Tuesday, January 14, 2014

The SEC's Failures, the Fiduciary Standard, and the Role of a Fiduciary Oath for Consumers and Professionals

“[W]hen the freedom they wished for most was freedom from responsibility then Athens ceased to be free.” – Edward Gibbon, The Decline and Fall of the Roman Empire

There was a time. There will be a time. But, sadly, that time is not now.

Integrity. Trust. Fiduciary. These words have, throughout history, possessed meaning. As applied to financial and investment advisors, these words define whom advisors might be, the confidence placed in advisors by their clients, and the status as a loyal, candid and honest servant, expert, and steward.

Yet, government – left in charge of these words – has and continues to subject these concepts to compromises. Unnecessary compromises. Dilution has occurred to such an extent that the very core of the concepts expressed by these words – the ability to trust one’s advisor – is eviscerated, leaving nothing but an empty shell.

This empty vessel exists today, as a result of the failure to apply and enforce bona fide fiduciary standards under the Investment Advisers Act of 1940 by the U.S. Securities and Exchange Commission (SEC) over the past few decades.


There was a time that the SEC cautioned that brokers who established relationships of trust with their clients, and who provided personalized investment advice, were fiduciaries with broad fiduciary duties. Yet today, curiously, the SEC wonders if it should even impose any kind of fiduciary duties upon brokers who provide personalized investment advice.

There was a time that the SEC cautioned against the use of titles which denote relationships of trust and confidence. Yet today the SEC permits anyone to use the terms “investment manager” or “wealth manager” or “financial advisor” or “financial consultant,” without regard to the reasonable belief created in clients by the use of such titles that expertise and trust can be reposed.

There was a time when the SEC cautioned broker-dealer firms to be careful in their advertising, and to not imply a relationship of trust and confidence exist when, in fact, such does not. Yet today such advertisements are abundant.

There was a time when the SEC noted that principal trades by fiduciary were only to be a rare activity, only undertaken in markets where agency trades were not available. Yet today the SEC has permitted dual registrants to engage in principle trades on a wholesale basis, without proper inspection and oversight.

There was a time when core fiduciary duties could not be waived. Yet today, many major broker-dealer firms’ Form ADV, Part 2A states, to the effect: “We are fiduciaries … but … and but … and but … and but.”

Wall Street firms now often say, in essence: “We are fiduciaries … but we may also receive additional compensation via 12b-1 fees in addition to the investment advisory fees you, our client, pay. No, we do not credit such fees against your investment advisory fee.”

And they also in essence often say: “We are fiduciaries … but we may also receive payment for shelf space and soft dollar compensation.  And although we are fiduciaries … we have no obligation to ensure that a tax-efficient strategy is utilized in your portfolio. We are fiduciaries … but we won’t even prepare an investment policy statement for you, nor will we design and implement a prudent investment strategy for you, nor even let you know when we are giving imprudent advice.”

And these “fiduciary” dual registrants also often, in essence, state: “Oh, yes. We can also wear two hats. And we can switch our hats at will, in the corner of our dimly lit offices, while you – the client – are unaware.”

There was a time when the SEC was respected. No more.


This is what happens when we leave the fiduciary standard in the hands of government. Under ongoing pressure from Wall Street’s banks and the insurance companies, it is abrogated, compromised, and gutted. And then, what little that remains of fiduciary obligations is not enforced through diligent oversight.

The fiduciary battles continue in Washington, D.C., and will for some time. Pro-fiduciary advocates may, largely through the courage of Phyllis Borzi and her team at DOL/EBSA, prevail to apply fiduciary standards to all providers of advice to defined contribution and IRA accounts.

Yet, I possess little hope that the SEC will act in similar fashion, either to correctly research what the fiduciary standard is all about, nor will they understand the reasons for its application to investment advisory and financial planning activities. The response of SEC staffers to each recitation of the long-understood requirements of the bona fide fiduciary standard will most certainly be: “Surely the fiduciary standard cannot mean that.”

Even if a bona fide fiduciary standard is made applicable to brokers’ personalized investment activities, it will not be enforced by the SEC. The SEC takes no action now against the wholesale abrogation by Wall Street’s firms of their fiduciary obligations when providing personalized investment advice. Such nullification of core fiduciary duties occurs by these firms’ mere disclosure of multiple and often insidious conflicts (followed by uninformed consent of the client, not understood, and without intelligent, informed consent). Of course, no client would ever consent to be harmed – the fiduciary standard requires ongoing substantive fairness to the client, even when a conflict of interest is permitted to continue to exist.

There are major economic forces that have, and continue to, diminish the fiduciary standard of conduct. It has already been diminished. The true, bona fide fiduciary standard, well understood and based upon centuries of legal precedent, will continue to be eviscerated.


The word “objective” has lost its meaning. Many of these broker-dealer firms tout their objectivity, when no such real objectivity exists due to multiple and nefarious conflicts of interest. Is this fraud?

When SIFMA stands up and says all of its members place the customer’s “best interests” above their own, is this fraud? Every other country which has adopted the common law of England as the basis for their jurisprudence understands that the term “acting in your best interests” is tantamount to the fiduciary duty of loyalty. When in the United States did we permit “best interests” to mean otherwise? When did we permit clients to be deceived so often, and to such detriment?

When those who use titles which denote relationships of trust and confidence, and who provide advice under the aura of such representations, yet disavow or disclaim their core fiduciary obligations, is such not blatant fraud?

I am not optimistic about the future of the fiduciary standard. The fiduciary standard, as the SEC presently applies it, is no longer a high standard of conduct. It has become the basis for a new type of fraud. “Trust me” and “fiduciary we” and “best interests” are the expressions of this fraud, when in fact such trust is betrayed by the users of these terms over and over.


What can right this ship? What can undo these wrongs?

Only true professionals can defend the fiduciary standard. By organizing and forming professional societies, dedicated to their members avoiding conflicts of interest rather than embracing them. Embracing of all of the core fiduciary obligations, with no need to disclaim these duties away.

Yet, in my travels, I have seen only a few voluntary professional societies that have actually adopted such high ideals. And less than 1% of those who are involved in financial services are members of these societies. Outgunned and outmatched by millions and millions of dollars from lobbyist contributions and often-secretive dealings resulting in a revolving door between Wall Street, their lobbying firms, and the SEC, these professional societies have no real chance to defend the fiduciary standard. Nor do professionals possess any hope that the fiduciary standard will be restored by the SEC to the preeminent standard of conduct it once was.


So what can we do?  We must persevere – not in the halls of Washington, D.C., but rather in the realm of public opinion and consumer demand.

Let it be known, loudly and clearly, that financial services regulation is largely a sham. It provides the illusion of protection for those who receive investment and financial advice, when in reality such protections rarely exist. Rather than be the bulwark for the preservation and application of the bona fide fiduciary standard, the SEC has become complicit in its demise.

Let it be known that fraud is rampant and widespread.

Let it be known, loudly and clearly, that there are a trusted few who will act in the clients’ best interest, with no need to disclaim away their core fiduciary obligations.

Let it be known, loudly and clearly, that without a trusted advisor bound by bona fide fiduciary duties at all times, consumers in this complicated financial world – whether they be Mom and Pop and Aunt Bea from Main Street, the fiduciary plan sponsor, or the fiduciary endowment or pension fund trustee – have little chance to be successful in attaining their financial goals.

Let it be known, by consumers and the media, loudly and clearly:






Hence, let it be known, that only those few advisors who are willing to sign the following oath (designed in some detail, to avoid ambiguous interpretations and to prohibit the most severe conflicts of interest) actually deserve the trust of our fellow Americans:



1.     I will always put your best interests first. I will not seek to remove my “fiduciary hat.” I will always be your trusted advisor during our trusted advisor-client relationship.

2.     I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional. I will only recommend to you prudent investment strategies backed by solid evidence (through extensive back-testing or through academic research which has withstood the test of time); if an investment strategy is recommend to you that cannot be shown to be prudent, I will ensure that you are fully aware of the risks of such strategy. I will conduct extensive due diligence on both the investment strategies and investment products which I recommend to you. I will ensure that the total fees and costs you pay for the receipt of investment and financial advice and in relation to the implementation of any strategies will be fully disclosed (or at least estimated, when not quantitatively known). I will ensure that the total fees and costs you pay are reasonable.

3.     I will not mislead you, and I will provide conspicuous, full and fair disclosure of all material facts. I will explain these facts to you. I assume the obligation to ensure your understanding of these important facts.

4.     I will avoid conflicts of interest. I will not suggest that I engage in a “principal trade” with you. I will never sell you a proprietary product of my firm, nor a product from any affiliated firm, nor a product from any firm in which I hold a material interest. I will never accept 12b-1 fees unless they are fully and completed credited by both me and my firm against the investment advisory fees that you pay to me. Neither me nor my firm will ever receive payment for shelf space or soft dollar compensation or other forms of revenue-sharing payments. I will avoid all other forms of material third-party compensation, to the extent that I can reasonably do so.

5.     I will fully disclose and fairly manage, in your favor, any unavoidable conflicts. I will ensure your complete understanding of these few and rare conflicts of interest, when they occur. I will seek out and obtain your intelligent, independent and informed consent to such unavoidable conflict of interest. Even then, I will recommend the best course of action for you, in adherence to my continuing obligation to act in your best interests and to ensure substantive fairness exists at all times.

6.     For my trusted advice and expertise as your financial guide and educator, I require only reasonable professional fees, fully disclosed and agreed-to in advance of any specific product recommendations.



There will be a time when the bona fide fiduciary standard will become commonplace in the service of individual consumers.

But this will not occur through government action (and inaction). Not through lobbying in the halls of Congress, nor in the conference rooms of government agencies.

Rather, bona fide fiduciaries will apply it, as they prevail in the marketplace in the years to come.

Only then might the wolves of Wall Street emerge to “see the light” and be willing to adopt bona fide fiduciary obligations to their customers. Only when it becomes apparent, as their market share continues its slow erosion, that they have no other choice but to wear the white hat of the fiduciary. Ultimately they will have no one left to fleece. But that’s a long, long, long time off – years and years, if not decades.


In the meantime, consumers will need to be diligent. They will need to demand the fiduciary oath above. They will need to seek out those very few advisors – who perhaps number only a few thousand in the United States today – who will freely and voluntarily sign the oath set forth above.

Where might consumers find such bona fide fiduciaries – advisors you can truly trust? I would suggest that the members of three professional organizations would likely sign the fiduciary oath set forth above:

            Alliance of Cambridge Advisors (www.acaplanners.org)

            Garrett Planning Network (www.garrettplanningnetwork.com)

National Association of Personal Financial Advisors (www.napfa.org)

Each of these organizations possess, on their web sites, “Find an Advisor” search tools for consumers to utilize to find trusted financial and investment advisors.

There are many other firms who practice as bona fide fiduciaries but whose advisors are not part of the foregoing observations. Seek out these firms, as well. Find a firm with which you are personally comfortable. And ... make certain such firm signs the fiduciary oath set forth above.

