) Id. at pp. 3-4 (citations omitted).
[18] “Currently, broker-dealers are compensated in various ways that pose multiple conflicts of interests with customers: they are paid by the issuers, underwriters, and sponsors of the securities products they sell (e.g. insurance companies sponsoring variable annuities); they earn higher commissions for selling certain (sometimes riskier) securities over other (sometimes less volatile) securities; and they may earn a commission for each security purchased or trade effected for the customer, among other conflicts. But as long as the broker-dealer does not recommend the sale, or recommends the sale of a security suitable for the customer, these conflicts of interest are not unlawful.” Matthew P. Allen, A Lesson from History, Roosevelt to Obama — The Evolution Of Broker-Dealer Regulation: From Self-Regulation, Arbitration, And Suitability To Federal Regulation, Litigation, and Fiduciary Duty, 5 Entreprenurial Bus.L.J. 1, 9 (2010), at p. 23. Additional conflicts of interest arise when mutual funds provide additional compensation in the form of “payment for shelf space” and soft dollar compensation, or when mutual funds or other investment or insurance product providers sponsor events at educational conferences attended by registered representatives.
[19] Cheryl Goss Weiss, A Review of the Historic Foundations of Broker-Dealer Liability for Breach of Fiduciary Duty, 23 Iowa J. Corp. L. 65, 68 (1997).
[20] See Blaine F. Aikin, Kristina A. Fausti, Fiduciary: A Historically Significant Standard, 30 Rev. Banking & Financial Law 155, 157 (2010-11).
[21] “[C]ourts have linked the fiduciary duty of loyalty to the biblical principle that no person can serve two masters.” Id., at pp.157-8.  See also Beasley v. Swinton, 46 S.C. 426; 24 S.E. 313; 1896 S.C. LEXIS 67 (S.C. 1896) (“Christ said: ‘No man can serve two masters, for either he will hate the one and love the other, or else he will hold to the one and despise the other. Ye cannot serve God and Mammon [money].’") Id. at ____, quoting Matthew 6:24.
[22] “Chinese historical texts also recognize fiduciary principles of trust and loyalty. One of the three basic questions of self-examination attributed to Confucius (551 BC–479 BC) asks: ‘In acting on behalf of others, have I always been loyal to their interests?’” Aitkin and Fauti, supra n.__,. at p.158.
[23] “Aristotle (384 BC–322 BC) consistently recognized that in economics and business, people must be bound by high obligations of loyalty, honesty and fairness and that society suffers when such obligations are not required.” Id.
[24] “Cicero (103 BC–46 BC) noted the relationship of trust between an agent and principal (known to Romans as mandatory and mandator, respectively), and emphasized that an agent who shows carelessness in his execution of trust behaves very dishonorably and ‘is undermining the entire basis of our social system.’” Id. at 158-9.
[25] See, e.g., Carter v. Harris, 25 Va. 199; 1826 Va. LEXIS 26; 4 Rand. 199 (Va. 826) (“It is well settled as a general principle, that trustees, agents, auctioneers, and all persons acting in a confidential character, are disqualified from purchasing. The characters of buyer and seller are incompatible, and cannot safely be exercised by the same person. Emptor emit quam minimo potest; venditor vendit quam maximo potest. The disqualification rests, as was strongly observed in the case of the York Buildings Company v. M'Kenzie, 8 Bro. Parl. Cas. 63, on no other than that principle which dictates that a person cannot be both judge and party. No man can serve two masters. He that it interested with the interests of others, cannot be allowed to make the business an object of interest to himself; for, the frailty of our nature is such, that the power will too readily beget the inclination to serve our own interests at the expense of those who have trusted us.”). Id. at 204.
[26] Wormley v. Wormley, 21 U.S. 421; 5 L. Ed. 651; 1823 U.S. LEXIS 290; 8 Wheat. 421 (1823). See also Michoud v. Girod, 45 U.S. 503; 11 L. Ed. 1076; 1846 U.S. LEXIS 412; 4 HOW 503 (1846) (“[I}f persons having a confidential character were permitted to avail themselves of any knowledge acquired in that capacity, they might be induced to conceal their information, and not to exercise it for the benefit of the persons relying upon their integrity. The characters are inconsistent. Emptor emit quam minimo potest, venditor vendit quam maximo potest.”]
