Commissioner Luis A. Aguilar of the Securities and Exchange Commission (SEC) gave a speech on April 29, 2010 on the topic of fiduciary duties owed by investment advisers and (not owed) by broker-dealers. Let’s start with some context.
SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963) is a U.S. Supreme Court opinion that dealt with whether the anti-fraud provision of the Investment Advisors Act of 1940 (IAA) encompassed nondisclosure of material facts, and not only intentional misrepresentations. For resolution of this issue, the 1963 Court looked to the history and purpose of the IAA. A fundamental purpose of the IAA and other securities legislation enacted during the era was to substitute a philosophy of full disclosure for the philosophy of caveat emptor, and thus to achieve a high standard of business ethics in the securities industry. The Court’s conclusion: “Considering what had transpired between 1933 and 1940, the most reasonable assumption is that Congress, in enacting the Investment Advisers Act of 1940 and proscribing any practice which operates ‘as a fraud or deceit,’ deemed a specific proscription against nondisclosure surplusage.”
Thus, the fiduciary duty standard included the requirement to act in the best interest of the client, including the dual prongs of loyalty and care. Omitting to disclose that the investment adviser has a financial interest relating to the investment advice being given to clients is a no-no.
In contrast, Mr. Aguilar summed up the current legal regime on fiduciary duties owed by broker-dealers that provide investment advice as being non-existent. “In other words, broker-dealers are being permitted to end-run the Advisers Act. While brokers are required by current law to make certain disclosures about securities that are offered to investors, they are not required to make disclosures about certain of their own conflicts of interest. As a consequence, investors are susceptible to receiving tainted advice from broker-dealers and they will have no way of knowing that the advice was tainted by an undisclosed conflict,” he said.
At this point we should make a distinction between brokers, as in stock brokers, and broker-dealers, as in investment banks or other financial institutions that make markets in, assist in the creation of (e.g., underwrite), or otherwise advise sophisticated investors with respect to, securities transactions. The former is subject to a degree of fiduciary duties. The latter has been allowed to disclaim the fiduciary responsibility in written agreements with their clients/counterparties.
The result — because broker-dealers are not fiduciaries, they are not required to inform investors of possible conflicts that may affect the advice they receive. In other words, investors cannot trust that broker-dealers don’t have a financial interest that is in conflict (i.e., competing) with the advice that they are receiving from that broker-dealer. Of course, this problem could be solved simply by investors being conscious of this fact and as a result, asking their broker-dealer if they have a conflict. If the broker-dealer replies in the negative, this transforms the legal omission to a potential illegal misrepresentation. And to the contrary, if they answer in the affirmative, then the investor can make a better informed decision as the advice given.
In any event, should Congress be successful in legislating a fiduciary duty upon broker-dealers, the next question becomes one of enforceability because, in truth, legislation can’t stamp out the fire of immorality. The take-away is this: Don’t rely on Congress to ensure that you – the investor – are not being taken advantage of. Protect yourself.
If you would like to discuss any aspect of the fiduciary duty laws, contact Jeffrey Wittenberg at (877) 352-2010.