There was a time when the words “fiduciary” and “best interests” and “trust” and “integrity” meant something truly special in America. With the grit and perseverance of bona fide fiduciary advisors, their clients, and the media, there will come another such time. In the interim, consumers must protect themselves, and advisors must voluntarily choose to act as true professionals.

Sunday, January 12, 2014

Disband FINRA (unabridged and with citations)

Ron's note - This is the white paper, unedited and with citations, which was published as a four-part series in June and July 2013, courtesy of www.RIABiz.com. The last installment of the four-part series, which contains links to the earlier parts, can be found at http://www.riabiz.com/a/23015131/what-the-8-pillars-of-a-finra-replacing-entity-for-ria-oversight-look-like-and-how-personal-accountability-is-key

I offer this unabridged version for those who are interested in the sources of authority, and for those who may seek to undertake further analysis or discussion of the issues involved.

Thank you. - Ron



FINRA is Hungry
That big Gorilla called FINRA - facing a continued decline in its membership (consisting of all broker-dealer firms conducting business with the public) – is hungry. Sitting nearby are registered investment adviser (RIA) firms – appearing to FINRA as juicy, growing bananas and a perfect treat to be consumed, chewed up, and digested.
Yet, we must ask - if you are a consumer, or if you are a registered investment adviser (RIA) or an investment adviser representative (IAR), would FINRA’s desired takeover of RIAs be a good thing? Not on your life. Permit me to explain why.
In this series for articles, I propose that, for long-lasting reforms, FINRA possesses fatal flaws and must be dismantled. In its place should arise a true professional regulatory organization bound to a bona fide fiduciary standard of conduct and to promoting the best interests of clients at all times and without exception. Only then will our fellow Americans receive the ongoing certainty of the substantial protections of the fiduciary standard that they so justly deserve.
I first explore the diminished trust in financial intermediaries, and its dire consequences for the future economic prosperity of all Americans.
FINRA Keeps the U.S. Economy Struggling
In over seven decades of existence, the Financial Industry Regulatory Authority, Inc. (FINRA) (formerly known as the National Association of Securities Dealers, or NASD) has failed to provide the essential safeguards necessary to limit its large Wall Street member firms’ ability to underwrite or sell investment products with exorbitantly high fees and costs. The result has been the preservation of an oligopoly of investment banks, as well as the preservation of conflicted broker-dealer business models long overdue for an extinction event. More importantly, FINRA’s long-standing protection of its members’ excessive rent-taking has led to a crisis in American capitalism, negative implications for U.S. economic growth, and a dismal personal financial outcome in retirement for tens of millions of Americans.
By way of explanation, American business is the robust engine that drives the growth of our economy and delivers prosperity for all. An important component of the fuel for this engine is monetary capital. Yet, this monetary capital is not efficiently delivered to the engine of business … it’s as if the engine is stuck using an outdated, clogged carburetor, in the form of substantial intermediation costs by current investment banking firm practices.
More importantly, the transmission system of our economic vehicle is failing, leading to far less progress in our path toward personal and U.S. economic growth. The transmission system is large, heavy and unwieldy; its sheer weight slows down our vehicle’s progress. Through costly investment products and hidden fees and costs, this transmission system unnecessarily diverts much of the power delivered by American business’ economic engine to Wall Street, rather than deliver it to the investors (our fellow Americans) who provide the monetary capital.
The ramifications of this inefficient vehicle, with its clogged carburetor and faulty transmission, are both numerous and severe. The cost of capital to business is much higher than it should be, due to the exorbitant intermediation costs Wall Street imposes during the raising of capital and its diversion of the returns of capital away from individual investors.
In fact, Wall Street currently diverts away from investors a third or more of the profits generated by American publicly traded companies. As Simon Johnson, former chief economist of the International Monetary Fund, observed in his seminal May 2009 article “The Quiet Coup” appearing in The Atlantic, wrote: "From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits … In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent."[1] More recently the financial services sector’s bite into corporate profits has been estimated at one-third or higher.[2]
Investor Distrust = Less Capital
The siphoning of profits by Wall Street, away from the hands of individual investors, has led to a high level of individual investor distrust in our system of financial services and in our capital markets. In fact, many individual investors, upset after finally discovering the high intermediation costs present, flee the capital markets altogether. (Many more would flee if they discovered all of the fees and costs they were paying, and realized the substantial effect such had on the growth or preservations of their nest eggs.) The effects of greed in the financial services industry can be profound and extremely harmful to America and its citizens. Participation in the capital markets fails when consumers deal with financial intermediaries who cannot be trusted.
As a result of the growth of investor distrust in financial intermediaries, the capital markets are further deprived of the capital that fuels American business and economic expansion, and the cost of capital rises yet again. Indeed, as high levels of distrust of financial services continue,[3] the long-term viability of adequate capital formation within the United States is threatened, leading to greater reliance on infusions of capital from abroad. In essence, by not investing ourselves in our own economy, we are selling our bonds, corporate and other assets to investors abroad.[4]
Less Capital Formation = Reduced Economic Growth
It is well documented that public trust is positively correlated with economic growth.[5]
Moreover, public trust is also correlated with participation by individual investors in the stock market.[6] This is especially true for individual investors with low financial capabilities – those who in our society are in most need of financial advice; policies that affect trust in financial advice seem to be particularly effective for these investors.[7]
The lack of trust in our financial system has potential long-range and severe adverse consequences for our capital markets and our economy. As stated by Prof. Ronald J. Columbo in a recent law review article: “Trust is a critical, if not the critical, ingredient to the success of the capital markets (and of the free market economy in general). As Alan Greenspan once remarked: ‘[O]ur market system depends critically on trust-trust in the word of our colleagues and trust in the word of those with whom we do business.’ From the inception of federal securities legislation in the 1930s, to the Sarbanes-Oxley Act of 2002, to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, it has long been understood that in the face of economic calamity, the restoration and/or preservation of trust – especially investor trust – is paramount in our financial institutions and markets.”[8]
There is no doubt that “[t]rust is a critically important ingredient in the recipes for a successful economy and a well-functioning financial services industry. Due to scandals ranging in nature from massive incompetence to massive irresponsibility to massive fraud; investor trust is in shorter supply today than just a couple of years ago. This is troubling, and commentators, policymakers, and industry leaders have all recognized the need for trust's restoration ….”[9]
Less Trust = Less Use of Financial Advisors
The issue of investor trust in financial intermediaries does not just concern asset managers and Wall Street’s broker-dealer firms; it affects all investment advisers and financial advisors to individual clients. As Tamar Frankel, a leading scholar on U.S. fiduciary law, once observed: “I doubt whether investors will commit their valuable attention and time to judge the difference between honest and dishonest … financial intermediaries. I doubt whether investors will rely on advisors to make the distinction, once investors lose their trust in the market intermediaries. From the investor’s point of view, it is more efficient to withdraw their savings from the market.”[10]
Harmful Impact on Americans’ Retirement Security
Even more severe are the long-term impacts of the high intermediation costs imposed by Wall Street firms on individual investors themselves. Individual investors, now largely charged with saving and investing for their own financial futures through 401(k) and other defined contribution retirement plans and IRA accounts, reap far less a portion of the returns of the capital markets than they should. These substantially lower returns from the capital invested, due to Wall Street’s diversion of profits, result in lower reinvestment of the returns by individual investors; this in turn also leads to even lower levels of capital formation for American business.
It must be remembered that, fundamentally, an economy is based upon trust and faith. Continued betrayal of that trust by those who profess to “advise” upon qualified retirement plans and IRA accounts, while doing so under an inherently weak standard of conduct, only serves to destroy the essential trust required for capital formation, thereby undermining the very foundations of our modern economy.
Burdens Placed Upon Governments – and Taxpayers
As individual Americans’ retirement security is not adequately provided through their own investment portfolios, saddled with such high intermediation costs, burdens will shift to governments – federal, state and local – to provide for the essential needs of our senior citizens in future years. These burdens will likely become extraordinary, resulting in far greater government expenditures on social services than would otherwise be necessary, precisely at the time when our governments can ill afford further burdens and cannot solve these burdens through the issuance of debt.
Consequentially, higher tax rates become inevitable, for both American business and individual citizens alike. This in turn consumes a greater share of our economy, leading to further economic stagnation, and perhaps to the permanent decline of America in the 21st Century and beyond.
We, the People: Servants of Wall Street
In essence, American business has become Wall Street’s servant, rather than its master. The excessive rents extracted at multiple levels by Wall Street fuels excessive bonuses paid, in large part, to young investment bankers.
Wall Street also drains some of the best talent away from productive businesses, as well. Far too many of our graduates of math and engineering programs make their way to Wall Street, and even more pursue finance majors rather than pursue studies in the STEM disciplines. This further distorts the labor market, as shortages of talent in our important information technology and engineering sectors continue.
Consequently, Wall Street has become a huge drain on American business and the U.S. economy. It derives excessive rents at the expense of corporations and individuals. The financial services sector, rather than providing the grease for American's economic engine, instead has become a very thick sludge.
Wall Street’s Control of Our Government
Wall Street and the large U.S. banks have “captured”[11] our regulatory bodies and Congress, to the detriment of individual American investors.[12]
As economist Simon Johnson also observed: “The (2008-9) crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform … we’re running out of time.”[13]
The Solution
There is but one solution to fix the affliction affecting our country’s capital markets, and the resulting lower levels of capital formation and economic growth. The compelling reply to the current state of affairs lies in the application of a bona fide fiduciary standard of conduct to all providers of personalized investment advice. Simply put, this broad-based fiduciary standard requires that financial advisors act in the best interests of their clients, and to subordinate their own interests (and those of their firms) in order to keep the best interests of the client paramount at all times.
Instead of preserving the economic interests of conflict-ridden investment banks, the best interests of individual American investors would be advanced under the fiduciary standard. This in turn would free America from the grip of Wall Street, and free individual Americans from personal financial prospects that are far too often dismal and bleak. 