[27] SEC v. Capital Gains Research Bureau, 375 U.S. 180; 84 S. Ct. 275; 11 L. Ed. 2d 237; 1963 U.S. LEXIS 2446 (1963) (“This Court, in discussing conflicts of interest, has said:
The reason of the rule inhibiting a party who occupies confidential and fiduciary relations toward another from assuming antagonistic positions to his principal in matters involving the subject matter of the trust is sometimes said to rest in a sound public policy, but it also is justified in a recognition of the authoritative declaration that no man can serve two masters; and considering that human nature must be dealt with, the rule does not stop with actual violations of such trust relations, but includes within its purpose the removal of any temptation to violate them ….’
. . . In Hazelton v. Sheckells, 202 U.S. 71, 79, we said: 'The objection . . . rests in their tendency, not in what was done in the particular case. . . . The court will not inquire what was done. If that should be improper it probably would be hidden and would not appear.' United States v. Mississippi Valley Co., 364 U.S. 520, 550, n. 14.”) Id. at p. 249 (fn.50).
[28] Generally, relationships between two parties fall into one of two categories.  The first category is that in which arms-length negotiations between the parties take place.  Sometimes the consumer is aided by specific laws which impose some additional duties on the other party. For example, upon broker-dealers there is imposed the requirement that investment products sold to an investor be “suitable,” at least as to the risks associated with that investment. Additionally, various disclosures may be required of broker-dealers under federal securities laws. Yet, even with enhanced safeguards, the arms-length relationship of the parties involved in the sale of an investment product can still be described as:
By contrast, the fiduciary relationship arises in situations where the law has clearly recognized that fiduciary duties attach, such as principal and agent relationships, or where there exists the actual placing of trust and confidence by one party in another and a great disparity of position and influence between the parties. In these situations, mere disclosure of material facts is thought to be inadequate as a means of consumer protection, and hence the fiduciary standards of conduct are imposed. The relationship of the parties in a fiduciary relationship is reversed, as follows:
[29] See e.g., Tamar Frankel, Fiduciary Law, 71 Calif. L. Rev. 795 (1983) (“Another social trend which increases the importance of fiduciary law is the change in perception of power, and the emergence of new forms of power … Specialization of labor has become one of the main features of our modem society. Specialization is important because it maximizes the benefits from labor … pooling: the transfer of resources by many persons to a small number of experts. Pooling benefits the participants because it may produce economies of scale … Financial institutions present one example of the benefits of pooling … Relations that stem from specialization and pooling are often classified as fiduciary because they pose the problem of abuse of power that is common to fiduciary relations….”) Id. at 803-4.
[30] See, e.g., Restatement (Second) of Torts § 874 cmt. a (1979) (“A fiduciary relation exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.” citing Restatement, Second, Trusts § 2).
[31] The Employee Benefits Securities Administration of the U.S. Department of Labor is expected to re-promulgate, in the second half of 2013, its “Definition of Fiduciary” proposed rule, which would greatly expand the situations in which those providing investment advice to plan sponsors and/or plan participants would be regarded as fiduciaries and subject to ERISA’s strict “sole interests” fiduciary standard and its prohibited transaction rules. EBSA’s re-proposal is also likely to extend ERISA’s fiduciary obligations to IRA accounts. See Melanie Waddell, “3 Issues That Will Dominate DOL Fiduciary Debate,” AdvisorOne (Feb. 28, 2013), available at http://www.advisorone.com/2013/02/28/3-issues-that-will-dominate-dol-fiduciary-debate.
[33] Jothann v. Irving Trust Company, 151 Misc. 107; 270 N.Y.S. 721, citing Wendt v. Fischer, 215 A.D. 196; 213 N.Y.S. 351 (1926).
[36] Southern Trust Co. v. Lucas (C.C.A.) 245 F. 286, 288 (____).
[37] Hancock v. Anderson, 160 Va. 225; 168 S.E. 458; 1933 Va. LEXIS 201 (Va. 1933)
[38] I can't advise you in this matter as I have told you I am representing the second mortgage man and therefore I can't give you any advice. You will have to go somewhere else and get your advice in the matter because I am interested in it.Id. at 236.
[39] Id. at 239.
[40] Id. at 240, 242-3.
[41] Arthur C. Laby, Fiduciary Obligation of Broker-Dealers and Investment Advisers, 55 Vill.L.R. 701, 714 (2010), noting that since the Investment Advisers Act of 1940 and the federal common law promulgated thereunder does not apply to broker-dealers, federal courts must look to state law to determine brokers’ fiduciary status.
