Brokers as fiduciaries

University of Pittsburgh Law Review

Volumn 71, Issue 3, 2010, Pages 439-456

  Langevoort, Donald C ^a  

^a GEORGETOWN UNIVERSITY LAW CENTER   (United States)

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EID: 77953280858     PISSN: 00419915     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (79)

1. See Press Release, Dep't of the Treasury, Fact Sheet Administration's Regulatory Reform Agenda Moves Forward Legislation for Strengthening Investor Protection Delivered to Capitol Hill, No.TG-205 (July 10,2009), available at httpy/ww.ustreas.gov/press/releases/tg205.htm.
2. The proposals were first articulated by the Treasury Department in its report entitled Financial Reoulatory Reform: ANew Foundation (May 2009), available at http://www.financialstability.gov/roadtostability/regulatoryreform. html.
3. In December, 2009, the House of Representatives passed a financial services bill (H.R. 4173) that included a modified version of the Administration's proposal on conforming broker-dealer and investment adviser obligations. See House Passes Broad Legislation to Reform Financial Services Sector, 41 Sec. Reg. & L. Rep. (BNA) 2253 (2009).
4. For other helpful discussions of this history, see Arthur B. Laby, Reforming the Regulation of Broker-Dealers and Investment Advisers, 65 Bus. Law. 2 (forthcoming 2010);
5. Barbara Black, Brokers and Advisers-What's in a Name?, 11 Fordham J.Corp.&Fin.L. 31 (2005);
6. see also sources cited infra note 10.
7. See RAND Corp., Investor and Industry Perspectives on Investment Advisers and Broker-Dealers Report (2008), available at http-yAvww.sec.gov/news/press/ 2008/2008-l-randiabdreport.pdf.
8. See Joel Seliogan, The Transformation of Wall Street 188-189 (3d ed. 2003).
9. SEC v. Capital Gains Res. Bureau, Inc., 375 U.S. 180,191 (1963).
10. See Certain Broker-Dealers Deemed Not to Be Investment Advisors, Exchange Act Release No. 51523, [2005 Transfer Binder] Fed. Sec. L. Rep. (CCH) 81,925, at 81,929-931 (Apr. 7,2005).
11. Rule 202(aXl 1)-1, adopted in Certain Broker-Dealers Deemed Not to Be Investment Advisors, supra note 7.
12. Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D.C. Cir. 2007).
13. See also Thomas v. Metro. Life Ins. Co., Fed Sec. L. Rep. (CCH) ¶ 95,344 (W.D. Okla. 2009) (finding the solely incidental standard applicable).
14. Three recent discussions are along similar lines to mine: One is a thoughtful discussion by Elisse Walter, Coramr, U.S. Sec. and Exch. Comm'n, Regulating Broker-Dealers and Investment Advisers: Demarcation or Harmonization? (May 5, 2009), available at http://www.sec.gov/news/speech/2009/spch050509ebw. htm. (For the somewhat different but also thoughtful views of Commissioner Luis Aguilar
15. see Luis Aguilar, U.S. Sec. and Exch. Comm'n, SEC's Oversight of the Adviser Industry Bolsters Investor Protection (May 7, 2009) available at httpy/www.sec.gov/news/speech/2009/spch0507091aa.htm.)
16. The second is Tamar Frankel, Fiduciary Duties of Broker-Advisers- Financial Planners and Money Managers (Boston Univ. Sen. of Law, Working Paper No. 09-36, 2009), available at www.ssrn.com/abstracts=1446750.
17. See also Laby, supra note 3.
18. Even though the Securities Exchange Act does not give the SEC plenary regulatory authority to set conduct standards for broker-dealers, it does have potent tools at its disposal. Most notably, Section 19(c) gives to the SEC the ability to amend the conduct rules of FINRA and other self-regulatory organizations on its own. In addition, Section 15(cX2)(D) of the Act gives the SEC the power to adopt rules to define "and prescribe means reasonably designed to prevent" broker-dealer fraud in the over the counter markets. For comments on the Chairman and CEO of FINRA on the subject, see Rick Ketchum, Chairman and CEO, FINRA, Remarks to the SIFMA Annual Meeting (Oct 27, 2009), available at http://events.sifma.org/uploadedFiles/Events/2009/annual/Ketchum- speech.pdf.
19. See Walter, supra note 10.
20. SEC v. Chenery Corp., 318 U.S. 80, 85 (1943) (Frankfurter, J., plurality opinion).