Why was the fiduciary standard not implemented in the early days of securities regulation, for brokers? The answer lies in FINRA, its inherent conflicts of interest, and its failure to protect the individual investor. Let’s examine FINRA’s early history, and the evidence of FINRA’s massive flop. To do so, we must first explore the relationship between brokers and their clients that existed prior to FINRA’s existence.
Brokers as Fiduciaries: Pre-FINRA History
At the beginning of the 20th Century, in “the United States the business of buying and selling stocks and other securities [was] generally transacted by Brokers for a commission agreed upon or regulated by the usages of” a stock exchange.”[14] Indicative of the known distinctions between brokers and dealers, an early Indiana law provided for the licensing of brokers but not for “persons dealing in stocks, etc., on their own account.”[15]
During the early part of the 20th Century, stockbrokers were known to possess duties akin to those of trustees, including the duty of utmost good faith and the avoidance of receipt of hidden forms of compensation. As stated in the 1905 edition of an early treatise:
He is a Broker because he has no interest in the transaction, except to the extent of his commissions; he is a pledgee, in that he holds the stock, etc. as security for the repayment of the money he advances in its purchase; so he is a trustee, for the law charges him with the utmost honesty and good faith in his transactions; and whatever benefit arises therefrom enures to the cestui que trust.[16]
By the early 1930’s, the fiduciary duties of brokers (as opposed to dealers[17]) were widely known. As summarized by Cheryl Goss Weiss, in contrasting the duties of an broker vis-à-vis a dealer:
By the early twentieth century, the body of common law governing brokers as agents was well developed. The broker, acting as an agent, was held to a fiduciary standard and was prohibited from self-dealing, acting for conflicting interests, bucketing orders, trading against customer orders, obtaining secret profits, and hypothecating customers' securities in excessive amounts -- all familiar concepts under modern securities law. Under common law, however, a broker acting as principal for his own account, such as a dealer or other vendor, was by definition not an agent and owed no fiduciary duty to the customer. The parties, acting principal to principal as buyer and seller, were regarded as being in an adverse contractual relationship in which agency principles did not apply.[18] [Emphasis added.]
The fact that stockbrokers were known to be fiduciaries at an early time in the history of the securities industry (when acting as brokers and not acting as dealers) should not come as a surprise. To a degree it is simply an extension of the laws of agency. One might then surmise that, if the broker provides personalized investment advice, then a logical extension of the principles of agency dictates that the fiduciary duties of the agent also extend to those advisory functions, as the scope of the agency has been thus expanded.[19]
While agency law provides one basis for the imposition of broad fiduciary duties upon brokers, early court cases confirmed the existence of broad fiduciary duties upon brokers in situations where brokers possessed relationships of trust and confidence with their clients. For example, In the 1934 case of Birch v. Arnold,[20] in a case which did not appear to involve the exercise of discretion by a broker, the relationship between a client and her stockbroker was found to be a fiduciary one, as it was a relationships based upon trust and confidence. As the court stated:
She had great confidence in his honesty, business ability, skill and experience in investments, and his general business capacity; that she trusted him; that he had influence with her in advising her as to investments; that she was ignorant of the commercial value of the securities he talked to her about; and that she had come to believe that he was very friendly with her and interested in helping her. He expected and invited her to have absolute confidence in him, and gave her to understand that she might safely apply to him for advice and counsel as to investmentsShe unquestionably had it in her power to give orders to the defendants which the defendants would have had to obey. In fact, however, every investment and every sale she made was made by her in reliance on the statements and advice of Arnold and she really exercised no independent judgment whatever. She relied wholly on him.[21] [Emphasis added.]
In this case the Massachusetts Supreme Court held that, in these circumstances, facts “conclusively show that the relationship was one of trust and confidence”[22] and therefore the broker could not make a secret profit from the transactions for which the advice was provided.
In another early (1938) pre-FINRA case the broker’s customer, “untrained in business – she had been a domestic servant for years – was susceptible to the defendant's influence, trusted him implicitly ….”  The court stated: “We are persuaded from the facts of the case that a trust relationship existed between the parties … The [broker] argues that he was not a trustee but a broker only. This argument finds little to support it in the testimony. He assumed the role of financial guide and the law imposed upon him the duty to deal fairly with the complainant even to the point of subordinating his own interest to hers. This he did not do. He risked the money she entrusted to him in making a market for hazardous securities. He failed to inform her of material facts affecting her interest regarding the securities purchased. He consciously violated his agreement to maintain her income, and all the while profited personally at the complainant's expense. Even as agent he could not gain advantage for himself to the detriment of his principal.”[23] [Emphasis added.]
Hence, while under the Securities Exchange Act of 1934 and FINRA rules, broker-dealers are not subject to an explicit fiduciary standard, in private litigation between customers and brokers and in some arbitrations fiduciary standards are applied when a relationship of trust and confidence is found. As noted in a recent law review article, “Notwithstanding the absence of an explicit fiduciary standard, broker-dealers are subject to substantially similar requirements when they act as more than mere order takers for their customers’ transactions.”[24] This appears in accord with the original intent of Franklin D. Roosevelt and the United State Congress: “Roosevelt and Congress used the 1934 Exchange Act to raise the standard of professional conduct in the securities industry from the standardless principle of caveat emptor to a ‘clearer understanding of the ancient truth’ that brokers managing ‘other people's money’ should be subject to professional trustee duties.”[25]
The fact that broker-dealers may, when providing more than trade execution services to individual investors, possess broad fiduciary duties was confirmed by the SEC Staff Study on Investment Advisers and Broker-Dealers (As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act) (Jan. 2011), which stated: “Broker-dealers that do business with the public generally must become members of FINRA. Under the antifraud provisions of the federal securities laws and SRO rules, including SRO rules relating to just and equitable principles of trade and high standards of commercial honor, broker-dealers are required to deal fairly with their customers. While broker-dealers are generally not subject to a fiduciary duty under the federal securities laws, courts have found broker-dealers to have a fiduciary duty under certain circumstances … This duty may arise under state common law, which varies by state. Generally, broker-dealers that exercise discretion or control over customer assets, or have a relationship of trust and confidence with their customers, owe customers a fiduciary duty similar to that of investment advisers.”[26]
What about the Investment Advisers Act of 1940 (“Advisers Act”)? At the time of its enactment it was designed to apply to investment counsel, a relatively new type of professional whom was paid directly by the customers for his or her advice. It required investment counsel (i.e., investment advisers) to register wFith the SEC. Moreover, Section 206 of the Advisers Act imposed a fiduciary duty upon investment advisers. Brokers were exempted from the registration requirements of the Advisers Act, provided that their investment advice remained “solely incidental” to the brokerage transactions and they received no “special compensation.” But here’s the key – the Advisers Act never stated that brokers providing personalized investment advice (whether “solely incidental” or otherwise) were not fiduciaries. The law applicable to brokers remained the same.
The Securities Markets Study (1935)
An influential early study of the securities market was conducted following the 1929 stock market crash. Written in large part prior to the adoption of the Securities Exchange Act of 1934,[27] the entire study was published by Twentieth Century Fund in 1935. Entitled “The Securities Market,” the study provided a long review of the functions of the securities markets and the activities of their various actors and participants (including brokers and “investment counsel”).
The authors of the study described the “brokerage-firm-customer relationship” as follows:
                  A brokerage firm stands in a four-fold relationship toward its customer.
1.     It acts as his broker in the purchase and sale of securities and in the borrowing and lending of stocks.
2.     It acts as a pledgee, in which capacity it either advances its own capital to finance his margin transactions, or, much more commonly, advances capital borrowed from banks.
3.     It is the custodian of his securities and cash.
4.      It exercises, to some extent, the function of an investment counsel to him.
These relationships imply great responsibilities and obligations on the part of a brokerage firm. Under these circumstances the customer is entitled to expect the fullest possible protection … To the greatest extent possible, a condition should be created where the conflict of interest between broker and customer is reduced to the minimum. [28]
[Emphasis added.]
The Securities Market study went further in suggesting protections for conflicts of interest for investment counsel – those individuals who were paid directly by their clients – stating:
We believe that anyone who entrusts his investment problems to an investment counsel is entitled to protection ... He should be assured that his financial advisor is possessed of at least certain minimum qualifications and, in addition, that he is free from all entanglements that might divide his loyalties
No individual should be granted, or permitted to retain, a license to practice as investment counsel for pay who is in the business of underwriting, distributing, buying or selling securities either as a broker or principal; or who is in the employ of, or is in any way affiliated with, or is a stockholder or partner in, any organizations engaged in any manner whatever in such activities … No licensed investment counsel should be permitted to employ, or to retain in his employment, any one in any way connected with any activity or implied [in the foregoing sentence]; or to associate himself as a partner, joint stockholder, or otherwise with any such disqualified person.[29]
[Emphasis added.]
In essence, the Securities Market study recommended that brokers be held to the “best interests” fiduciary standard of conduct, with conflicts of interest minimized. Also, the study recommended the separation of brokers and dealers (who deal in their own securities, or who sell offerings of securities firms in initial or subsequent public offerings).
The Securities Market study also, in essence, recommended that investment counsel be held to the “sole interests” fiduciary standard in which avoidance of all conflicts of interest was required. Additionally, no “dual registration” (as exists today) as both a broker (or dealer) and investment adviser (“investment counsel” in 1935) would be permitted, given the insidious conflicts of interest under such affiliations.
1938 Maloney Act: A Noble Attempt to Raise Standards
By the mid-1930’s broker-dealer firms were subject to registration requirements, but the attributes of a profession were sorely lacking. Partly to escape from direct government regulation,[30] but also as a result of the aspirational desires of the Maloney Act’s primary author to create a true profession, the Maloney Act of 1938 amended the Securities Exchange Act of 1934 and created the authority for the recognition of a self-regulatory organization.
Public policy makers in 1938 clearly understood that the goal of the Maloney Act was to create a true profession, bound by fiduciary standards. In 1938, the Assistant General Counsel of the SEC stated that the “Commission has concluded that the next stage in the job – the job of raising the standards of those on the edge to the level of the standards of the best – can best be handled … by placing the primarily responsibility on the organized associations of securities dealers throughout the country.”[31] [Emphasis added.]
The theme of continually raising the standards of the industry was repeated in a speech by SEC Commissioner George C. Matthews, shortly after the Maloney Act was passed in Congress, in which he stated, “Ideally, the industry should eventually play the predominant role in its own regulation and development ... It should in the largest possible measure achieve that ideal under democratic institutions which Josiah Royce described as the forestalling of restraint by self-restraint … I wish to re-emphasize the evolutionary character of the program provided for in the [Maloney] Act … it is our hope … that the work of construction [of regulation] will continue through the years until there shall finally have been erected a professional edifice commensurate with the importance of the investment banking and over-the-counter securities businesses in our national economy.”[32]
Even Senator Francis Maloney, for whom the Maloney Act of 1938 was named, stated that the Maloney Act had, as its purpose, “the promotion of truly professional standards of character and competence.”[33]
FINRA’S Very Early Statements
Confirmed Fiduciary Duties of Brokers
