Can the use of a title – such as “financial planner” (or CFP) or “financial consultant” or “wealth manager” or “investment consultant” or similar – by the registered represent of a broker-dealer firm, and/or by an insurance agent, result in the application of fiduciary duties?
The short answer is “yes” (in many instances). The use of titles such as “wealth manager” or “financial consultant” or “financial planner” or “financial advisor” likely results in justifiable reliance by a consumer, resulting in fiduciary status under state common law – and (soon) under ERISA. The use of a title has been a key factor in many decisions applying fiduciary status under state common law. Under the recent proposed rule from the U.S. Department of Labor, this will likely now extend to determinations of fiduciary status under ERISA.
Ron A. Rhoades is the Principal and Financial Advisor of Scholar Financial, LLC. He also serves as Associate Professor of Finance in the Gordon Ford College of Business at Western Kentucky University, where he is Program Director for its Personal Financial Planning Program. Ron’s comments in this blog post are his own, and do not necessarily represent the views of any institution, organization, firm, gang or cult to which he currently belongs or has ever been kicked out of. Ron may be contact at: ron@scholarfinancial.com.
BACKGROUND: ERISA INCORPORATES STATE COMMON LAW
By way of (summary) explanation, in the latest development in the battles over the application of fiduciary standards to financial advice, the U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) on November 3, 2023 proposed its “Retirement Security Rule: Definition of an Investment Advice Fiduciary” rule. 88 Federal Register 75890.
This 2023 proposed rule follows on the heels of the decision of the Fifth Circuit U.S. Court of Appeals decision in 2018, in which the court concluded that “all relevant sources indicate that Congress codified the touchstone of common law fiduciary status — the parties’ underlying relationship of trust and confidence — and nothing in the statute ‘requires’ departing from the touchstone.” While I do not agree with this part of the decision, EBSA in its new rule proposal has sought to adhere to its dictates.
Under the EBSA’s 2023 proposed rule, there are three separate prongs for finding that fiduciary status attaches to a person who provides advice to a plan sponsor or plan participant in an ERISA-covered plan, and in connection with IRA rollovers. The second prong that could lead to the application of fiduciary status states: “The person either directly or indirectly (e.g., through or together with any affiliate) makes investment recommendations to investors on a regular basis as part of their business and the recommendation is provided under circumstances indicating that the recommendation is based on the particular needs or individual circumstances of the retirement investor and may be relied upon by the retirement investor as a basis for investment decisions that are in the retirement investor’s best interest.”
As EBSA stated in the preamble to the proposed rule, “The Department’s proposal is also
intended to be responsive to the Fifth Circuit’s emphasis on relationships of trust and confidence. The current proposal is much more narrowly tailored than the 2016 Final Rule, which treated as fiduciary advice, any compensated investment recommendation as long as it was directed to a specific retirement investor regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA. In contrast, the proposal provides that fiduciary status would attach only if compensated recommendations are made in certain specified contexts, each of which describes circumstances in which the retirement investor can reasonably place their trust and confidence in the advice provider.“
EBSA goes on to state: “In determining whether proposed [second prong] is satisfied, the
Department intends to examine the ways investment advice providers market themselves and describe their services. For example, some stakeholders have previously expressed concern that investment advice providers that adopt titles such as financial consultant, financial planner, and wealth manager, are holding themselves out as acting in positions of trust and confidence while simultaneously disclaiming status as an ERISA fiduciary. In the Department’s view, an investment advice provider’s use of such titles routinely involves holding themselves out as making investment recommendations that will be based on the particular needs or individual circumstances of the retirement investor and may be relied upon as a basis for investment decisions that are in the retirement investor’s best interest.”
Also in the preamble to the proposed rule, the “Department invites comments on the extent to which particular titles are commonly perceived to convey that the investment professional is providing individualized recommendations that may be relied upon as a basis for investment decisions in a retirement investor’s best interest (and if not, why such titles are used). The Department also requests comment on whether other types of conduct, communication, representation, and terms of engagement of investment advice providers should merit similar treatment.”
