Massachusetts Court Says Broker-Dealers Can Be Held to Fiduciary Standard
Commentary by Steven Lofchie
The Massachusetts Supreme Judicial Court held that the Secretary of State could reasonably adopt a new rule under state law that holds broker-dealers to a fiduciary standard when making recommendations to customers.
According to the decision by the highest appellate court in Massachusetts, the Secretary of State had the authority to conclude that "the fiduciary duty rule best ensured that [state securities law] protections aligned with investors' expectations in the evolving investment landscape." The Massachusetts fiduciary duty rule deems it dishonest for a broker-dealer to "fail to act in accordance with a fiduciary duty to a customer when providing investment advice or recommending an investment strategy, the opening of or transferring of assets to any type of account, or the purchase, sale, or exchange of any security." On the basis of that rule, the Secretary of State had charged Robinhood Financial with improper conduct.
Robinhood Financial challenged the Secretary's rulemaking as going beyond his authority under the relevant statute. A Massachusetts Superior Court found that the Secretary did not have authority to promulgate a new rule expanding the duties to which broker-dealers were subject. On appeal, the Supreme Judicial Court determined that because of changes in the brokerage industry, such as the development of payment for order flow, the Secretary acted reasonably in imposing a greater duty on broker-dealers than had historically been the case. The Court also held that the Massachusetts rulemaking was not preempted by federal law, (i.e. Regulation Best Interest.)
Commentary
This decision raises troubling questions. Here are two big ones:
- what acts by a broker dealer trigger the "fiduciary" standard imposed by the Massachusetts rulemaking; and
- what would a broker-dealer have to do to meet the fiduciary standard?
The appellate decision quotes the Secretary of State declaring that: "[t]here is no room for 'you get what you pay for' when it comes to the quality and integrity of investment advice . . . [The fiduciary duty rule would] enhance[] the quality of advice in the transactional, episodic brokerage model without imposing any new ongoing obligations upon those providing it." at p17.
This statement simply ignores the trade-offs that are inherent in any business or regulatory requirement. Further, the new regulation applies additional obligations. It would be better to state plainly what those new obligations are and to provide a roadmap as to how they can be satisfied, if in fact they can be.
The statement that it can not be sufficient to get what you pay for is a political statement, not an economic statement. Companies that stay in business cannot give you more than you pay for. It should be obvious that a broker-dealer that only charges a few cents a trade, or only makes money on payment for order flow, does not make sufficient revenue to undertake a detailed analysis of its customers' financial situation sufficient to allow the broker-dealer to act as an investment adviser. Accordingly, two potential consequences follow from this:
- the broker-dealer must stop providing any information that could be deemed a recommendation (what information would be permissible?); or
- the broker-dealer must charge the customer substantially higher fees, which is to say advisory fees, that compensate the broker-dealer for acting as a fiduciary.
It is certainly possible to have a securities brokerage system for retail customers that operates under those two paradigms: Customers either get no information or they pay higher fees. But regulators should acknowledge that those paradigms squeeze some people out; i.e., they do not have enough money to pay the higher fees. The consequence is that these retail customers will either disengage from the securities markets or trade without any information provided by a broker, or they will get their information from the Internet. If regulators would simply acknowledge that imposing substantial obligations is not cost-free, then it would be possible to have a balanced conversation as to how brokers can best serve retail investors. For more on this, see: Choose One: Best Interest or Full Service.