Early statements by NASD (now FINRA) confirmed the existence of high, fiduciary standards of conduct for brokers in the very early days of FINRA’s existence. In only the second newsletter for its members issued by the self-regulatory organization for broker-dealers, the NASD unequivocally pronounced that brokers were fiduciaries: “Essentially, a broker or agent is a fiduciary and he thus stands in a position of trust and confidence with respect to his customer or principal. He must at all times, therefore, think and act as a fiduciary.  He owest his customer or principal complete obedience, complete loyalty, and the exercise of his unbiased interest.  The law will not permit a broker or agent to put himself in a position where he can be influenced by any considerations other than those to the best interests of his customer or principal … A broker may not in any way, nor in any amount, make a secret profit … his commission, if any, for services rendered … under the Rules of the Association must be a fair commission under all the relevant circumstances.”[34]
A little more than a year later, in discussing the decisions of two cases, the NASD wrote that it was “worth quoting” statements from the opinions:  “In relation to the question of the capacity in which a broker-dealer acts, the opinion quotes from the Restatement of the law of Agency: ‘The understanding that one is to act primarily for the benefit of another is often the determinative feature in distinguishing the agency relationship from others. *** The name which the parties give the relationship is not determinative.’ And again: ‘An agency may, of course, arise out of correspondence and a course of conduct between the parties, despite a subsequent allegation that the parties acted as principals.’”[35]
When Chairman Benjamin Howell Griswold, Jr., called to order the first meeting of the NASD Board of Governors, he described the Association as a "worthwhile experiment" that would succeed only through "coordinated effort, careful study, good will, and hard thinking.” “If you do succeed,” he told the Board, "then both the Securities and Exchange Commission and yourselves are entitled to the credit for the development of a plan that may tend more than anything else to restore confidence, remove the legal obstacles that now alarm you, and re-establish the capital issues market of this country.”[36]
The Tide Turns in 1942:
FINRA Enacts Low Standards of Conduct
By 1942 the committee appointed by the NASD (now FINRA) to enact rules of conduct for its members had finished its work, and NASD’s (now FINRA’s) rules of conduct (via a “Uniform Practice Code” and “Rules of Fair Practice”[37]) were adopted. Yet, despite the clear pronouncements by early NASD writers in FINRA’s 1940 and 1941 newsletters, the aspirations of SEC Commissioners and Senator Maloney himself for adoption the highest professional standards, and case law clearly setting forth that a broker was a fiduciary when in a relationship of trust and confidence with a customer, NASD’s rules of conduct omitted any reference to the fiduciary duties of brokers when providing personalized investment advice.
Yet, in 1942, and now, there exists little doubt that the relationship between most clients and their brokers, when personalized investment advice is provided, is a personal one.[38] Indeed, as recognized by the SEC Staff as recently as 2005, “[f]ull-service broker-dealers have always sought to develop long-term relationships with their customers who often come to rely on them for expert investment advice.”[39] In such relationships a broker “does not simply execute orders at a client's command, but rather renders investment advice to the client ….”[40] Such brokers are not simply functionaries, but rather "are clearly fiduciaries in the broadest sense."[41]
Yet FINRA’s omission of any mention of fiduciary standards in its rules for its brokerage firms and their registered representatives continues to this day. By, in effect, ignoring the law and the statements of the Maloney Act’s principal author, FINRA continues to keep the standards for brokers at the very low level of suitability.
In fact, the true purpose of FINRA was revealed early on. “In October, 1943, the NASD Board adopted a policy that set general guidelines for markups in customer transactions. Members' reactions to it ranged from endorsement to opposition, leading Executive Director Fulton to further explain the policy: ‘The NASD did not and does not seek to regulate, let alone curtail, profits of its members. [The NASD, now FINRA] is devoted to the principle that its members are in business to make money.’”[42] [Emphasis added.]
This devotion by NASD and its firms to protection of their profits was strongly felt in 1943, when the SEC sought to impose a rule requiring disclosure by dealers of all of their profits from any transaction. The securities industry reacted most sharply, and by 1947 the SEC’s proposal was abandoned.[43]
As will be seen, FINRA and its member firms have continued their fight, for more than seven decades, against heightened standards of conduct or other restrictions which might impede their outsized profits.
The Disastrous Suitability Standard
There exist a broad range of consumer protections available to regulate the sale of securities and/or the delivery of investment advice, ranging from the arms-length standard generally applicable to contracts between parties with relatively equal knowledge and bargaining power, to the strict “sole interests” fiduciary standard of conduct.
The Arms-Length Standard. In most commercial transactions, the consumer and the merchant of securities operate at arms-length. In these arms-length relationships of parties, such as exists for most sales and purchases of everyday products, the relationship can be characterized as follows:
Suitability. Sometimes the consumer is aided (or denied protections) by specific laws which impose some additional duties on one party, other than just by those duties which the general common law might provide. For example, upon broker-dealers there is imposed the requirement that investment products sold to an investor be “suitable,”[44] at least as to the risks associated with that investment. In essence, suitability requires an effort on the part of the broker to “match” customers to particular products, by matching products to objectives.[45] The duties relate mainly to the risk assumed by the customer; the broker must ascertain the risk-return characteristics of the security against the particular characteristics and objectives of the customer.
The “suitability doctrine,” explicitly set forth as a rule by FINRA, and recognized by the SEC as a "fundamental duty of brokers" enforceable by FINRA under the securities laws' general antifraud rule (Rule 10b- 5).[46]  However, the suitability doctrine demands only that a broker/brokerage firm “will make specific recommendations of securities only if it has a reasonable basis for believing that they are suitable for the customer.”[47]
Yet suitability, while imposing upon brokers the responsibility to not permit investors to “self-destruct,” confines the duties of brokers to their customers, with respect to the broad common law duty of due care. With the rise of the concept of the due care and actions for breach of one’s duty of due care (via the negligence doctrine that saw accelerated development in the early 20th Century), brokers sought a way to ensure they would not be held liable under the standard of negligence. After all, “[t]o the extent that investment transactions are about shifting risk to the investor, whether from the intermediary, an issuer, or a third party, the mere risk that a customer may lose all or part of its investment cannot, in and of itself, be sufficient justification for imposing liability on a financial intermediary.”[48]  This appears to be a valid view as to the duty which should be imposed upon brokers; provided, however, that the broker is only providing execution services to the customer.
Yet the sales of mutual funds and other pooled investment vehicles exploded[49] following the SEC’s abolition of all fixed commission rates, which was effective on May 1, 1975. In effect, no longer were brokers performing execution services, but they were, in fact, recommending investment managers. Yet, FINRA permitted the suitability doctrine to be extended, over the decades, to incorporate recommendations of investment managers. In essence, brokers continue to operate with a free hand today – unburdened by the duty of nearly every other person in the United States with respect to their activities – which, at a minimum, require adherence to the duty of due care of a reasonable person.
The Limited Disclosure Obligations of Brokers and their Registered Representatives. Federal and state securities laws also impose, at times, various disclosure obligations upon broker-dealers beyond the “no-lying baseline” which exists in arms-length transactions. Yet, there is no obligation of a broker, generally, to disclose to customers all of the compensation that it, or its registered representatives, receives.[50] “Neither the SEC nor [FINRA] 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 – such as differential compensation resulting from soft dollar payments and payment for shelf space, management bonuses, and sales contests.[51] Moreover, brokers and their registered representatives don’t even possess a duty to disclose the receipt of additional compensation for selling proprietary mutual funds than other funds.[52]
Briefly Contrasting the Fiduciary Relationship. The fiduciary relationship arises in situations where the law has clearly recognized that fiduciary duties attach, such as principal and agent relationships, or where there exists the actual placing of trust and confidence by one party in another and a great disparity of position and influence between the parties. Under the fiduciary standard of conduct the financial advisor possesses both a duty of due care (judged by comparison of the financial advisor’s acts to other professionals, not consumers), as well as a fiduciary duty of loyalty. Under the fiduciary duty of loyalty there arises a duty to disclose all material facts.
Yet even then the fiduciary standard requires more, as mere disclosure of material facts is thought to be inadequate as a means of consumer protection for clients in a relationship of trust and confidence with their advisor.[53] Stated differently, even with full disclosure of conflicts of interest and specific compensation amounts, disclosure does not come close to being a substitute for the protections offered by a bona fide fiduciary standard of conduct.
The relationship of the parties in a fiduciary relationship is reversed from that of an arms-length relationship. The fiduciary relationship can be illustrated as follows:
In summary, the low standard of conduct possessed by brokers under the suitability standard continues despite the fact that the negligence standard today applies to govern the duties of care owed by most of us in our society. In contrast, the fiduciary standard for professional advisors requires adherence to a professional duty of care, as well as mandatory disclosure of all material facts (including compensation). Even then, the fiduciary standard requires much more of the advisor providing personalized investment advice.
The Maloney Act Failure
Why has FINRA had so many documented failures? Because — at its core — FINRA acts as the protector of its member firms, rather than protecting the public interest. As Tamar Frankel, America’s leading scholar on fiduciary law as applied to the securities industry, wrote in 1965:
NASD … [does] not, as do the professions, consider the public interest as one of [its] goals … Let us consider the attitude of the professions toward the public interest. The goal of public service is embedded in the definition of a profession. (Pound, The Lawyer from antiquity to modern times 5 1963). A profession performs a unique service; it requires a long period of academic training. Service to the community rather than economic gain is the dominant motive. We may measure the broker-dealer’s activities against these criteria … Although at least part of his trade is to give service, profit is his goal. The public interest is stated in negative terms: he should refrain from wrongdoing because it does not pay. This attitude is the crux of the matter, the heart of the difference between a profession and the broker-dealer’s activity … The industry emphasizes its merchandising aspect, and argues that the broker-dealer is subject to the duties of a merchandiser even when he is also acting is his advisory capacity … the NASD [has] proved incapable of establishing accepted standards of behavior for the activities of the trade … Past experience has proved that it is unrealistic to expect the NASD to regulate in the public interest ….[54] [Emphasis added.]
Sadly, Professor Frankel’s observations from nearly five decades ago continue to ring true.
FINRA: A Sad Excuse for a Regulator
FINRA possesses an inherent conflict of interest because, at its core, FINRA remains under the control of its large Wall Street broker-dealer firms, while also regulating those same broker-dealers. This means that FINRA will always be an ineffective protector of consumers, and that its rules and regulations will instead foster the excessive profits of its members.
The adoption of the failed suitability standard, and its extension to broker-dealer’s advisory activities, rather than an appropriate professional standard of due care, insulates FINRA’s broker-dealer firm members from much of the liability which might otherwise attach to their recommendations. FINRA’s failure to recognize, or enforce, the fiduciary duties of brokers when providing personalized investment advice (rather than trade execution services) remains a dismal omission from the rules of conduct which govern its members. Even the failure to simply mandate specific disclosures of compensation by broker-dealers, in all circumstances, is another black eye on FINRA’s over seven decades of oversight of its member firms.
While FINRA prides itself on the robustness of its broker-dealer examination program, including the frequency of examinations, no amount of examinations will serve to protect the public interest adequately if the standards to which brokers are held remain inherently weak and flawed.
As FINRA itself has noted, it exists to preserve the profits of its members. Sadly, FINRA’s continued existence, and the weak conduct requirements it imposes upon its members, do not serve the public interest.