MY TESTIMONY (WITH CITATIONS TO AUTHORITY)
On Dec. 12, 2023, I was privileged to provide testimony to EBSA on the proposed rule. My testimony, along with citations (submitted via written comments to EBSA), follows.
REGARDING LIMITS ON CONSUMER CHOICE
First, the argument made by some panelists today that the DOL’s rule inappropriately limits “consumer choice” is a red herring. By their very nature fiduciary duties imposed by ERISA constrain conduct, and by doing so counter greed.
The U.S. Supreme Court, in the unanimous Hughes vs. Northwestern decision, clearly concluded that imprudent investments must be removed from defined contribution plans governed by ERISA.
Stated simply, bad choices have no place in retirement plan accounts. Defined contribution plan accounts benefit from economies of scale. And the academic evidence is clear – higher-cost products underperform, on average and over time, similar investments that have lower fees and costs. For example, I have never found an instance where a variable annuity, sold by a broker, survives a cost-benefit analysis.
Consumer choice is, and should be, limited under ERISA, to only the good choices.
RELATIONSHIPS OF TRUST AND CONFIDENCE: THE USE OF TITLES AND DESCRIPTION OF SERVICES
Second, while I do not agree with the 5th Circuit’s stretched statutory interpretations in defining “fiduciary,”[i] permit me to discuss the historic application of a “special relationship of trust and confidence.”
There are many cases under state common law which support the Department’s view that the use by securities brokers[ii] or by insurance producers of titles can support the application of fiduciary status.
Court decisions have found that the use of terms such as “financial advisor,”[iii] “financial consultant,” “financial planner,”[iv] “financial guide,”[v] “investment counselor,”[vi] “investment planner,”[vii] “estate planner,”[viii] or “expert,”[ix] lead to the justifiable repose of trust and confidence by a consumer.
The formation of a retirement plan[x] or investment plan,[xi] or an investment policy statement, or an estate plan, can also trigger the application of fiduciary status under common law.[xii]
The giving of “fiduciary warranties” also results in justifiable reliance leading to fiduciary status.[xiii]
I suggest that the Department expressly extend the proposed rule’s application to representations that are made by the firm, not just by an individual broker or insurance agent employed by a firm. The ways that financial firms describe their services today – and teach their financial consultants to utilize trust-based and relationship-based sales techniques – should lead to the imposition of fiduciary status.
The SEC, in its 1940 Annual Report, noted that a broker should not “disguise” himself or herself as a “confident and protector” but rather “must stand at arms length … openly as an adversary.”[xiv] I note that a stockbroker or insurance agent who states to a customer, either verbally, or in any written document, including Form CRS, that he or she is acting in the “best interests” of the customer, results in justifiable reliance by that customer, and fiduciary status should attach. To provide recommendations under the mantra of acting in a customer’s “best interests” – a phrase which over 10,000 judicial decisions in the United States have applied as equivalent to the fiduciary duty of loyalty – but then for that person or firm to disavow fiduciary status – is tantamount to actual fraud.
I find it disturbing that the very plaintiffs who secured the 5th Circuit’s opinion, which stressed the need for the Department to approach the application of fiduciary status by applying common law principles – are now opposed to being held accountable – as fiduciaries – when a relationship of trust and confidence exists.
RELATIONSHIPS OF TRUST AND CONFIDENCE: SALESPEOPLE HAVE HISTORICALLY BEEN FIDUCIARIES WHEN JUSTIFIABLE RELIANCE EXISTS
Third, some commentators on the DOL’s proposal have opined that salespeople – registered representatives and insurance producers – are “being turned into” fiduciaries, and that they are “historically distinct” from fiduciaries. Yet, legal history reveals the breadth of the application of fiduciary status upon financial services salespeople:
- By the early 1930’s, the fiduciary duties of brokers were already widely known under state common law,[xv] applying the common law of agency. [xvi]
- Judicial decisions from 1934[xvii] and 1935[xviii] applied fiduciary status upon brokers where a relationship of trust and confidence existed, applying state common law.