[42] Trust law, largely followed by the Employee Retirement Income Security Act’s (ERISA’s) application of its “sole interests” fiduciary standard, seeks to solve the problem of agency problems by placing limits upon the fiduciary’s conduct, and prohibiting certain forms of action. “The problem with problem with disempowerment is that in protecting the principal from mis- or malfeasance by the agent, the law also disabled the agent from undertaking acts useful for the principal.” Robert Sitkoff, The Economic Structure of Fiduciary Law, 91 Boston U.L.Rev. 1039, 1042 (2011).
[43] “Agency is the fiduciary relationship that arises when one person (a "principal") manifests assent to another person (an "agent") that the agent shall act on the principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise consents so to act.” § 1.01 “Agency Defined,” Restatement (Third) of Agency (2006). “An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with the agency relationship.” § 8.01 “General Fiduciary Principle,” Restatement (Third) of Agency (2006).
[44] The incorporation of aspects of contract law into fiduciary duties has led to a broad academic discussion regarding whether fiduciary duties are default rules. Over two decades have passed since Cooter and Freedman (1991) and Easterbrook and Fischel (1993) espoused the contractualists’ model of fiduciary law.  See, e.g., Sitkoff, supra n.___, at , 1041.
Yet, the contractualists’ theory of fiduciary law appears misplaced, at least in the context of advisory relationships. “[C]ontract law concerns itself with transactions while fiduciary law concerns itself with relationships.” Rafael Chodos, Fiduciary Law: Why Now! Amending the Law School Curriculum, 91 Boston U.L.R. 837, 845 (and further noting that “Betraying a relationship is more hurtful than merely abandoning a transaction.” Id. See also Laby, The Fiduciary Obligation as the Adoption of Ends, 56 Buff. L. Rev. 99, 104-29 (2008) (rejecting contractual approach as descriptive theory of fiduciary duties, and at 129-30 (arguing that signature obligation of fiduciary is to adopt ends of his or her principal).
The author posits that there may be greater flexibility in contracting around fiduciary duties where the entrustor is an employer of a non-expert employee (i.e., in an employer-employee relationship) and has greater control and, presumably, knowledge than the employee. Even then, the “tendency of courts to construe fiduciary limitations narrowly and to be suspicious of provisions purporting to eliminate all fiduciary duties is understandable given the long tradition of treating business partners and managers as fiduciaries.” Chodos, at p.894 (further noting that: “This approach also is consistent with the general drafting principle that limitations on fiduciary duties are strictly construed. See, e.g., Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 171–72 (Del. 2002); Restatement (Third) Of AgencY § 8.06 (2006).”) Id.
Hence, greater emphasis on the contractual nature of fiduciary obligations may exist when contracting parties enter into a partnership agreement or a limited liability company operating agreement, given that most state statutes permit these parties, upon entry into the relationship, to negotiate (to a degree) the legal duties owed to one another. Yet, in relationships of an advisory-client nature, where there exists a vast disparity in knowledge between the advisor and the client, and where clients do not normally seek legal advice prior to entry into such relationships, the ability of the advisor to negate fiduciary duties by contract is properly more circumscribed.
Other scholars appear reject the contractualist theory of fiduciary duties more broadly. See, e.g., Tamar Frankel, Fiduciary Duties as Default Rules, 74 Or. L. Rev. 1209 (1995) (“[C]ircumstances exist where fiduciary duties are not waivable for reasons such as doubts about the quality of the entrustors' consent (especially when given by public entrustors such as shareholders), and the need to preserve institutions in society that are based on trust. Further, non-waivable duties can be viewed as arising from the parties' agreement ex ante to limit their ability to contract around the fiduciaries' duties.  Under these circumstances fiduciary rules should generally be mandatory and non-waivable … I conclude that private and public fiduciaries should be subject to a separate body of rules and reject the contractarian view..”) Id. See also Scott FitzGibbon, Fiduciary Relationships Are Not Contracts, 82 MARQ. L. REV. 303, 305 (1999) (“This Article explores the nature of fiduciary relationships, shows that they arise and function in ways alien to contractualist thought, and that they have value and serve purposes unknown to the contractualists.”)
[45] As Professor Laby notes, “Historically, providing advice has given rise to a fiduciary duty owed to the recipient of the advice. Both the Restatement (First) and Restatement (Second) of Torts state, “[a] fiduciary relation exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation” [citing Restatement (Second) Of Torts § 874 cmt. a (1979) (citation omitted) (emphasis added); Restatement (First) Of Torts § 874 cmt. a (1939) (citation omitted) (emphasis added)].
[46] John R. Dos Passos, A Treatise on the Law of Stock-Brokers and Stock Exchanges, The Banks Law Publishing Co., 2ND Edition (1905), Vol. 1, p.2 (available at http://ia700303.us.archive.org/28/items/lawofstockbroker01dosp/lawofstockbroker01dosp.pdf).