21. See Robert Cooter, The Fiduciary Relationship: Its Economic Character and Legal Consequences, 66 N.Y.U. L. Rev. 1045,1067 (1991).
22. For a discussion of this long-standing debate, see Kelli Alces, Debunking the Corporate Fiduciary Myth, 35 J. Corp. L. (forthcoming 2009).
23. E.g.,Tamar Frankel, Fiduciary Duties as Default Rules,74 Or. L. Rev. 1209(1995).
24. See Deborah DeMott, Beyond Metaphor: An Analysis of Fiduciary Obligation, 1988 duke L.J. 879.
25. See E.F. Hutten & Co., [1988-89 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 84,303 (SEC Admin. Proc. July 6,1988).
26. Newton v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 267 (3d Cir. 1998) (en banc).
27. E.g., Oeman v. SEC, 334 F.3d 1183 (10th Cir. 2003).
28. De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293 (2d Cir. 2002) (applying New York law).
29. Paine, Webber, Jackson & Curtis, Inc. v. Adams, 718 P.2d 508 (Colo. 1986).
30. See Seligman, supra note 5.
31. See Charles Hughes & Co. v. SEC, 139 F.2d 434 (2d Cir. 1943).
32. Norman S. Poser & James A. Fanto, Broker-Dealer Law and Regulation (4th ed. 2009).
33. While this body of law still has ample case law support, it is built on a fragile conceptual basis, because the implied representation is something of a fiction.
34. See Roberta S. Karmel Is the Shingle Theory Dead?, 52 Wash. & Lee L. Rev. 1271 (1995)
35. One other concern has to do with the broker's obligation to intervene when a customer decides on his or her own to undertake a risky trading strategy. Absent fiduciary characterization, the basis for a duty to warn in the absence of any recommendation is weak. For discussions of this problem.
36. see Frederick M. Gedicks, Suitability Claims and Purchases of Unrecommended Securities: An Agency Theory of Broker-Dealer Liability, 37 Ariz. St. L.J. 535 (2005);
37. Barbara Black & Jill L Gross, Economic Suicide: The Collision of Ethics and Risk in Securities Law, 64 U. Pitt. L. Rev. 483 (2003).
38. FINRA has recently undertaken to revse and codify its standards in this area. See Regulator Notice 09-25 (May 2009).
39. See Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc. 461 F. Supp. 951, 953 (E.D. Mich. 1978). For a more recent decision situating the duty to disclose in the half truth doctrine, see In re Credit Suisse First Boston Corp. Sec. Litig., [1998 Transfer Binder] Fed. Sec. L. Rep. (CCH) 90,306(S.D.N.Y. 1998).
40. E.g. Chasins v. Smith, Barney & Co., 438 F.2d 1167 (2d Cir. 1970).
41. See United States v. Skelly, 442 F.3d 94, 97 (2d Cir. 2006) ("[N]o SEC rule requires the registered representatives who deal with the customers to disclose their own compensation, whether pegged to a particular trade or otherwise.");
42. United States v. Alvarado, 2001 WL 1631396, *8 (S.D.N.Y. 2001) ("Neither the SEC nor NASD have required registered representatives of broker/dealers to disclose their own compensation in a securities transaction, although both have been fully aware that registered representatives often received special incentives beyond the normal compensation to sell a particular product").
43. Shivangi v. Dean Witter Reynolds, 825 F.2d 885 (5th Cir. 1987).
44. Compare In re Edward Jones & Co., Admin. Proc. 3-11780, Dec. 22, 2004 (joint action by SEC, the NASD, and the NYSE), with Hoffman v. UBS-AG, 591 F. Supp. 2d 522 (S.D.N.Y. 2008)
45. FINRA intends to fill this gap. See FINRA Notice 09-34, June 2009, available at http;//www.finra.org/web/groups/industiy/@ip/@reg/@notice/ documents/notices/pl19013.pdf (last visited Feb. 16,2010).
46. See Donald C. Langevoort, Selling Hope, Selling Risk: Some Lessons for Law from Behavioral Economics About Stockbrokers and Sophisticated Customers, 84 Cal. L. Rev. 627 (1996) [hereinafter Langevoort, Selling Hope);
47. see also Troy A. Paredes, Blinded by the Light: Information Overload and its Consequences for Securities Regulation, 81 Wash. U. L.Q. 417 (2003);
48. Jeff Schwartz, Reconceptualizing Investment Management Regulation, 16 Geo. Mason L. Rev. 521 (2009);
49. Lauren Willis, Against Financial Literacy Education, 94 Iowa L. Rev. 197 (2008).