- While the vision has not yet been fulfilled, the 1934 Exchange Act was intended by President Franklin Roosevelt to impose fiduciary duties upon brokers.[xix]
- The Securities Markets Study of 1935 recognized that a broker “exercises, to some extent, the function of an investment counsel” and recommended that conflicts of interest be minimized.[xx]
- In 1940, FINRA – formerly NASD – concluded that brokers were fiduciaries to their customers.[xxi], stating that a broker “owest his customer or principal complete obedience, complete loyalty, and the exercise of his unbiased interest.” FINRA went on to state: “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.”
- In its 1940[xxii] and 1942 Annual Reports, the SEC discussed at length a series of cases in which brokers were found to be fiduciaries, and the SEC also noted that “the very function of furnishing investment counsel constitutes a fiduciary function.”[xxiii]
- Note also that the 1940 Advisers Act exempted brokers from registration as investment advisers; but this exemption did not negate the fiduciary status of brokers when they entered into relationships of trust and confidence.
- In the often-cited 1948 Arleen Hughes opinion, the SEC found that a broker-dealer was a fiduciary where she created a relationship of trust and confidence with her customers.[xxiv]
- The 1963 SEC Study on the capital markets also noted that brokers in relationships of trust and confidence with their customers were fiduciaries. The Study cautioned that brokers should not obscure the merchandising aspects of the retail securities business.[xxv]
ANNUITIZATION REQUIRES EXTENSIVE FINANCIAL PLANNING
Fourth, the rollover of an ERISA plan account or IRA account into an immediate fixed annuity – a decision of huge financial consequences which requires consideration of complex and inter-related financial planning issues – should be subject to fiduciary duties.[xxvi] This is just one example where one-time advice can easily require a great deal of financial planning spanning many hours of work and consultation.
SOPHISTICATED INVESTORS ARE VERY RARE
Fifth, I have advised hundreds of individual investors. I have never met one who I would regard as a sophisticated investor, with the ability to undertake the extensive due diligence required on today’s investment and insurance products.
PLAN SPONSORS NEED HELP
Sixth, I am aghast that an association representing the interests of U.S. corporations, who are plan sponsors, would oppose badly-needed protections for those plan sponsors. Large and mid-size businesses have been subject to many class action suits where a broker’s or insurance producer’s non-fiduciary status leaves the plan sponsor solely liable for the investment recommendations previously provided. That association’s views are opposite of the interests of the majority of its member firms.
FIDUCIARY ADVICE LOWERS FEES AND COSTS, AND IS WIDELY AVAILABLE TODAY
Seventh, reading between the lines of a prior panelist, the position he took was, essentially, that small investors could not be served except through selling highly expensive products to them. Yet the marketplace is full of low-cost fiduciary advice options for small investors today. It has been my experience that fiduciary advice is nearly always far more comprehensive, yet less expensive, than conflicted commission-based advice.
Also, realize that every commission could be replaced by a transparent fee paid directly by a consumer.
Many non-commissioned annuity products are coming onto the market today. There is no need for commissions, anymore.
As the SEC’s 2008 RAND study revealed, most customers of brokers and insurance producers have no idea how much they pay. I wish I could do an objective, independent analysis of the products sold to that customer who testified earlier today.
INVESTMENT ADVICE TRIGGERS FIDUCIARY STATUS
Eighth, some commentors may opine that fiduciary duties don’t apply to “advice” and rather only apply to where a fiduciary controls or manages assets. Yet such a statement is blindly incorrect. There has long been recognition that the provision of advice may result in a fiduciary relationship where a relationship of trust and confidence exists.[xxvii]
Lastly, who is going to pay for the billions of dollars consumers will lose if this rule does not go forward. I urge the Department to strengthen and finalize the proposal.
Thank you for the opportunity to testify.
[i] “The ERISA definition of fiduciary is broad, extending well beyond the concept of trustee in trust law and generally further than the scope of individuals who owe fiduciary duties to third parties under the common law. Both ERISA (Title I) and the Internal Revenue Code (Title II) define ‘fiduciary’ in the same way. In Title I, fiduciaries are subject to comprehensive DOL regulation, while in Title II individual plans, they are subject to the prohibited transactions provisions.” West’s Key Number Digest, Labor and Employment, 461.
