February 23, 2017


Of all the tempests in all the teapots of all the world, none perturbs me less than the fiduciary responsibility of securities brokers to the investing public. Whether broker-dealers and their registered representatives should be subjected to a fiduciary duty rule, generally through the SEC, or with respect to retirement accounts through the Department of Labor, is so academic to my litigator's eyes that they glaze over whenever it comes up. Now I hear the Trump administration has killed it. Really???

The fiduciary rule is stone-simple. Brokers providing investment advice need to put customers' interests ahead of their own and disclose how much they get paid to push the products they sell. This is a dog-bites-man story if ever there was. Why on earth DOL needed 1,000 pages of regulations to implement it is beyond me, and for that reason alone it's probably good to have been put out of its misery. But here's a truth: Across three decades of suing and defending brokers in customer cases, never once have I seen a broker avoid liability by claiming that he had no obligation to do right by his customer or that he didn't need to disclose conflicts. Those may be perfectly good legal defenses; it's just that they don't work in the real world. What difference does it make that a broker has no fiduciary duty as a matter of law if, when push comes to shove in an arbitration, it is forced upon him as a matter of practice? So don't believe the failing media -- the regulatory need for brokers to document compliance with a fiduciary rule may perhaps be dead, but brokers' fiduciary duty itself is very much alive.

However, I want to take this discussion in the opposite direction and ask, "Why should it be so?" It may be out of fashion these days, but I still like to look at the world as it really is rather than how I'd like it to be. Brokers are salesmen -- by talent, training and temperament. To expect salesmen to assume the fiduciary mantle of professional advisers is like trying to fit round pegs into square holes -- a fool's errand that we should abandon. Fiduciary duties should be imposed only on true investment advisers who are willing to be held to somewhat professional standards. Instead of trying to impose ill-fitting fiduciary duties on brokers, we should force brokers to tell customers the truth about what they do, so that customers can fairly know and be held to the limited remedies they should have against them. This may be a contrarian view-so much the better-but before you write me off as another Trumpian lunatic, hear me out.

When the federal securities laws were enacted there were broker-dealers and there were investment advisers. Broker-dealers earned commissions as agents or profits as principals in executing trades on the exchanges and over the counter, while advisers earned fees for counseling how investments should be chosen and portfolios managed. Brokers were paid as agents owing customers only contractual duties to execute their trades properly; as brokers their "advisory" role was unpaid and limited to letting customers know what available securities fit their investment criteria -- from which arose the original "suitability" standard. Advisers, on the other hand, gave investment advice and in doing so were obligated under the Investment Advisers Act of 1940 to act in the best interests of their customers -- in other words to act as professionals with related fiduciary obligations. 

But back then, only the rich had true advisers. The not-so-rich just had brokers, and they would come to ask their brokers which securities the broker thought the customer should choose.That's when the line between brokers and investment advisers started to blur. Should brokers who gave such "incidental investment advice" to customers have to register as full-fledged investment advisers? It was decided early on that they did not, and out of that original sin arose today's problem.

Back in the 40s and even into the 70s, brokers financially had the upper hand over investment advisers thanks to their regulated monopoly over access to the markets. Brokers then tended to be Ivy-League educated pillars-of-the-community types earning artificially fat commissions. But those days are long gone. Who has a mere "stockbroker" anymore? Now brokers are called something concocted by placing "financial," "investment," "asset," or "wealth" in front of "adviser," "consultant," "manager," or "representative"-any permutation will do except "investment adviser," which, still somewhat surprisingly, remains reserved for the real deal.

This resulted from the major firms' efforts to steal the professional aura of true investment advisers so as to fool the public into thinking they were getting comparable service from simple commissioned brokers. The major firms sought to cut into the business of investment advisers because after the deregulation of brokerage commissions mere brokerage became less profitable and advisory fees became where the money was. And it worked. Studies show that the investing public now has no idea what is the difference between a broker and an adviser, or what obligations are owed by one versus the other. Is it any surprise that brokers now face universal imposition of fiduciary duties as if they really were investment advisers?

