District Court Says "Prospective" IAs Owe No Fiduciary Duty
Commentary by Jeff Ziesman
A US District Court granted summary judgment to a brokerage firm, finding that no fiduciary duty was owed to the plaintiff class because the firm "was not acting as either a broker-dealer or investment adviser, but rather as a prospective investment adviser."
Before the District Court for the Eastern District of California, the plaintiffs alleged that the firm failed to conduct proper suitability assessments before encouraging them to switch from commission-based accounts to a "flat annual management fee" account model. Plaintiffs claimed this resulted in higher fees and argued that the firm breached its fiduciary duty under California and Missouri law. The plaintiffs contended that the firm violated FINRA rules and the Investment Advisers Act by recommending accounts that were inappropriate for "buy and hold" investors like themselves.
The Court found, however, that the firm was acting as a prospective investment adviser when recommending the advisory accounts, and therefore did not owe the plaintiffs a fiduciary duty at that time. The Court stated that "a fiduciary duty [under the] IAA does not apply" until a client relationship is formally established.
The Court rejected the plaintiffs' claims that the mere increase in fees constituted a breach, finding that the advisory accounts were appropriately recommended based on the plaintiffs' investment profiles. In granting summary judgment, the Court dismissed all claims.
Commentary
This case stands for the commonsense proposition that an advisory relationship must be actually established before any fiduciary obligation will be created. Presumably, this requires both an intent to enter into a formal legal relationship, and the actual signing of an investment management agreement (or equivalent). Also of note is the Court's finding that a mere increase in fees, will not, standing alone, constitute a breach of obligation. To the contrary, to be successful, a plaintiff must present additional facts showing that the fiduciary standard was not met.