Broker-Dealers, Fiduciary Duties and Enhanced Conduct Standards Under the Financial Reform Act

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I. Introduction

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”)1 passed by Congress on July 15, 2010 is the culmination of years of debate and negotiation over the scope of reform in the financial services industry. Among the most contentious topics debated in Congress was the call to adopt a uniform and enhanced fiduciary standard to be applied to all relationships between broker dealers and their retail clients.

Section 913 of the Act authorizes the United States Securities and Exchange Commission (“SEC”) to conduct a study that permits the SEC to adopt rules imposing the same fiduciary standard of care on broker-dealers who provide “personalized investment advice” as is currently required of investment advisers under the Investment Advisers Act of 1940.2 The most likely long-term result will be the imposition of a fiduciary duty on brokers (who recommend transactions to customers) that mirrors the current suitability framework already in place. The Act is notable because it provides that this fiduciary duty ceases once the transaction is complete; thus, a broker-dealer in a non-advisory relationship does not have a continuing duty of care and loyalty after providing personalized investment advice to a customer. This paper will examine the current law governing broker dealers, the likely impact the Act will have on future relationships with retail customers, and the potential compliance and supervisory issues that will arise from the new standards.

II. Current Fiduciary Standards for Broker-Dealers and Advisers

The current regulatory regime differentiates between investment advisers subject to fiduciary duties under the Investment Advisers Act of 1940 (“Advisers Act”) and broker-dealers who do not receive fee based compensation.3 Investment advisers—those engaged in the primarybusiness of providing investment advice, research, or analysis in exchange for compensation4 —must comply with Section 206 of the Advisers Act, a general antifraud provision, which the Supreme Court has held creates a general fiduciary duty owed by investment advisers to their clients.5 An investment adviser’s fiduciary duty of “utmost good faith, and full and fair disclosure of all material facts”6 includes a duty of loyalty “to act with the highest degree of honesty and loyalty toward another person, and in the best interests of the other person”7 and to avoid potential conflicts of interest. Thus, investment advisers are prohibited from engaging in principal transactions without express consent8 and from receiving capital gains-based compensation.9 This is a public fiduciary duty whose violation may be prosecuted by the SEC but would not give rise to a private cause of action.10

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