The 5th Circuit opined on “one out of three provisions explaining the scope of fiduciary responsibility under ERISA and the Internal Revenue Code. The second of these three provisions states that ‘a person is a fiduciary with respect to a plan to the extent . . . he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so[.]’” In my view, Congress supplied the scope of the application of fiduciary duties by clear, unambiguous language; Congress could have but did not require that a “special relationship of trust and confidence” existed. Congress, through its multiple-prong test for applicability of fiduciary duties under ERISA, provided the “other indication” which the 5th Circuit ignored. The 5th Circuit appeared to conflate the scope of application of fiduciary duties with the need to look to the law of trusts to determine the “contours of an ERISA fiduciary’s duty.” The 5th Circuit cited these cases, incorrectly:
- Kennedy v. Plan Adm’r for DuPont Sav. & Inv. Plan, 555 U.S. 285, 294–96 (2009) involves not whether ERISA fiduciary duties applied to the situation presented in the case, but rather the interpretation of the how fiduciary duties are applied, specifically the anti-assignment provision of ERISA. Justice Souter stated that “the law of trusts …. serves as ERISA’s backdrop” – citing Beck v. PACE Int’l Union, 551 U. S. 96, 101 (2007), a case which required the Court to “delve into the statutes provisions for plan termination” – again, the interpretation of how fiduciary duties are applied (in this instance, the construction of the statutory language involving how ERISA plans are terminated).
- Aetna Health Inc. v. Davila, 542 U.S. 200, 218–19 (2004) is more relevant. Justice Scalia wrote: “At common law, fiduciary duties characteristically attach to decisions about managing assets and distributing property to beneficiaries. Pegram, supra, at 231; cf. 2A A. Scott & W. Fratcher, Law of Trusts §§182, 183 (4th ed. 1987); G. Bogert & G. Bogert, Law of Trusts & Trustees §541 (rev. 2d ed. 1993). Hence, a benefit determination is part and parcel of the ordinary fiduciary responsibilities connected to the administration of a plan. See Varity Corp. v. Howe, 516 U. S. 489, 512 (1996) (relevant plan fiduciaries owe a fiduciary duty with respect to the interpretation of plan documents and the payment of claims).” (Emphasis added.)
- Pegram v. Herdrich, 530 U.S. 211, 223–24 (2000), which addressed not whether ERISA applied, but rather how fiduciary duties were applied under ERISA, with Justice Souter stating:
In general terms, fiduciary responsibility under ERISA is simply stated. The statute provides that fiduciaries shall discharge their duties with respect to a plan “solely in the interest of the participants and beneficiaries,” §1104(a)(1), that is, “for the exclusive purpose of (i) providing benefits to participants and their beneficiaries; and (ii) defraying reasonable expenses of administering the plan,” §1104(a)(1)(A). These responsibilities imposed by ERISA have the familiar ring of their source in the common law of trusts. See Central States, Southeast & Southwest Areas Pension Fund v. Central Transport, Inc., 472 U. S. 559, 570 (1985) (‘[R]ather than explicitly enumerating all of the powers and duties of trustees and other fiduciaries, Congress invoked the common law of trusts to define the general scope of their authority and responsibility’). Thus, the common law (understood as including what were once the distinct rules of equity) charges fiduciaries with a duty of loyalty to guarantee beneficiaries’ interests: ‘The most fundamental duty owed by the trustee to the beneficiaries of the trust is the duty of loyalty…. It is the duty of a trustee to administer the trust solely in the interest of the beneficiaries.’ 2A A. Scott & W. Fratcher, Trusts §170, 311 (4th ed. 1987) (hereinafter Scott); see also G. Bogert & G. Bogert, Law of Trusts and Trustees §543 (rev. 2d ed. 1980) (“Perhaps the most fundamental duty of a trustee is that he must display throughout the administration of the trust complete loyalty to the interests of the beneficiary and must exclude all selfish interest and all consideration of the interests of third persons”); Central States, supra, at 570–571; Meinhard v. Salmon, 249 N. Y. 458, 464, 164 N. E. 545, 546 (1928) (Cardozo, J.) (“Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior”).
- Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 110 (1989), which again addressed how ERISA applied its fiduciary duties, rather than whether ERISA applied to the situation at hand, with the Court stating:
ERISA abounds with the language and terminology of trust law. See, e. g., 29 U. S. C. §§ 1002(7) (“participant”), 1002(8) (“beneficiary”), 1002(21)(A) (“fiduciary”), 1103(a) (“trustee”), 1104 (“fiduciary duties”). ERISA’s legislative history confirms that the Act’s fiduciary responsibility provisions, 29 U. S. C. §§ 1101-1114, “codif[y] and mak[e] applicable to [ERISA] fiduciaries certain principles developed in the evolution of the law of trusts.” H. R. Rep. No. 93-533, p. 11 (1973). Given this language and history, we have held that courts are to develop a “federal common law of rights and obligations under ERISA-regulated plans.” Pilot Life Ins. Co. v. Dedeaux, supra, at 56. See also Franchise Tax Board v. Construction Laborers Vacation Trust, 463 U. S. 1, 24, n. 26 (1983) (” ‘[A] body of Federal substantive law will be developed by the courts to deal with issues involving rights and obligations under private welfare and pension plans’”) (quoting 129 Cong. Rec. 29942 (1974) (remarks of Sen. Javits)). In determining the appropriate standard of review for actions under § 1132(a)(1)(B), we are guided by principles of trust law. Central States, Southeast and Southwest Areas Pension Fund v. Central Transport, Inc., 472 U. S. 559, 570 (1985).
[ii] The application of fiduciary standards of conduct to the personalized investment advisory activities of brokers is nothing new. It preceded the enactment of the Securities Exchange Act of 1934 and continued thereafter. Moreover, the Investment Advisers Act of 1940 never stated that brokers were not fiduciaries; it only provided an exemption from registration as an investment adviser.
[iii] “In the fall of 1985, plaintiff, having recently divorced and relocated to Columbus, Ohio, sought investment advice from Thomas J. Rosser. At the time, Rosser was a licensed salesman for Great Lakes Securities Company and held himself out as a financial advisor … [T]he evidence established that Rosser was a licensed stockbroker and held himself out as a financial advisor, and that plaintiff was an unsophisticated investor who sought investment advice from Rosser precisely because of his alleged expertise as a broker and investment advisor. Further, Rosser testified that plaintiff had relied upon his experience, knowledge, and expertise in seeking his advice. Therefore, we conclude that plaintiff presented sufficient evidence to establish that she and Rosser were in a fiduciary relationship.” Mathias v. Rosser, 2002 OH 2531 (OHCA, 2002). The court further noted, that under Ohio law, a fiduciary relationship is “a relationship in which one party to the relationship places a special confidence and trust in the integrity and fidelity of the other party to the relationship, and there is a resulting position of superiority or influence, acquired by virtue of the special trust.” Id.
In another judicial decision, a dual registrant crossed the line in “holding out” as a financial advisor, and in stating that ongoing advice would be provided, and other representations, and in so doing the dual registrant, who sold a variable annuity, and was found to have formed a relationship of trust and confidence with the customers to which fiduciary status attached. “Obviously, when a person such as Hutton is acting as a financial advisor, that role extends well beyond a simple arms’-length business transaction. An unsophisticated investor is necessarily entrusting his funds to one who is representing that he will place the funds in a suitable investment and manage the funds appropriately for the benefit of his investor/entrustor. The relationship goes well beyond a traditional arms’-length business transaction that provides ‘mutual benefit’ for both parties.” Western Reserve Life Assurance Company of Ohio vs. Graben, No. 2-05-328-CV (Tex. App. 6/28/2007) (Tex. App., 2007).
