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How the SEC and FINRA Can Strengthen the Fiduciary Standard Now

Posted by Duane Thompson on June 12, 2013 in Advocacy

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>>>>The Securities and Exchange Commission is awaiting public comment on its March 1 request for data involving the costs and benefits of adopting a uniform fiduciary standard for brokers and advisors.  Whether it eventually adopts a rule, after receiving clear authority from Congress three years ago to do so, remains open to question.    

In the meantime, the Commission could utilize its longstanding amicus program to bring important issues involving brokers and advisers before the courts now, similar to the Department of Labor’s active amicus program.  Unfortunately, the SEC has a poor track history in defending the fiduciary standard under securities laws.

As I have written previously in this blog, since 2001 the SEC has filed only one of 45 amicus briefs on a fiduciary issue.  In stark contrast, over the same time period the Department of Labor has filed 67 of its 316 “friend of the court” briefs on fiduciary conduct related to investment issues.  This amounts to one out of every five briefs, evidence of the DOL’s unflagging support for a strong common-law fiduciary standard under ERISA. 

It’s probably not for a want of cases that the SEC has not done so, even if binding arbitration has reduced the overall number in the courts.  However, one case in point, Remington v. Newbridge Securities Corporation, is a counterfactual example of what the SEC could accomplish if it considered the matter more closely.  In February of this year, plaintiffs filed a class action in the U.S. District Court for the Southern District of Florida in Fort Lauderdale, alleging that Newbridge, a broker-dealer, charged unauthorized and excessive handling fees for brokerage transactions.  The fees allegedly varied from $5.00 to $49.95 per trade.   Newbridge filed a motion to dismiss for failure to provide specific facts. 

Applying New York and Massachusetts law, U.S. District Judge James I. Cohn agreed with Newbridge on June 5, holding that the four counts -- breach of contract, breach of a duty of good faith and fair dealing, negligence, and conversion of client funds by wrongfully charging handling fees -- were insufficiently pleaded to support a claim for relief.  However, should the plaintiffs elect to do so by a June 21, 2013 deadline, the judge has allowed three of the counts to be re-filed in an amended complaint.  The remaining count, breach of the duty of good faith, was dismissed with prejudice, according to the Court, because under New York law a claim for breach of the implied covenant of good faith will fail if based on the same facts as a claim for a breach of contract.  

The count of negligence appears to hold out more promise for examining the appropriate standard of care, had the SEC or FINRA been interested in expressing its views on the duty of best execution.  This would not be a novel exercise, since both authorities have clearly stated in other forums that broker-dealers have a fiduciary duty of best execution.   In Remington, plaintiffs alleged that the broker-dealer negligently breached “its duty to act in the best interests of its customers” based on FINRA Rule 2430, which governs charges for services performed.  Rule 2430 provides that “Charges, if any, for services performed, including miscellaneous services such as collection of moneys due for principal, dividends, or interest; exchange or transfer of securities; appraisals, safe-keeping, or custody of securities, and other services, shall be reasonable and not unfairly discriminatory between customers.” 

Newbridge argued that the negligence count should be dismissed because FINRA rules do not create a private right of action, but the Court rejected that point as mischaracterizing the plaintiffs’ claim.  As pointed out by the plaintiffs, the Court said, in Merrill Lynch v. Cheng, 697 F. Sup. 1224 (D.D.C. 1988), a similar argument was rejected.  In Cheng, the Court noted that plaintiffs brought claims for negligence, breach of fiduciary duties, and fraud based on a violation of NASD suitability rules.  That court responded that, even if NASD rules did not provide for a private cause of action, the negligence claim was nonetheless properly brought because violation of the rule was not the question at hand, but simply a factor for consideration as to whether the broker “acted as a ‘reasonable person’ in his conduct.”   

In the instant case, Judge Cohn concluded that, “while there may not be a private right of action for violation of Rule 2430, Plaintiffs are not suing merely for a violation of Rule 2430.  Rather, they allege that Newbridge’s failure to comply with the rule is evidence that they breached their duty of care, which includes a duty to act in accordance with the standard of care used by other professionals in the community.”   Observing that Newbridge cited no case law to the contrary, Judge Cohn said the motion would be denied in this regard.  The negligence count instead was dismissed by the Court based on “a very sparse set of factual claims” submitted by the plaintiffs.

Given the SEC’s interest in considering a fiduciary standard for brokers today, one might think that a common duty of best execution for brokers and advisers would be a good starting point for shaping a fiduciary standard for both.  In 2001, FINRA’s predecessor, the NASD, affirmed that the duty of best execution by a broker-dealer “derives from common law agency principles and fiduciary obligations.1  The Commission, in turn, has long recognized a similar duty of best execution for investment advisers, citing various rules and guidance.2

Here, in Remington, the door was seemingly open for the SEC to advance the theory that excessive fees, even if contained in a supplementary handling charge, should be viewed in the same context as Cheng: not as a violation of SRO rules, but as a standard of care, in this case, addressing the question of whether the broker acted as a reasonable person in imposing ancillary transaction fees.

Certainly industry groups recognize the strategic importance of friend of the court briefs in shaping common law standards.  The American Medical Association, SIFMA, National Federation of Independent Business, U.S. Chamber of Congress, and others have active litigation and amicus programs.  Last year, in SIFMA’s annual year in review of its amicus program, Wall Street’s main trade group candidly stated that its amicus briefs “generally focus on cases where parties seek to expand legal theories, ease pleading standards, or tilt procedural rules in their favor, in a manner that would increase litigation risks and costs to our industry.”

The SEC actually invites the securities bar to bring cases to the attention of the General Counsel’s office, particularly when a case reaches the appellate level where precedent may be set in important matters of law.  The purpose of its amicus program, according to the SEC website, is “to offer its views on important securities law issues, rather than to support the interests of a specific party in a particular case.”  One of the criteria considered in determining whether a brief should be filed that appears to relate to fiduciary points of law is “whether the case raises issues important to the Commission’s ability to carry out its statutory objectives or other important securities law issues.”

In the scheme of things, the Remington court may be small potatoes when it comes to shaping a fiduciary standard for brokers.  Indeed, it may end with the current order if an amended complaint is not filed by the Court’s June 21 deadline.  However, it should not be the end of the story.  Seemingly obscure cases have arisen over the centuries to shape the common law of trusts – and securities and pension laws – sometimes in ways that can have a large and positive impact on the financial services industry and society as a whole.  There are very likely other cases out there with fiduciary implications.  It is up to the SEC to seize the moment, and find them, if it indeed has the same commitment to investor protection as the Department of Labor has to protecting retirement plan assets.



1 NASD Notice to Members 01-22, Best Execution: NASD Regulation Reiterates Member Firm Best Execution Obligations And Provides Guidance To Members Concerning Compliance, April 2001, 201.

2 See, e.g., Advisers Act Rule 206(3)-2(c) (acknowledging adviser’s duty of best execution of client transactions); and 2006 Soft Dollar Release, (stating that investment advisers have “best execution obligations”).

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