“Americans are angry at Wall Street, and rightly so. First the financial industry plunged us into economic crisis, then it was bailed out at taxpayer expense. And now, with the economy still deeply depressed, the industry is paying itself gigantic bonuses. If you aren’t outraged, you haven’t been paying attention.” - Paul Krugman[55]
Here we stand, more than seven decades after FINRA’s creation, and we see that FINRA has resisted nearly every attempt to raise the standards of conduct for its members above the low standard of suitability. The organization has completely neglected its mission to protect consumers, and instead has fostered conflict-ridden business practices and the lax regulation of its members. To observe these failures one need only view this litany of failures by FINRA.
FINRA’s Opposition to Broker vs. Dealer Segregation
The 1936 Securities Market study recommended a complete separation of the functions of broker and dealer.[56] A later study by the SEC also recommended further study of the possibility of separation of broker and dealer functions,[57] with the SEC conceding “that some of the abuses in the securities industry are the direct result of the combination of broker and dealer functions: namely, the inducement of brokerage customers to buy the securities which the broker dealer had underwritten or in which he has a trading position; the persuasion of a customer to sell good securities in order to buy securities in which the dealer has an interest and the difficulty for the unsophisticated customer in distinguishing between the two functions and their implications.”[58] However, under intense pressure from FINRA and its member firms this separation of function was never achieved.
Troubles continue today for even sophisticated investors in protecting themselves when dealing with brokers who also act as dealers. There is an inherent conflict of interest in functioning as both a dealer (and trading for its own account, as well) and as a broker; one need only recall the recent sale by Goldman Sachs to its customers of mortgage-backed securities it manufactured, while simultaneously making bets that these securities would fail. Goldman Sachs executives’ recent testimony to Congress revealed the confusion customers of the firm faced, as these executives professed that the firm acted in the “best interests” of their customers as a broker, yet also defended their ability to manufacture and sell “sh***ty products.”[59]
Early in the 1940s, shortly after its formation, FINRA (then the NASD) hailed its achievement in preventing the possible mandated split of “dealer” (including investment underwriting) functions from the functions of a broker (i.e., undertaking trades as an agent). “Mr. Wallace H. Fulton, in his address on the twentieth anniversary of the NASD, considered the successful combatting of the segregation proposals as one of the chief achievements of the NASD.”[60] This author believes FINRA’s actions to preserve the existence of brokerage and dealer functions within the same firm is not an achievement, but one of FINRA’s colossal failures and a cause for many of the ills which pervade U.S. financial services today.
FINRA Defended Price-Fixing by Its Member Firms
NASD/FINRA failed to prevent — and even defended — the price-fixing activities of its market-making member firms in the mid-1990’s. Former SEC Chairman Arthur Levitt stated that the evidence showed FINRA “did not fulfill its most basic responsibilities” and concluded that by FINRA’s failure “American investors — large and small, sophisticated and inexperienced, institutional and individual — all were hurt by these practices.” Levitt further stated that FINRA was “the cop on the beat” that “simply looked the other way.”[61]
FINRA Abets Fraudulent Use of Titles and Descriptors
FINRA continues to permit its members and their registered representatives to use the titles “financial consultant,” “financial advisor,” and “wealth manager.” Yet, these terms infer a relationship based upon trust and confidence, when such relationship of trust and confidence is later denied by the broker and its registered representative.
FINRA has the ability to combat fraud by its member broker-dealer firms and their registered representatives. Exchange Act Section 15A(b)(6) requires the rules of an association be designed to promote just and equitable principles of trade. FINRA satisfies this statutory requirement in part through FINRA Rule 2010, which reads: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” The SEC has held that FINRA’s authority under Rule 2010 relating to “just and equitable principles of trade” permits FINRA to sanction member firms and associated persons for a variety of unlawful or unethical activities, including those that do not implicate “securities.”
Additionally, Exchange Act Section 15(c) prohibits any broker-dealer firm from effecting any transaction in or inducing or attempting to induce the purchase or sale of any security by means of any manipulative, deceptive, or other fraudulent device or contrivance. Under this prohibition, broker-dealers are precluded from making material omissions or misrepresentations and from any act, practice, or course of business that constitutes a manipulative, deceptive, or other fraudulent device or contrivance.
Earlier this year Gil Weinrich quoted Dalbar’s CEO Lou Harvey as stating: “Imagine, for example, if anyone could describe themselves as ‘doctor’ or ‘attorney’ but the real ones were ‘fiduciary doctor’ and ‘fiduciary attorney’ ….”[62] The article goes on to state: “The heart of Harvey’s proposal is to restrict the use of the word ‘advisor’ (or ‘adviser’) to fiduciaries alone, leading to prosecution for non-fiduciaries using that label.” At the fi360 Annual Conference in April 2013, Skip Schweiss, President of TD Ameritrade Trust Company, pointed out Lou Harvey’s suggestion during a panel discussion in which this author participated. Skip Schweiss also suggested that anyone calling himself or herself a “financial advisor” or “financial consultant” be held to the fiduciary standard of conduct.
The view that one holding out as an advisor should be governed by the fiduciary standard of conduct finds recent support in academic literature: “The relationship between a customer and the financial practitioner should govern the nature of their mutual ethical obligations. Where the fundamental nature of the relationship is one in which customer depends on the practitioner to craft solutions for the customer’s financial problems, the ethical standard should be a fiduciary one that the advice is in the best interest of the customer. To do otherwise – to give biased advice with the aura of advice in the customer’s best interest – is fraud. This standard should apply regardless of whether the advice givers call themselves advisors, advisers, brokers, consultants, managers or planners.”[63] [Emphasis added.]
There exists authority, as well, on the inappropriate use of titles, from the SEC itself. Very early on the SEC took a hard line on representations made by brokers. In its 1940 Annual Report, the U.S. Securities and Exchange Commission noted: “If the transaction is in reality an arm's-length transaction between the securities house and its customer, then the securities house is not subject to a fiduciary duty. However, the necessity for a transaction to be really at arm’s-length in order to escape fiduciary obligations has been well stated by the United States Court of Appeals for the District of Columbia in a recently decided case: ‘[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest.  He who would deal at arm's length must stand at arm's length.  And he must do so openly as an adversary, not disguised as confidant and protector.  He cannot commingle his trusteeship with merchandizing on his own account…’” [Emphasis added.][64]
Additionally, in its 1963 comprehensive report on the securities industry, the SEC stated that it had “held that where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer … [BD advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business … Where the relationship between the customer and broker is such that the former relies in whole or in part on the advice and recommendations of the latter, the salesman is, in effect, an investment adviser, and some of the aspects of a fiduciary relationship arise between the parties.”. [Emphasis added.][65]
The fact that misrepresentations of one’s status amounts to fraud is reflected in a recent regulatory action filed by the State of Illinois Attorney General, who sought civil penalties against Mr. Richard Lee Van Dyke, Jr. (a.k.a. "Dick Van Dyke"), a seller of fixed indexed annuities. Mr. Van Dyke is alledged to have stated in advertising: “If you want a successful financial plan, you need a financial advisor you can really trust … He believes in principles like full disclosure and transparency and he doesn’t sell investments on commission which means he’s on your side so you get to reach your goals first before he does. When’s the last time an investment advisor put you first?” The basis of the complaint is a violation of Illinois’ Consumer Fraud and Deceptive Business Practices Act. The Attorney General’s complaint notes: “The representations cited above, on which Defendants intended consumers will rely, as well as others on Defendants’ website, lead consumers to believe Defendant Dick Van Dyke is an objective, knowledgeable and unbiased financial services expert for consumers facing retirement, when in fact he is an insurance salesman.”[66]
As a result of regulatory missteps by FINRA over many decades, substantial consumer confusion now abounds as to the standard of conduct consumers can expect from their providers of investment advice. In large part this is due to the improper use of titles by registered representatives, which, as discussed above, rises in the view of many to the level of intentional misrepresentation (i.e., fraud). Yet FINRA does nothing to prevent this ongoing fraud from occurring.
FINRA Permits the Use of the Fraudulent Term “Fee-Based”
As knowledgeable consumers became more aware that true fiduciary advisors, with few conflicts of interest, were available, Wall Street re-doubled its efforts to obfuscate and confuse consumers, in a valiant but ill-advised attempt to preserve its archaic business model.
The past few decades have seen a small but now significant rise in the number of fee-only financial advisors, such as those who are members of the National Association of Personal Financial Advisors, www.napfa.org and/or those advisors who are members of the Garrett Planning Network, www.garrettplanningnetwork.com). These personal financial advisors eschew all commissions and material third-party compensation paid by product manufacturers (including 12b-1 fees). Instead, they choose to accept reasonable fees paid directly by the clients. In this manner, they avoid many of the conflicts of interest found in Wall Street's large broker-dealer firms. These independent, fee-only and fiduciary financial advisors act solely as the “client’s representative,” researching and then choosing far-lower-cost investments and investment products (and insurance products) for their clients.
Fee-only advisers continue to thrive within their own small universe of clients.  Yet attracting tens of thousands more advisors to the “fee-only” trusted advisor space has been difficult. Why? The reasonable compensation these fee-only advisers receive is insufficient to fund promotional efforts sufficient in quantity to counter the huge marketing budgets of the broker-dealer firms. Wall Street’s marketing machine, fueled by the high diversion of returns from individual investors, is extremely powerful.
For example, in recent years Wall Street’s promotional machine has further confused consumers (and even advisors) by adopting the term “fee-based” to refer to advisors who receive both fees (paid by clients) and commissions (through product sales).  Originally the term “fee-based” referred to fee-based brokerage accounts, which by virtue of a 2007 U.S. Court of Appeals decision were shut down.[67] Following that decision, Wall Street firms embraced using the term "fee-based" to refer not to a type of account, but rather to many (if not most) of its dual registrants.
FINRA failed to step in to warn that the use of “fee-based” to describe an advisor (as opposed to an account), where the advisor was also receiving commission-based compensation, is inherently misleading. While a dual registrant might accurately portray herself or himself as “commission-and-fee-based” or “fee-and-commission-based” (depending upon which form of compensation received was predominant), the exclusion of the word “commission” from the term “fee-based” is nothing more than an omission designed to mislead individual investors. Since the term “fee-based advisor” is intended to obfuscate, confuse, and lead to greater business, the necessary intent requisite for actual fraud likely exists through the use of the term, at least in most instances.
In essence, the use of common or similar titles, and the high fees received by those operating under a conflict-ridden standard of conduct (which in turn funds Wall Street's marketing efforts) results in the inability by consumers to distinguish higher-quality advisors from lower-quality advisors, leading to pernicious effects upon both consumers and true professionals[68] alike. Of course, such insidious results are adored by Wall Street, as its preserves the archaic, conflict-ridden, business model which extracts high levels of rent from individual investors and, indeed, from our economy.
Still today, FINRA, the regulator of its broker-dealer firm members, does nothing to stop this continued obfuscation – and by all accounts intentional fraud – by its member firms.
FINRA Fails to Oversee Derivatives
FINRA failed to seek appropriate supervision of derivatives created and sold by its members, a regulatory oversight which was a substantial cause of the 2008-09 Great Recession from which America still suffers today. FINRA has failed to be held accountable for these many failures to protect the public interest and the financial crisis caused by its failure to regulate its member firms.
An Alliance for Economic Stability report, regarding NASD/FINRA’s failure to assure proper supervision of the OTC derivatives market and other failures (hereafter “AES Report”), detailed two other specific major failures by the SRO:
First, FINRA had the most expansive jurisdiction of any regulator. It can request whatever information it sees fit about its members’ business affairs or even personal affairs, without the same constraints of due process imposed upon government agencies. As such, it could have initiated investigations into the activities surrounding mortgage-backed securities. It failed to do so.
Second, FINRA failed to take any disciplinary action against Joseph Cassano from American International Group Inc.'s financial products division. Even if Cassano did not willfully intend to act as recklessly as he did, his behavior nonetheless shows a gross negligence which has had an impact upon the world financial system whose cost is beyond estimation.
According to AES’ report, “The reason for FINRA not taking steps to address its apparent deficiencies is that FINRA serves to benefit the interests of its members. FINRA worked for the interests of its members to the detriment of the public in the price-fixing in the OTC stock market; it did the same in the OTC derivatives market; FINRA continues to do so now by not addressing its mistakes and toughening its rules.”
The Alliance for Economic Security concluded, in a Jan. 4, 2010 proposal for new FINRA rules, that “FINRA is not a reliable regulatory authority.”[69]
The Stock Analyst Conflict of Interest Scandals
FINRA failed to prohibit the promulgation of stock analyst conflicts of interests, leading to the many scandals of nearly a decade ago. Only actions by state securities regulators (finally joined by the SEC), resulting in a 2003 landmark settlement with ten of the nation’s top broker-dealers, forcing these Wall Street firms to address conflicts of interest between their equity research analysts and investment bankers.
However, FINRA’s rule-making in this area continued to stall. A 2012 GAO Report found that “FINRA has not yet finalized its 2008 proposal designed to consolidate the SRO research analyst rules and implement recommendations made by NASD and NYSE staff in 2005 … FINRA staff, as well as most market participants and observers we interviewed, acknowledged that additional rule making is needed to protect investors, particularly retail investors. In that regard, until FINRA adopts a fixed-income research rule, investors continue to face a potential risk.”[70]
FINRA’s Opposition to a True Fiduciary Standard
Unlike the aloofness expected of a regulatory organization, NASD/FINRA engaged in a decade-long advocacy promoting fee-based brokerage accounts without subjecting its members to the fiduciary standard of conduct required under the Advisers Act.[71]
Indeed, at one time FINRA even argued that its conduct rules were superior to broad fiduciary duties, stating: “[T]he contours of an adviser’s ‘fiduciary duty’ are imprecise and indeterminate. Indeed, these contours have been developed unevenly over time, and much of what the FPA describes as an adviser’s fiduciary duty is more implied than expressed. This general, implied duty simply cannot afford retail investors with the same level of protection as the explicit regulatory standards governing the conduct of business as a broker-dealer, which are developed after extensive public comment and Commission approval. In clearly articulating the obligations of a broker-dealer, SEC and NASD rules provide much better assurance that brokerage customers will be protected.”[72] [Please …!]
FINRA’s Leading Role in the Financial Crisis of 2008-'09