50. John Beshears et al., How Does Simplified Disclosure Affect Individuals' Mutual Fund Choices?, (NBER Working Paper 14859, April 2009), available at www.nber.org/papers/wl4859.
51. E.g., Michael J. Cooper et al., Changing Names with Style: Mutual Fund Name Changes and their Effects on Fund Flows, 60 J. Fin. 2825 (2005);
52. Prem C. Jain & Joanna Sbuang Wu, Truth in Mutual Fund Advertising: Evidence on Future Performance and Fund Flows, 55 J. FIN. 937 (2000).
53. There is some psychological evidence to suggest that simply disclosing a conflict of interest may prompt more opportunism by the conflicted party and greater trust by the trusting party (the latter, presumably, because the trusting party considers the disclosure an act of candor).
54. See Daylian Cain et al., The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest, 34 J. legal stud. 1 (2005).
55. Whether this effect is truly robust in settings where consumers have the ability to sanction agents who overreach has been questioned. See Bryan Church & Xi (Jason) Kuang, Conflicts of Interest, Disclosure and (Costly) Sanctions: Experimental Evidence, 38 J. Leg. Stud. 505 (2009).
56. See Donald C. Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, 95 Va. L. Rev. 1025, 1048-1055 (2009).
57. See Daniel Bergstresser et al., Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry, 22 Rev. Fin. Stud. 4129 (2009).
58. See supra note 26.
59. See James D. Cox & John W. Payne, Mutual Fund Expense Disclosures: A Behavioral Perspective, 83 Wash. U. L.q. 907 (2005).
60. For an expression of doubt about the efficacy of disclosure of differential commissions in the insurance industry, see Daniel Schwarcz, Beyond Disclosure: The Case for Banning Contingent Commissions, 25 Yale L. & Pol'y Rev. 289 (2007).
61. Jill Fisch, Does Analyst Independence Sell Investors Short?, 55 UCLA L. Rev. 39 (2007).
62. Andrew Boni & Kent Womack, Wall Street Research: Will New Rules Change its Usefulness?, 59 Fin. Analysts J., No.3, May/June 2003, at 25.
63. See supra note 10.
64. See Wall Street's bruising musical chairs, http://blogs.ft.com/ gapperblog/2007/11/wall-streets-brhtml (Nov. 15, 2007) (comment to the Financial Times).
65. See Markus Brunnermeier & Stefan Nagel Hedge Funds and the Technology Bubble, 59 J. Fin. 2013 (2004).
66. See Andrew Lo, Hedge Funds, Systemic Risk and the Financial Crisis of 2007-2008, available at http://papers.ssm.com/sol3/papers.cfin?abstract-id= 1301217.
67. Andrew Lo et al., Fear and Greed in the Financial Markets: An Online Clinical Study, 95 Am. Econ. Rev. 352 (2005).
68. See NASD IM-2310-3, approved by the SEC pursuant to Exchange Act Rel. No., 36921, Mar. 14,1996 (proposed to be codified pursuant to FINRA Regulatory Notice 09-25 (May 2009)).
69. The institution can waive this upon satisfaction of certain conditions. On the debate over this issue, see Norman Poser, Liability of Broker-Dealers for Unsuitable Recommendations to Institutional Investors, 2001B YU. L. Rev. 1493.
70. Langevoort, Selling Hope, supra note 27.
71. Jerry Markham, Protecting the Institutional Investor-Jungle Predator or Shorn Lamb?, 12 Yale J. ReG. 345 (1995).
72. 132 F.3d 1017 (4th Or. 1997).
73. Professor Frankel argues that "sales talk" should be subject to fiduciary duties. See Frankel, supra note 10, at 16.
74. See Hanly v. SEC, 415 F.2d 589 (2d Cir. 1969).
75. James D. Cox et al., Securities Regulation : Cases and Materials 1034-1035 (6th ed. 2009).
76. See MacDonald v. Alan Bush Brokerage Co., 863 F.2d 809 (11thCir. 1989). Like so many other areas of broker-dealer liability law, the trend toward mandatory arbitration also truncates the doctrinal guidance that judicial decisions provide.
77. In re Worldcom Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N. Y. 2004) (rejecting argument that shelf registration due diligence is limited to what is practicable within a short amount of time).
78. Gustafson v. Alloyd Corp., 513 U.S. 561 (1994) (effectively limiting scope of section 12(aX2)-a negligence-based cause of action for sales of securities via false or misleading prospectuses and oral communications-to public offerings).
79. See Laby, supra note 3.