In an article recently published, Larry Landsman, partner of Block & Landsman, discusses major reform that is coming to the rules governing the broker-investor relationship. On July 21, 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in response to the 2008 financial meltdown in the U.S. economy. Among the many challenges the statute is intended to address are long-simmering battles concerning the relationship between brokers, broker-dealers and their customers. After protracted clashes between investor advocates and industry representatives, the Dodd-Frank Act has authorized the SEC to engage in rule-making that will overhaul the securities laws in ways long sought by investors.
Soon brokers will be held to higher standards of care toward their clients, and investors will have access to greater protections where brokers have breached their standards of care.
This post will address the revised standard of care they brokers may be held to. In a later post, I will explore the changes expected in the arbitration proceedings used when an investor has a claim of wrongdoing against a broker. In both instances, the changes will offer greater protections to the investor against historical abuses that have been hotly disputed for years.
1. Brokers' Owe Limited Standard of Care to Investors
Under current law, brokers are required to adhere to relatively lax standards of care as compared to investment advisors whose conduct is governed by the Investment Advisors Act of 1940. Brokers, who are regulated by the Financial Industry Regulatory Authority ("FINRA") are required only to recommend investments that are "suitable," meaning that a broker need only have a reasonable basis to recommend the security in light of the client's investment objectives and financial circumstances. Investment advisers, on the other hand, must abide by a more stringent fiduciary standard of care which mandates a duty of loyalty and obligates them to act only in the best interests of their clients. The principal distinction is that brokers need not put the clients' interests ahead of their own, while an investment adviser must. The Dodd-Frank Act is poised to eliminate this difference.
From the investor's perspective, it is difficult to discern that the "advice" given by brokers is held to a lesser standard than that given by investment advisers. In a 2008 study commissioned by the SEC, the Rand Corporation found that the roles of brokers and investment advisers are confusing to investors, who are not clear about their respective legal duties. Indeed, a majority of participants erroneously believed that both brokers and investment advisers were required by law to act in the client's best interest and to disclose any conflicts of interest. The study found that investors were confused on key distinctions between investment advisers and brokers -- their duties, the titles they use (brokers often designate themselves as "financial consultants" or "financial advisors") or the services they offer.
2. The SEC Is Poised To Add Necessary Investor Protections
The difference in these standards of care has a significant impact on investors. The obvious effect is in the propriety of the securities in an investor's portfolio -- whether or not thy were selected in the bests interests of the client. Fortunately for the investor, the confusion regarding the scope of a broker's duties may soon be eliminated. The Dodd-Frank Act empowered the SEC to determine the existence of, and correct, any deficiencies in the broker's standard of care as compared to the fiduciary duty governing investment advisers' conduct. Indicates are that the SEC will do just that. The Rand report mentioned above found that current securities laws and regulations are based on distinctions between brokers and investment advisers that date back to the early 20th century, "and that these distinctions appear to be eroding today."
Additionally, the Chairperson of the SEC, Mary Schapiro, recently recognized that "investors who turn to a financial professional often do not realize there's a difference between a broker and an adviser -- and that the investor can be treated differently based on who they're getting their investment advise from." Ms. Schapiro further advocated that the only duty owed to investors flow "from the perspective of the investor we are seeking to protect" rather than "from the perspective and legal regimes of the adviser or broker." Given this background, Ms. Schapiro has advocated a uniform fiduciary standard and is "pleased" that the new legislation gives the SEC the authority to implement it.
While the SEC Chairperson's position does not constitute an official decision by the Commission, it is apparent that there is clear support to equalize the standards of care of brokers and investment advisers, and rules achieving that goal can be expected to be implemented. Such a result will provide significant protections to investors by making their interests the controlling concern for any financial adviser.
In my next post, I'll discuss the changes we can expect in the arbitration process when investors believe their brokers engage in misconduct.
The investment fraud lawyers at Block & Landsman concentrate their practice in the area of securities arbitration and securities litigation. Please visit their website for additional information.