In 2008-09, a massive financial crisis shook the United States and the world. Mortgage-backed securities created from toxic mortgages — the “sh***y products,” as Sen. Carl Levin (D-Mich.) famously demeaned them in the Goldman Sachs hearings in April 2010 — became increasingly devalued. Wall Street’s investment banks made billions packaging toxic mortgages into pooled MBS investment vehicles, then selling them to unsuspecting investors — both institutional investors and individual consumers.[73]
It is well-documented that the largest and most powerful FINRA members worked in the late 1990’s to ensure that the over-the-counter derivatives market would be kept out of the purview of government agencies. Counter-party risk rose even further due to the prevalence of credit default swaps, the holdings of trillions of dollars of which made capital in the investment banks impossible to accurately judge, and credit markets froze.
As the financial crisis and its resulting Great Recession continued, hundreds of largely innocent community banks were seized. The larger investment banks, most with large broker-dealer organizations, were bailed out by Congress — and subsequently thrived and further expanded their already huge market share of the banking sector of the economy.
The cause of the financial crisis lay squarely in the hands of one regulator — the Financial Industry Regulatory Authority Inc., formed in 2007 by the merger of NASD and the enforcement arm of the New York Stock Exchange.
At its core, FINRA was charged with the regulation of brokers and dealers and their related business activities. Yet FINRA, being a membership organization heavily influenced by the same large Wall Street firms which it also regulated, largely ignored the mounting risks to America’s economic vitality and failed to regulate the market-making activities of its member broker-dealer firms. FINRA’s failure to perform its direct oversight duty led to the spectacular and costly collapse of two of its larger members, including the largest bankruptcy in U.S. history.
As the Alliance for Economic Stability, a nonpartisan economic policy organization dedicated to promoting a fair financial marketplace, subsequently observed: “FINRA, as an SRO, has the closest relationship with and most direct scrutiny of Wall Street investment banks. When these investment banks initiated discussions on policy regarding OTC derivatives in 1994, FINRA [then NASD] was in the best position among regulators to intercede and assure appropriate supervision. FINRA failed to do this, even after recommendations for oversight from the GAO.”
AES also noted that despite its expansive powers over broker-dealers, “FINRA failed to oversee the risks posed by OTC derivatives, though all transactions were carried out through FINRA member broker-dealers or their affiliates.”
Finally, AES observed: “FINRA has shown itself to be inept at properly addressing gross negligence done by its members, even when that negligence impacts the entire world economy.”[74]
FINRA’s Role in the Bernie Madoff Scandal
An internal report found that FINRA didn’t fully probe Bernard Madoff’s firm (despite inspecting it annually). When FINRA officials initially denied any wrongdoing in the failure to detect Madoff’s Ponzi scheme, Coffee, a securities law scholar, said in his testimony before the Senate Banking Committee that “Madoff’s brokerage business was by definition within … FINRA’s jurisdiction.”
FINRA Blew It (Big) Again: Stanford
Additionally, in an internal report FINRA admitted that it repeatedly failed to investigate tips about R. Allen Stanford’s alleged $7 billion fraud.[75]
FINRA Misleads Congress
FINRA lay largely silent in the two years following the financial crisis, and by means of its silence largely escaped congressional scrutiny for its key role in effecting the financial crisis. But then, in 2011 and 2012, FINRA began to lobby Congress extensively for an expansion of FINRA’s powers, under the pretense that such an expansion would have prevented Bernie Madoff’s massive Ponzi scheme. Yet many industry observers noted that it was FINRA’s own failures as a regulator which enabled Madoff’s Ponzi scheme to grow to such massive proportions.
FINRA acknowledged that “Mr. Madoff engaged in deceptive and manipulative conduct for an extended period of time….”[76] FINRA even acknowledged that during the 20 years before the Madoff scheme was revealed, “FINRA (or its predecessor, NASD) conducted regular exams of Madoff’s broker-dealer operations at least every other year.”[77] Yet, instead of acknowledging its key failures, FINRA instead asserted that it “regulates broker-dealers, but not investment advisers,” and complained that it could not have detected Madoff’s massive fraud.
But many industry observers note that FINRA’s own failures were largely responsible for enabling Bernie Madoff to perpetuate its fraud. As Professor John C. Coffee Jr. testified before Congress: “Prior to 2006, Madoff Securities was only a broker-dealer and not a registered investment adviser. Thus, during this period, I see no reason that FINRA (or at that time NASD) should have abstained from examining and monitoring the advisory side of Madoff Securities. This side was never formally separated in a different subsidiary; nor was it even geographically remote.”[78]
Professor Coffee continued: “Madoff Securities had no right or privilege to resist any inspection by NASD (or later FINRA) or to fail to provide information on the ground that its investment advisory business was exempt from NASD oversight. If it resisted on this ground, the NASD and FINRA had full power to discipline it severely. NASD Rule 8210 makes it clear beyond argument that NASD can require a member firm to permit NASD to inspect its books, records and accounts, and to provide other information. As NASD further advised its members in its Notice to Members 00-18 (March 2000): 'Implicit in Rule 8210 is the idea that the NASD establishes and controls the conditions under which the information is provided and the examinations are conducted.’”[79]
Furthermore, as noted in the AES Report: “In addition to Coffee’s testimony, Peter J. Chepucavage, general counsel at Plexus Consulting Group LLC; Pete Michaels, partner at Michaels Ward & Rabinovitz LLP; and Samuel Y. Edgerton, partner at Edgerton and Weaver LLP; all of whom are competent to opine on FINRA’s jurisdiction, have made statements concluding that FINRA had jurisdiction over Madoff.”
Over the 20-year span of its multiple examinations, all NASD/FINRA had to do was to ask Bernie Madoff one or two simple questions, which should have been discerned from even a cursory review of the Madoff Securities’ firm’s operations: “Why is Madoff Securities not also registered as an investment adviser?” and “Where are all of the trades you state you make as an investment adviser?” (These trades didn’t show up in the records of Madoff Securities’ clearing arm, as would be expected.)
Even though Bernie Madoff’s investment scheme was uncovered in the year after Madoff Securities finally registered with the SEC as an investment adviser, Rep. Spencer Bachus bemoaned the “lack of oversight [of investment advisers] particularly in the aftermath of the Madoff scandal” in proposing a bill to effect FINRA’s power grab over investment advisers. In so doing, Rep. Bachus perpetuated FINRA’s inappropriate characterization of the Bernie Madoff scandal as a “regulatory gap” — rather than, as so many experts have in essence opined, a colossal failure by FINRA itself.
Many More Scandals at FINRA’s Doorstep
Through its lax regulatory practices and oversight, NASD/FINRA failed to prevent a number of other often-repeated industry-wide scandals that have plagued the broker-dealer industry over the last decade — from the insider trading scandals to penny stocks, limited partnerships, sales of unsuitable mutual fund share classes,[80] and inappropriate sales of auction-rate securities.
FINRA’s Fines Support Its Members!
When FINRA does act against its member firms, the fines it imposed on its member broker-dealer firms are paid to FINRA — to fund FINRA’s activities itself. In essence, its member firms indirectly benefit from their own fines, which serve to lower the annual fees the firms pay for their “self-regulation.”
FINRA Lied to the SEC
In 2011 the SEC stated that FINRA provided “altered documents” during SEC inspections. According to the SEC’s order, the production of the altered documents by FINRA’s Kansas City district office was the third instance during an eight-year period in which an employee of FINRA or its predecessor, NASD, provided altered or misleading documents to the SEC. The SEC ordered FINRA to hire an independent consultant and “undertake other remedial measures to improve its policies, procedures and training for producing documents during SEC inspections.”[81]
FINRA Refuses to Share With State Regulators
FINRA’s continues to largely refuse to share information with state securities regulators, important government authorities in protecting consumer interests and the successful identification and prevention of fraud.[82]
FINRA Wants BDs to Regulate Their Competition
FINRA, a “self-regulatory organization” for broker-dealer firms, essentially proposes that broker-dealer firms would regulate their competition — independent registered investment advisory firms. It’s like drug companies being given control over the regulation of physicians. Only here, investment product manufacturers and their distributors would take over the regulation of fee-only independent financial advisors. It does not take a rocket scientist to realize that the role of the independent financial advisor would be diminished, through regulation, in favor of the product-sales-driven broker-dealer firms.
FINRA’s proposal does not expand, but rather destroys, the concept of “self-regulation.” In this instance, independent small financial advisors would be regulated not by their own professional leaders, but rather by the conflict-ridden large Wall Street broker-dealer firms with which they compete. And since these large broker-dealers and their regulator, FINRA, would love to stem the flow of their customers and their employees from expensive product-sales-oriented broker-dealers to lower-total-fee-and-cost fiduciary fee-only registered investment advisers, there is no doubt that regulation after regulation would be adopted to make it onerous for investment advisers to survive, much less thrive. Consumers would be forced back into the hands of profit-driven, conflict-ridden Wall Street firms.
FINRA seeks to impose an additional layer of costs and bureaucracy on registered investment advisers, who have been directly overseen by the SEC for more than seven decades. Even if FINRA’s own estimates of the additional costs of its regulation were believable, the small businesses which make up the core of the registered investment advisory community would pay thousands and thousands of dollars a year in additional fees. These fees would be the death knell for many of the small, professional firms that seek to provide low-cost investment and financial advice to their clients. The remaining firms would have to raise their fees to their clients substantially to pay the increased registration fees and the attendant compliance costs. Consumers of modest means, such as the young couple starting a family, or the single mother struggling to save and invest for her future retirement needs and the educational futures of her children, would be unable to afford to pay these resulting higher costs.
FINRA, Long Opposed to the Application of a True Fiduciary Standard, Seeks to Redefine the True Fiduciary Standard Out of Existence
FINRA and its members seek to redefine the highest standard of conduct under the law — the fiduciary standard — as a much lower “new federal fiduciary standard.” In essence, they want the low standard of conduct for their members to be one in which conflicts of interest are not avoided — or even brought out into the open.
All Wall Street desires to occur, in connection with the SEC’s current Dodd-Frank Act Section 913 rule-making efforts, is the imposition of “casual disclosures” such as: “The interests of my firm may not be the same as yours.” Of course, such disclosures don’t adequately inform the consumer. Nor are casual disclosures even remotely close to a true fiduciary standard.
Moreover, Wall Street firms are keenly aware of the large body of academic research which reveals that even robust disclosures are ineffective to protect the interests of individual investors in today’s highly complex modern financial world. That’s why a true fiduciary standard which requires keeping the best interests of the client paramount even after disclosures are undertaken — long opposed by FINRA — is so important to consumers.
The Failed “Suitability Doctrine” Continues to Permit “S***y” Products to be Sold to Individual Consumers
The failed doctrine called “suitability” would continue to permit broker-dealer firms to manufacture and sell to their customers “sh***y products” (as Sen. Carl Levin called them), such as securities stuffed with junk mortgages.
Broker-dealer firms desire to escape these higher standards by controlling FINRA[83] and the continued development of standards — not only for themselves, but also for the trusted investment advisory profession which is their competition. For more than seven decades FINRA and its predecessor, NASD, have resisted efforts to raise the standard of conduct of its broker-dealer members above the failed, horrendously low standard of “suitability.” FINRA desires to preserve this failed standard, which offers little protection for the customers of broker-dealers and instead preserves the high profits of broker-dealer firms.
FINRA Attempts to Redefine “Best Interests”
FINRA recently appeared to embrace the duty of a broker to act in the “best interests” of its customers,[84] similar to the language contained in Section 913 of the Dodd Frank Act.[85] Does this recent pronouncement by FINRA herald a fiduciary duty, imposed by FINRA, upon brokers?[86] After all, it has been stated that, “The centerpiece of the fiduciary duty is the requirement that investment advisers act in the best interest of their clients.”[87]
FINRA’s member firms fear that the phrase “best interests” may not be in accord with current broker-dealer business practices,[88] although FINRA has stated that its member’s business practices are still permitted.[89] In essence, FINRA touts that its members are required to act in the “best interests” of their customers, yet does little to give true meaning to, or enforce, that standard. In fact, FINRA’s understanding[90] of its own “best interests” standard – based upon mere disclosure of conflicts of interest and not requiring full disclosure of compensation received by the broker-dealer and/or its registered representative (certainly a material fact which should be disclosed) – is not in accord with consumer or advisor[91] understanding of the fiduciary standard of conduct, nor in accord with recent judicial pronouncements, not only under the Advisers Act[92] but also in other contexts applying the “best interests” standard in fiduciary law.[93]
In fact, FINRA recently stated in a letter to the SEC that it believed “it would be a mistake to … impose the investment adviser standard of care and other requirements of the Advisers Act to broker-dealers,”[94] seemingly setting the stage for defining a “fiduciary standard” which is anything but the real thing.
This all begs the question. Shouldn’t the phrase: “Member, FINRA”, be viewed like the warnings on cigarette packages – i.e., as a consumer warning sign?
Consolidating power in FINRA over all investment business would give Wall Street increased control over America’s economy
FINRA would continue as the most powerful organization affecting nearly all aspects of the securities industry. Yet it is an organization whose failure to achieve the purposes for which it was created makes it highly questionable whether it should even continue.
Individual Americans denied affordable, trusted advice
Individual Americans — all of whom deserve trusted, independent advice — would be denied the protections of the true fiduciary standard and access to professional investment advice — a woeful prospect for the future economic security of all Americans — and America itself. “[E]ffective financial planning is important to the success of a free-market economy. If people do not make careful, rational decisions about how to self-regulate the patterns of consumption and savings and investment over their life cycles, government will have to step in to save people from the consequences of their poor planning.”[95]
FINRA’s Dishonesty – Even with Respect to its Own Name
FINRA has been dishonest.
In 2007, NASD and NYSE’s member regulation, enforcement and arbitration functions merged to form FINRA, the primary securities industry SRO responsible for overseeing broker-dealers. At the time of its formation, an objection was made by the Financial Planning Association (FPA) to FINRA’s all-encompassing name, “Financial Industry Regulatory Authority.” The FPA stated that the name implied that the self-regulatory organization would have jurisdiction over more than just the brokerage industry and hence was “misleading to the public.”[96] FINRA’s response? “I would need a degree in psychology to comment on the level of paranoia,” stated a FINRA spokesman.
Yet, despite its assertion FINRA shortly thereafter, and to this day, lobbies for oversight over registered investment advisers, a direct contradiction to its earlier statements.
While one might seek to ascribe such action to a “change of heart” by FINRA, in September 2007 this author was approached by a FINRA vice-president who admitted that not only had FINRA contemplated within the preceding year oversight of registered investment advisers, but that FINRA even had a committee explore the resources needed for such a task.
Not “paranoia.” Rather, a simple conclusion that FINRA cannot be trusted.


