Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Tuesday, May 4, 2010

Amendment to Harmonize Broker-Dealer/Investment Adviser Regulation Will be Introduced in the Senate

Senators Menendez and Akaka plan to introduce an amendment (Download Menendez amendment) to the Senate's version of the financial reform legislation that will require the SEC to enact rules to provide that broker-dealers that offer personalized investment advice about securities to retail customers are subject to the same standard of conduct applicable to investment advisers.  However, the law would not require broker-dealers to have a continuing duty of care or loyalty to the customer after providing personalized investment advice.  In addition, an amendment to the Investment Advisers Act would provide that the standard of conduct for all brokers, dealers and investment advisers, when providing personalized investment advice about securities to retail customers, shall be "to act in the best interest of the customer without regard to the financial or other interest of the advice giver."  The receipt of compensation based on commission or other standard compensation for the sale of securities shall not, by itself, be considered a violation of the standard.  The section specifically provides that any material conflicts of interest must be disclosed and consented to in advance by the customer.  The SEC would have the authority to extend the standard to other customers as well.This amendment would replace the current language in the Senate bill that calls for the SEC to conduct a study. 

As I have discussed in a recent paper, there is a consensus that applying different standards of conduct for those who provide investment advice to retail customers makes no sense; the battle (and it is a fierce one) is what the common standard should be.  Unfortunately, the debate is generally framed as whether broker-dealers should be subject to a fiduciary duty as investment advisers are.  Framing the issue this way is an unfortunate simplication since it is based on two basic misunderstandings: (1) there is a clear understanding of what a fiduciary standard requires of investment advice providers, and (2) brokers do not currently owe their customers standards of care and loyalty. 

I argue in my paper that retail customers will benefit from improved protection if the law gave full effect to the existing professional standards of care and  competence (due diligence, suitability) recognized under SRO rules.  In addition, the disclosure rules with respect to conflicts of interest need to be strengthened; the boilerplate after-the-fact disclosure of possible conflicts of interest on confirmations is manifestly inadequate.  All this can be accomplished by the SEC through its existing rule-making authority without mention of the confusing amorphous "fiduciary duty" language.

Moreover, the Akaka/Menendez amendment has one serious deficiency -- it would not permit the SEC to adopt rules that would extend the broker's duties to the customer after the time of the transaction.  This reflects the current law that generally the broker's duty is transaction-specific and does not include monitoring the customer's portfolio.  However, many brokers sell their services to the customer on the basis of their ongoing attention to the customer's needs.  Where brokers represent that they are monitoring the account, they should be held to their word.

Finally, if Congress is serious about improving investor protections, it should adopt a federal private cause of action for negligent adviser advice.  Unless there is an explicit private federal remedy, brokers can recite the current law that there is no private cause of action for breach of SRO and SEC rules (apart from Rule 10b-5, which requires scienter), to limit their liability.  Fortunately, under SRO arbitration, arbitrators are not required to apply legal tests about the limits of implying private causes of action and frequently will allow customers to recover.  Whatever the deficiencies in manddatory SRO arbitration, this is its great benefit to investors.  However, if Congress determines that mandatory SRO arbitration should be prohibited, investors will be forced to bring their claims in either state or federal court, which will apply the current anti-investor law. There is nothing in the proposed legislation that would give investors any right to recover damages based on any SEC conduct rules adopted pursuant to this legislation.

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