[iv] A U.S. District Court in 1985 held that a fiduciary relationship existed in part because of a defendant’s status as financial planner to a client. In Koehler v. Pulvers, 614 F. Supp. 829 (USDC, Cal, 1985) the defendant, CSCC, was primarily in the business of real estate syndication, but also in business under the name Creative Financial Planning. As stated in the decision, “The developer defendants obtained investment capital from the public by posing as financial planners … The financial planners typically had a background in either insurance or real estate sales … As an alleged financial planning company, CSCC, dba Creative Financial Planners, contacted potential investors by conducting Creative Financial Planning seminars open to the public. Utilizing a slick presentation… CSCC attempted to lure investment capital out of savings accounts, home equity, insurance policies, and other conservative investment vehicles and into the speculative real estate ventures it controlled … At the seminars, CSCC offered to draft a ‘Coordinated Financial Plan’ for attendees at little or no charge. Individuals who accepted this offer received recommendations to purchase limited partnership or trust deed interests in CSCC controlled partnerships and project ….” The court also noted, “Most of the plaintiffs are and were unsophisticated investors. Few had a preexisting relationship with the developer defendants at the time they purchased their securities … [the investors] relied upon the misrepresentations discussed in detail below. This reliance was reasonable in part because of the developer defendants’ purported disinterested financial planner status.”
[v] “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).
[vi] Insurance agents who introduced themselves as “investment counselors or enrollers” and who tailored retirement plans for each person depending on the individual’s financial position, and who led the customers to believe that an investment plan was being drafted for each customer according to each customer’s needs, was held by a federal court, apply Iowa state common law, to lead to the possible imposition of fiduciary status. Cunningham vs. PLI Life Insurance Company, 42 F.Supp.2d 872 (1990).
[vii] When a bank held out as either an “investment planner,” “financial planner,” or “financial advisor,” the Wisconsin Supreme Court held that a fiduciary duty may arise in such circumstances. Hatleberg v. Norwest Bank Wisconsin, 2005 WI 109, 700 N.W.2d 15 (WI, 2005).
[viii] In a case arising from Oregon, a self-employed insurance seller and licensed financial planner took advantage of his position as a financial advisor to gain the trust of an 87-year-old man, Stubbs, convincing the elderly man to grant him a power of attorney, with which the financial planner stole about $400,000. The court held that the licensed financial planner was employed as a fiduciary, specifically noting that the elderly man relied upon the fiduciary as a financial advisor and estate planner. U.S. v. Williams, 441 F.3d 716, 724 (9th Cir. 2006).
[ix] 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”).
[x] See, e.g., Hanick v. Ferrar, 161 N.E. 3rd 1 (Ohio 7th Dist. Ct. of Appeals (2020) (“Ferrara also disclosed at deposition that he lectured Appellant about spending money on her friend. He even told her that if she continued to run through her money in this manner he could no longer ‘in good faith’ be her agent, suggesting he occupied a position akin to a financial adviser … There was a genuine issue of material fact as to the existence of a fiduciary relationship.”)
[xi] Insurance agents who introduced themselves as “investment counselors or enrollers” and who tailored retirement plans for each person depending on the individual’s financial position, and who led the customers to believe that an investment plan was being drafted for each customer according to each customer’s needs, was held by a federal court, apply Iowa state common law, to lead to the possible imposition of fiduciary status. Cunningham vs. PLI Life Insurance Company, 42 F.Supp.2d 872 (1990).
[xii] In Koehler v. Pulvers, 614 F. Supp. 829 (USDC, Cal, 1985) the defendant, CSCC, was primarily in the business of real estate syndication, but also in business under the name Creative Financial Planning. As stated in the decision, “The developer defendants obtained investment capital from the public by posing as financial planners … The financial planners typically had a background in either insurance or real estate sales … As an alleged financial planning company, CSCC, dba Creative Financial Planners, contacted potential investors by conducting Creative Financial Planning seminars open to the public. Utilizing a slick presentation… CSCC attempted to lure investment capital out of savings accounts, home equity, insurance policies, and other conservative investment vehicles and into the speculative real estate ventures it controlled … At the seminars, CSCC offered to draft a ‘Coordinated Financial Plan’ for attendees at little or no charge. Individuals who accepted this offer received recommendations to purchase limited partnership or trust deed interests in CSCC controlled partnerships and project ….” The court also noted, “Most of the plaintiffs are and were unsophisticated investors. Few had a preexisting relationship with the developer defendants at the time they purchased their securities … [the investors] relied upon the misrepresentations discussed in detail below. This reliance was reasonable in part because of the developer defendants’ purported disinterested financial planner status.”