Disband FINRA - Part Four. Planning for the Next Opportunity with a PRO.

The next financial crisis will come. The reforms instituted, and which remain to be instituted, during the legislative and regulatory processes following the 2008-9 financial crisis have been severely watered down. As a result, Congress and regulatory agencies have laid the foundation for yet another resurgence of excessive greed, with its ultimate dire consequences for the capital markets and our economy.
The U.S. Congress rarely acts until a crisis has occurred. So, sitting here in mid-2013, we must ask whether we can outline the reforms that can voluntarily be adopted, in preparation for such an event. Why? So we can, as a profession, be prepared when the next crisis triggers Congress to take action.
Embrace the Fiduciary Principle
Given the complexity and global nature of the modern financial market, attempts to regulate the provision of personalized investment advice by specific rules as utilized by FINRA under its current regulatory regime will fail. Such an approach will inevitably encounter the fundamental problem of regulatory arbitrage. Such specific rules should just permit “financial institutions find new ways to get around government rules, thus creating a never-ending spiral of rulemaking and rule evading.”[97]
Instead, we must embrace principles-based regulation, and in particular the fiduciary principle. While there have been many judicial elicitations of the fiduciary standard, including Justice Benjamin Cardozo’s lofty elaboration, a relatively recent and concise recitation of the fiduciary principle can be found in a case in which Lord Millet undertook what has been described as a “masterful survey”: “A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.  The distinguishing obligation of a fiduciary is the obligation of loyalty.  The principle is entitled to the single-minded loyalty of his fiduciary.  This core liability has several facets.  A fiduciary must act in good faith; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal.  This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of the fiduciary obligations.  They are the defining characteristics of a fiduciary.”[98]
Disband FINRA
 “[A] cursory examination of FINRA’s current leadership paints a clear picture of a regulator that is still captured by the [broker-dealer] industry it is tasked with regulating … Effective, independent and efficient government regulation is the only proper way to safely oversee our markets. Our economy is too important to be left in the hands of the very financial industry that brought us to the brink of collapse … [FINRA CEO Robert] Ketchum argued that FINRA has a ‘strong track record in our examination and enforcement oversight.’ However, POGO believes that FINRA’s track record tells a very different story. In fact, financial sector self-regulators, despite the power vested in them by the federal government, have failed to prevent virtually all of the major securities scandals since the 1980s.”[99]
Even in 1941, FINRA (NASD) commented upon the necessity of raising the standards of conduct, when the Chairman of the NASD early on opined: “[T]he time may come when we can arrive at a more professional status and we can give more of our attention as to who should be in the investment business ... The principal by-product [of formation of the SRO], which I don’t believe the founding fathers of this Association ever thought of, is that for the first time in history the securities dealer begins to see what he looks like and it hasn’t been altogether a pleasing sight.”[100] Of course, as discussed over the past several days in this series of articles, FINRA has failed miserably to attain "professional status" for the "securities profession," primarily because it has never raised its standards of conduct for its members and has never put the interests of the consumer first.
The Maloney Act is a failed experiment. Congress should disband FINRA and return broker-dealers to direct oversight by the SEC. Certainly, FINRA’s failures should not be rewarded.
A New Professional Regulatory Organization: 8 Key Attributes
To replace FINRA, with regard to the market conduct regulation of those brokers and advisors providing financial planning and/or personalized investment advice, I propose the formation of a Professional Regulatory Organization (PRO), similar to the organizations which exist today for lawyers and certified public accountants.
How would a PRO be different from FINRA? Through these eight key attributes:
First and foremost, the PRO would have as its members individuals (not firms) who are qualified to become members of the profession. History has shown that individuals, when guiding professional organizations (assisted by consumer representatives), seek to preserve and enhance professional standards of conduct. In contrast, firms as members of an SRO seek to consistently lower standards of conduct. (This is, perhaps, the primary reason for FINRA’s abject failure to raise standards over the past seven decades.)
Second, the PRO would possess a clear and unambiguous adherence to a bona fide fiduciary standard for its members. The principles of the fiduciary standard would be clearly stated. As part of same, it would be recognized that, under the fiduciary duty of loyalty, disclosure of the conflict of interest is only a minor part of the fiduciary’s obligation. Such disclosure must be affirmatively and comprehensively made in a manner in which the financial advisor ensures client understanding of the conflict of interest and its possible ramifications. Thereafter, the client’s informed consent (not mere consent) must be secured. Even then the transaction must remain substantively fair to the client. In other words, it would be recognized that no client would voluntarily provide consent to be harmed; clients are not that gratuitous toward their financial advisors.
Additionally, removal of the fiduciary “hat,” while not impossible, would be restricted to those situations in which is was likely that no further personalized investment advice would be provided to the client. Moreover, the fiduciary obligations would extend to the entire relationship with the client; the fallacy that a dual registrant can wear two hats at once will be forever buried.
Third, the PRO would possess as its primary purpose the protection of the public interest.
Fourth, a four-year college degree from accredited institution would be required, plus an advanced course of study in financial planning and investments.[101] Passage of comprehensive entrance exam would also required for licensure to provide "personalized investment advice" to "consumers." Consumers reasonably expect that their financial and investment advisors are experts; we should educate and test to ensure a baseline level of expertise exists, rather than permitting nearly anyone to become licensed to provide financial advice following a couple of weeks of study of an exam manual. Continuing education would also be required.
Fifth, peer review of alleged violations would be initiated. One of the problems of securities regulation today is its focus on disclosure; in part, this is because securities examiners can test adherence to disclosure obligations fairly easily. Yet, evaluation of adherence to the full extent of the fiduciary’s duty of loyalty, and adherence to the fiduciary’s duty of due care, will usually require the judgment of professionals with substantial experience in the field. Hence, mandatory peer review of disciplinary matters should occur.
Sixth, all fines imposed would be paid to U.S. Treasury and/or to the states, as appropriate, to avoid the inevitable conflict of interest arising from using fines imposed upon members to pay any expenses of the professional organization. Only the costs actually incurred by the professional organization in undertaking an investigation and any enforcement action could be recovered against a firm found to have committed a breach of duty.
Seventh, either mandatory pro bono hours each year, or a mandatory annual contribution to a not-for-profit providing such services, would be required of all members. Because, in the end, the profession must serve the public, including those who may be unable to afford (even on an hourly basis) the services of professional advisors.
Eighth, through legislative fiat (at the national and/or state levels), only professionals duly licensed as financial and investment advisors would be permitted to hold out as such (including a prohibition on the use of similar titles, or designations, by non-licensed individuals). Only those persons duly qualified would be permitted to practice and be allowed to utilize titles denoting professional status.
The Journal of Financial Planning initially published Dick Wagner's seminar article, "To Think...Like a CFP" over 30 years ago, in 1980. Dick Wagner called for financial planning to become a true profession. Mr. Wagner observed: "A true profession and its standards are important enough that its principles generally will prevail—often at the expense of apparent self-interest. Certain types of employment will be refused, certain procedures will be unacceptable under any circumstances. Financial sacrifices will be made in the course of these decisions. However, the ultimate financial impact will be positive because consumers will know what to expect and will have made the informed decision to pay for it!"
In other words, should consumers finally be able to trust all financial and investment advisers, as would exist if a true profession exist founded upon the fiduciary principle, demand for financial and investment advice in today’s complex financial world would soar. Additionally, the profession would attract more and better new entrants, to assist in serving the burgeoning demand for advice.
Can’t FINRA Change?
This is doubtful, even if legislative action and SEC rule-making occurs which enables FINRA to achieve all of the foregoing attributes of a true Professional Regulatory Organization.
At its core, FINRA does not understand a true fiduciary standard of conduct, nor does it embrace a true fiduciary standard. It would take years, if not decades, to effect the culture change within FINRA necessary to effectuate the adoption, promulgation and enforcement of a true fiduciary standard of conduct.
Many a time I have seen a non-fiduciary broker hired by a registered investment adviser (not dual registrant) firm. And many a time I have seen the non-fiduciary broker unable to adjust, even after a year or more, to the strict ethical code to which true fiduciary advisors adhere. FINRA would encounter even more difficulties in this regard.
Of course, the SEC could compel FINRA to adopt Rules of Conduct which embrace all of the attributes of a true fiduciary standard of conduct. If FINRA refused to do such, the SEC could proceed administratively against FINRA as a substandard SRO, applying Securities Exchange Act § 19(9)-(h).[102] Yet, realistically, given the close relationship between the SEC and FINRA, movement of personnel back and forth between the SEC, FINRA, the law firms serving Wall Street, and large Wall Street firms themselves, this does not appear to be an option. It would take tremendous courage for three SEC Commissioners to force through such changes, as well as a Congress which understood the importance of the fiduciary standard of conduct for all Americans.
Hence, the far better approach is to “start over” and form a true Professional Regulatory Organization.
Can a PRO Be Formed Now?
Not right away. It would likely require action by Congress (although enactment one state at a time is an alternative). And, as we know, Congress does not usually act until a major financial crisis comes along.
But we can’t wait until the next financial crisis to begin the process of forming a Professional Regulatory Organization. It must begin soon, if not now.
What Can We Do to Prepare?
We must, as professionals, define and embrace bona fide fiduciary standards of conduct.
Currently financial and investment advisors have several voluntary organizations. Some of them award certifications and designations; some do not. Many of them have ethical codes of conduct, but I would argue that most of these ethical codes fail to set forth the parameters of fiduciary obligations correctly, or in sufficient detail.[103]
If we are to achieve a true profession, at the time of the next financial crisis, we must prepare, and voluntarily unite around, robust Rules of Professional Conduct in which a true fiduciary standard is embraced by all of the members of such an organization and enforced through appropriate peer review. Then, armed with experience over the years in applying such a standard, the organization and its professionals would be well-equipped to petition and inform Congress of the merits of a true PRO at the time of the next major financial crisis.
What About the Dodd Frank Act?
It is possible that a bona fide fiduciary standard can be imposed by the SEC on all those who provide personalized investment advice under Section 913 of the Dodd Frank Act. I (and many others) will continue to advocate for this, through comment letters, other writings, and visits to the SEC. I will also continue my advocacy in support of the DOL’s re-proposal of its “Definition of Fiduciary” – in which the strict “sole interests” standard would be applied to nearly all providers of investment advice to defined contribution plans and IRA accounts.
Yet, as seen in the SEC’s March 2013 Request for Information (“RFI”), major economic interests (Wall Street firms and insurance companies) have influenced the SEC to “assume” various parameters for a “fiduciary standard” that is not really a fiduciary standard at all – at least in the context of the world of professional advisors. Rather, the SEC’s RFI posits a standard which is more akin to the very weak fiduciary standard seen in the world of employer-employee relationships, applying only basic principles of agency law. The SEC’s RFI ignores the stricter fiduciary law requirements found in professional advisor-client relationships[104] and reflects an inadequate understanding of the substantial public policy rationale leading to the imposition of fiduciary status upon the professional advisor.[105]
While the chance exists to “turn the tide” of rule-making at the SEC, and hence we should work diligently for the SEC’s enactment of an appropriate and bona fide fiduciary standard. However, we must be prepared for the more likely outcome that the SEC will fail to act appropriately.
Take the Next Step
Hence, in the event (as appears likely at present) that the “fiduciary standard” is either not imposed upon brokers providing personalized investment advice by the SEC, or some weaker standard is imposed, as professionals we must be prepared to take the next step.
We must be prepared to embrace, voluntarily, through an existing organization (which possesses the courage to step up to the table) or a new organization, bona fide fiduciary obligations similar to those seen for other professional advisors (such as attorneys). We must be prepared to hold that, while reasonable restrictions can be imposed upon the scope of an engagement, that such professional, core fiduciary obligations cannot be waived.
We must be prepared to approach Congress, when the next financial crisis occurs. Only we, as professionals, if armed with a history of its practical application, will be able to call upon Congress to implement a true fiduciary standard and the formation of a Professional Regulatory Organization. It may take years, if not decades, for the opportunity to arise … but it will.
Hopefully the opportunity to spur Congress to act will occur soon (although I don’t wish for another financial crisis and its dreadful effects on our society), in order that our fellow citizens no longer suffer the harm they currently endure, far too often, at the hands of those not currently bound by a fiduciary standard.
Hopefully the opportunity will appear soon, in order that trust can be restored to our system of capital markets, greater capital formation occur, and we enter into a new era of American economic prosperity as a result.
Hopefully a true fiduciary standard and a Professional Regulatory Organization will come to fruition soon, for the benefit of all providers of investment and financial advice, in order that we may then walk the streets proudly as the members of true profession.
Hopefully this vision will achieve reality, and soon. For the benefit of all consumers of financial and investment advice. For the sake of the financial futures of our fellow Americans. For the economic stability and vitality of America itself.
Ron Rhoades, JD, CFP® serves as Chair of the Steering Committee of The Committee for the Fiduciary Standard.  He is an Asst. Professor of business law and financial planning at Alfred State College, Alfred, NY.