[47] Id. at pp.3-4.
[48] Id. See also Banta v. Chicago, 172 Ill. 204; 50 N.E. 233; 1898 Ill. LEXIS 2855 (Ill. 1898) (“the business of brokers continued to expand, and they subsequently undertook to effect the negotiation of bonds and other evidences of indebtedness, and certificates of shares in the capital stock of incorporated companies. The advent of brokers into this branch of business is referred to by Chief Justice Beck in the early case of Gibbons v. Rule, 12 Moore, 539, (13 E.C.L. 444,) which was decided in 1827, as follows: The statute 8 and 9 William III, chap. 20, by which the first government loan was raised, speaks of a new description of brokers, -- persons employed in buying and selling tallies, the government securities of those days. These have since been called stock brokers. The statute referred to was enacted by the Parliament of England in the year 1697.”) Id. at 237.
[49] See An Act to Restrain the Number and Ill Practice of Brokers and Stock Jobbers, 1697, 8 & 9 Will. 3, c. 32 (Eng.) [hereinafter Statutes], available at http://www.british-history.ac.uk/report.aspx?compid=46880
[50] John R. Dos Passos, supra n.__, at p.4.
[51] See James A. Klimek, A Brief History of Securities Law, available at http://www.klimek-law.com/Brief%20History.shtml  (“In 1707 Parliament was in a deregulatory phase and allowed the statute to lapse.”).
[52] The Act permitted brokers to receive not more than ten shillings per cents for a brokerage fee, and imposed a stiff penalty for receiving additional compensation not permitted by the Act, stating: “if any such Broker or Brokers so to be admitted as aforesaid shall directly or indirectly deal for him or themselves in the Exchange or Remittance of Moneys or shall buy any Talleys Orders Bills or Share or Interest in any Joint Stock to be assigned or transferred to his owne Use or buy any Goods Wares or Merchandizes to sell againe for his owne Benefitt or Advantage or shall make any Gain or Profitt in buying or selling any Goods over and above the Brokage allowed by this Act hee or they so offending shall forfeit the Su[m]m of Two hundred pounds and being convicted of [any] such Offence shall be for ever incapable to trade act or deal as a Broker for any Person or Persons whatsoever.” Id. at section IX. The Act ws only in existence for approximately ten years. See James A. Klimek, A Brief History of Securities Law, available at http://www.klimek-law.com/Brief%20History.shtml (“In 1707 Parliament was in a deregulatory phase and allowed the statute to lapse.”).
[53] John R. Dos Passos, supra n.__, at p. 173.
[54] Id., at p.176, citing Banta v. Chicago, 172 Ill. 201.
[55]  John R. Dos Passos, supra n.__, at pp. 180-1.
[56] As was well-known in the early case law: "The principle is undeniable that an agent to sell cannot sell to himself, for the obvious reason that the relations of agent and purchaser are inconsistent, and such a transaction will be set aside without proof of fraud.” Porter v. Wormser , 94 N. Y. 431, 447 (1884). The Investment Advisers Act of 1940 provided a specific exception to this legal principle for investment advisers who engaged in principle trades, but requiring as a safeguard in-advance disclosures and the consent of the client.
[57] Cheryl Goss Weiss, A Review of the Historic Foundations of Broker-Dealer Liability for Breach of Fiduciary Duty, 23 J. CORP. L. 65, 66 (1997) (providing a summary of the historical development of brokers and dealers before the ’33 and ’34 securities acts).
[58] Matthew P. Allen, supra n. ___, at p.21.  See also Frederick Mark Gedicks, Suitability Claims and Purchases of Unrecommended Securities: An Agency Theory of Broker-Dealer Liability, 37 ARIZ. ST. L.J. 535, 586-87 (2005).
See also Angela Hung, Noreen Clancy, Jeff Dominitz, Eric Talley, Claude Berrebi, & Farrukh Suvankulow, Perspectives on Investment Advisers and Broker Dealers, RAND INST. FOR CIV. JUST., 49, t.4.9 (2008) [hereinafter RAND Study], at 7.
[59] See RESTATEMENT (THIRD) OF AGENCY § 1.01 cmt. e (2006) (“Any agent has power over the principal’s interests to a greater or lesser degree. This determines the scope in which fiduciary duty operates.”).
[60] Laby, supra n.__, at 751.