[xiii] “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.” James J. Angel, Ph.D., CFA and Douglas McCabe Ph.D., “Ethical Standards for Stockbrokers: Fiduciary or Suitability?” (Sept. 30, 2010). Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686756.
[xiv] 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.
[xv] By the early 1930’s, the fiduciary duties of brokers (as opposed to dealers[xv]) 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.
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).
[xvi] 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. 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.”).
[xvii] In the 1934 case of Birch v. Arnold, 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. [Emphasis added.]
Birch v. Arnold, 88 Mass. 125; 192 N.E. 591; 1934 Mass. LEXIS 1249 (Mass. 1934).
[xviii] 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).
[xix] “Roosevelt and Congress used the 1934 Exchange Act to raise the standard of professional conduct in the securities industry from the standardless principle of caveat emptor to a ‘clearer understanding of the ancient truth’ that brokers managing ‘other people’s money’ should be subject to professional trustee duties.” 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, Entrepreneurial Bus. Law. J. (2010), at p. 20, citing Steven A. Ramirez, The Professional Obligations of Securities Brokers Under Federal Law: An Antidote for Bubbles?, 70 U. Cin. L. Rev. 527 (2002), at p. 534 (quoting H.R. Rep. No. 73-85, at 1-2 (1933)).
[xx] The Securities Markets study, in fact, recognized that a broker “exercises, to some extent, the function of an investment counsel” and recommended that “a condition should be created where the conflict of interest between broker and customer is reduced to a minimum.”
In essence, the Securities Market study recommended that brokers be held to the “best interests” fiduciary standard of conduct, with conflicts of interest minimized. Also, the study recommended the separation of brokers and dealers (who deal in their own securities, or who sell offerings of securities firms in initial or subsequent public offerings).
The Securities Market study also, in essence, recommended that investment counsel be held to the “sole interests” fiduciary standard in which avoidance of all conflicts of interest was required. Additionally, no “dual registration” (as exists today) as both a broker (or dealer) and investment adviser (“investment counsel” in 1935) would be permitted, given the insidious conflicts of interest under such affiliations.
[xxi] In an opinion issued by this self-regulatory organization for broker-dealers, in only its second newsletter to members, the NASD unequivocally 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.” The Bulletin, published by the National Association of Securities Dealers, Volume I, Number 2 (June 22, 1940).
[xxii] “In some of these cases, including Commonwealth Securities, Inc. and Securities Distributors Corporation, the registered broker ordealer had attempted to avoid fiduciary responsibility by use of wordson the confirmation intend to indicate that in the particular transactionit had not acted in a fiduciary capacity, but, in such cases,the Commission held that the form of confirmation could not alterthe fiduciary character of the relationship where this was clearlyestablished from the other facts and circumstances surrounding thetransaction.” Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158.
[xxiii] 1942 SEC Annual Report, p. 15, referring to In the Matter of Willlam J. Stelmack Corporation, Securities Exchange Act Releases 2992 and 3254.
[xxiv] 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);
[xxv] 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.
[xxvi] Federation of Americans for Consumer Choice, Inc. vs. DOL, 2023 WL 5682411, U.S.D.C. N.D. Texas (June 30, 2023), stating: “[A]s another court has noted, ‘[n]othing in the phrase ‘renders investment advice’ suggests that the statute applies only to advice provided ‘on a regular basis.’ ’ Nat’l Ass’n for Fixed Annuities v. Perez, 217 F. Supp. 3d 1, 23 (D.D.C. 2016). Indeed, ERISA expressly authorizes the DOL to impose fiduciary duties on those who provide recommendations concerning Title I assets, if that investment advice is given ‘for a fee or other compensation.’ While a regular, ongoing relationship may be indicative of one based in confidence and trust, the length of the relationship itself is not dispositive of whether the recommendation is investment advice … First-time advice may be sufficient to confer fiduciary status and is consistent with ERISA … ERISA does not include a regular basis requirement.”
[xxvii] 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)]. Arthur C. Laby, Fiduciary Obligation of Broker-Dealers and Investment Advisers, 55 Vill.L.R. 701, 714 (2010). See also, 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).
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