And so, the broker-dealer community's success has come back to haunt it. What started on May Day has progressed to its logical capitalist conclusion, as competition, complexity and technology have reduced trade execution to a commoditized business having the thinnest of margins yet needing more and more expensive computer systems to support it. Stuck between an economic rock and a hard place, the brokerage business today can ill afford the regulatory overhead of having to document compliance with fiduciary duties to retail customers. So now, after having conned the investing public into seeing its commissioned brokers as the functional equals of investment advisers, the industry flees from the fiduciary burdens that come with being investment advisers-they talked the talk, but now they can't walk the walk. And this should not surprise anyone either.

Yet, the brokers do have a point.The cost of doing a business must remain in line with the profitability of that business. If it costs too much to be a broker there simply won't be any more brokers. Whether or not that would be a good thing for the planet, I'll leave to others. For now, however, here is my simple solution:brokers should go back to being brokers and stop pretending to be investment advisers. The line between broker and investment adviser should be restored. Indeed, the distinction between the two should be made clearer than ever to the investing public-etched in stone and illuminated in neon-so as to make investors more responsible for what happens in their accounts when they deal with brokers.

A radical idea? No, it isn't! A few weeks ago I went skiing. On the back of my lift ticket it said, in bold: 

The user of this ticket agrees that use of the ski area premises, including its lifts, trails, and other facilities, can be hazardous. Holder assumes all risks of injury arising out if its use. Holder further agrees that risks inherent to these mountain sports include but are not limited to changing snow, surface and weather conditions, bare spots, drainage bars, rocks, stumps, trees, whether or not they are marked and/or visible; collisions with natural objects, man-made objects, other skiers, slope vehicles, buildings and other structures, and variations in terrain, any of which may cause serious injury and/or death.

Which is to say if I crash into a tree while skiing to catch a forward pass, I have only myself to blame.

Doing business with a broker should carry the same kind of package warning. Something, perhaps, along the lines of:

Investing is an inherently dangerous activity. You could loss all your savings, all your retirement money, all your kids' college fund. You could end up broke, eating cat food for the rest of your life. You assume all risks of these things happening. You are dealing with a stockbroker -- no matter what we may be calling him or her. Your broker is ONLY responsible for executing trades on your behalf, following the instructions that YOU give him.Your broker does not ever control your account, no matter what you think, unless he executes trades that you did not authorize, and you agree that you absolutely and with no exception accept ALL trades in your account that you do not dispute within at most 90 days after receiving your monthly statement showing those trades. Your broker is NOT a professional investment advisor. Your broker doesn't know any more about how to invest your money than you, your brother-in-law, your barber or your bartender. Your broker is paid a commission whenever you trade, gets paid whether you make or lose money, and gets paid more with every trade you make. It is in your broker's interest for you to trade early and often. Your broker might even be paid extra by his firm or someone else for selling you securities that might not be in your best interest. In light of all that, you agree that you will not rely on any trade solicitations, financial advice, investment ideas, suggestions, opinions or gut instincts that your broker gives you, whether you ask him to or not. If you want to be able to hold someone responsible for bad investment advice, you must engage a real investment adviser, registered with the SEC, and preferably a Certified Financial Planner. Otherwise, proceed at your own risk, and don't be surprised to be reminded someday that a fool and his money are soon parted.

There, that should about do it.

We only kid ourselves if we think we solve anything by piling fiduciary obligations on brokers who are not investment advisers. Any broker with the inclination, intellect, temperament and moral fiber always to put their clients' interests first would already and willingly assume those fiduciary duties by being or becoming a full-fledged investment adviser without any prodding. We are much better off making sure investors understand what they are doing when they choose to deal with a broker rather than an adviser, and then make them live with the natural consequences of their choice. Then perhaps some modicum of common sense can be restored, at least to this quadrant of the regulatory cosmos.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento has also represented clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.