[61] See, e.g. In re Ruskay (U.S. Ct. App. 2nd Cir.), 5 F.2d 143; 1925 U.S. App. LEXIS 2618 (1925) (“Equity regards a fund so paid and received as impressed with a trust in favor of the one who paid it over and who is beneficially entitled.”) Id. at p. 144.
[64] Norman S. Poser and James A. Fano, Broker-Dealer Law and Regulation (Wolters Kluwer,  Fourth Edition) (2011 Supp.), at p.16-36.
[65] Birch v. Arnold, 88 Mass. 125; 192 N.E. 591; 1934 Mass. LEXIS 1249 (Mass. 1934).
[66] Id. at ____.
[67] Birch v. Arnold , citing Reed v. A. E. Little Co., 256 Mass. 442, 152 N.E. 918, and Wendt v. Fischer, 243 N.Y. 439, 443, 444, 154 N.E. 303.
[68] Patsos vs. First Albany Corp., 433 Mass. 323; 741 N.E.2d 841; 2001 Mass. LEXIS 19 (Mass. 2001), at pp. 322-3.
[69] Id. at pp.332-3.
[70] Id. at pp. 334-5.
[71] Id. at 334.
[72] Id. at p.335. In Romano v. Merrill Lynch, Pierce, Fenner & Smith, 834 F.2d 523; 1987 U.S. App. LEXIS 16820; Fed. Sec. L. Rep. (CCH) P93,693; 9 Fed. R. Serv. 3d (Callaghan) 1318; Comm. Fut. L. Rep. (CCH) P24,179 (C.A. 5th Cir. 1987), the Court stated: “It is clear that the nature of the fiduciary duty owed will vary, depending on the relationship between the broker and the investor. Such determination is necessarily particularly fact-based. And although courts draw no bright-line distinction between the fiduciary duty owed customers regarding discretionary as opposed to nondiscretionary accounts, the nature of the account is a factor to be considered.” Id. at 530. See also Broofield vs. Kosow, 349 Mass. 749; 212 N.E.2d 556; 1965 Mass. LEXIS 804 (1965) (“the plaintiff alone, by reposing trust and confidence in the defendant, cannot thereby transform a business relationship into one which is fiduciary in nature. The catalyst in such a change is the defendant's knowledge of the plaintiff's reliance upon him. In redressing an abuse of trust and confidence equity will review such factors as the relation of the parties prior to the incidents complained of, the plaintiff's business capacity or lack of it contrasted with that of the defendant, and the readiness of the plaintiff to follow the defendant's guidance in complicated transactions wherein the defendant has specialized knowledge. Equity will, in sum, weigh whether unjust enrichment results from the relationship.”) Id. at 755.
[73] Matthew P. Allen, A Lesson from History, Roosevelt to Obama — The Evolution Of Broker-Dealer Regulation: From Self-Regulation, Arbitration, And Suitability To Federal Regulation, Litigation, and Fiduciary Duty, 5 Entreprenurial Bus.L.J. 1, 9 (2010).
[74] SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). See also Transamerica Mortgage Advisors, Inc., 444 U.S. 11, 17 (1979) (“[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.”). As stated by SEC staff, “The adviser’s fiduciary duty is enforceable under Advisers Act Sections 206(1) and (2), which prohibit an adviser from “employ[ing] any device, scheme, or artifice to defraud any client or prospective client” and from engaging in “any transaction, practice or course of business which operates as a fraud or deceit on any client or prospective client.” SEC Staff 2011 Study, supra n.__, at pp. 21-2.
[75] Brandt, Kelly & Simmons, LLC, Admin. Proc. File No. 3-11672 (SEC Sept. 21, 2004), citing SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 180 (1963).
[76] “A main theme in the cases that developed the sole interest rule was the fear that without the prohibition on trustee self-interest, a conflicted trustee would be able to use his or her control over the administration of the trust to conceal wrongdoing, hence to prevent detection and consequent remedy. Lord Hardwicke, sitting in 1747, before the sole interest rule had hardened in English trust law, was worried about a self-dealing trustee being able to conceal misappropriation. In 1816 in Davoue v. Fanning, the foundational American case recognizing and enforcing the then-recently-settled English rule, Chancellor Kent echoed this concern: “There may be fraud, as Lord Hardwicke observed, and the [beneficiary] not able to prove it.” In order “to guard against this uncertainty,” Kent endorsed the rule allowing the beneficiary to rescind a conflicted transaction “without showing actual injury.” In his Commentaries on American Law, Kent returned to the point that the sole interest rule “is founded on the danger of imposition and the presumption of the existence of fraud, inaccessible to the eye of the court.” John H. Langbein, Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest, 114 Yale L. J. 929, 944 (2005).