[1] Simon Johnson’s complete article is available at http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/307364/?single_page=true. See also Simon Johnson, 2011, 3 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Vintage Press.
[2]Finance, which accounts for only about 8% of GDP, reaps about a third of all profits.” Noah Smith, http://noahpinionblog.blogspot.com/2013/02/finance-has-always-been-more-profitable.html.
See also James Kwak, Why Is Finance So Big? (Feb. 29, 2012): “Many people have noted that the financial sector has been getting bigger over the past thirty years, whether you look at its share of GDP or of profits. The common defense of the financial sector is that this is a good thing: if finance is becoming a larger part of the economy, that’s because the rest of the economy is demanding financial services, and hence growth in finance helps overall economic growth. But is that true? … the per-unit cost of financial intermediation has been going up for the past few decades: that is, the financial sector is becoming less efficient rather than more.” Available at http://baselinescenario.com/2012/02/29/why-is-finance-so-big/.
[3] The consulting firm Edelman Berland publishes a “Trust Barometer” each year that surveys various issues dealing with trust in both the U.S. and globally. One question posed is, “How much do you trust businesses in each of the following industries to do what is right?” Globally, the two industries listed at the bottom of the list are “Financial services” and “Banks” - both at 50% in the 2013 survey. 2013 Edelman Trust Barometer Executive Summary, available at http://trust.edelman.com/trust-download/executive-summary/.
[4] “Foreign investors now hold slightly less than 55% of the publicly held and publicly traded U.S. Treasury securities, 26% of corporate bonds, and about 12% of U.S. corporate stocks.1 The large foreign accumulation of U.S. securities has spurred some observers to argue that this foreign presence in U.S. financial markets increases the risk of a financial crisis, whether as a result of the uncoordinated actions of market participants or by a coordinated withdrawal from U.S. financial markets by foreign investors for economic or political reasons.” James K. Jackson, “Foreign Ownership of U.S. Financial Assets: Implications of a Withdrawal” (Congressional Research Service, April 8, 2013), p.1.
[5] Putnam, R., 1993, Making Democracy Work: Civic Traditions in Modern Italy, Princeton University Press, Princeton, NJ.; La Porta R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny, 1997, “Trust in Large Organizations,” American Economic Review, 87, 333-338.
In an influential paper, Knack and Keefer found that a country's level of trust is indeed correlated with its rate of growth. Knack, S. and Keefer, P. (1996). "Does social capital have an economic payoff?: A cross country investigation," The Quarterly Journal of Economics, vol 112, p.p 1251. See also Zak, P., and S. Knack, 2001, “Trust and Growth,” The Economic Journal, 111, 295-321.
[6] Guiso, L., P. Sapienza, and L. Zingales, 2007, “Trusting the Stock Market,” Working Paper, University of Chicago.
[7] Georgarakos, Dimitris and Inderst, Roman, Financial Advice and Stock Market Participation (February 14, 2011). ECB Working Paper No. 1296. Available at SSRN: http://ssrn.com/abstract=1761486.
[8] Ronald J. Colombo, Trust and the Reform of Securities Regulation, 35 Del. J. Corp. L. 829 (2010).
[9] Id. at 875. Prof. Colombo further observed: “Increased regulation of broker-dealers is likely to do little harm, as it is unclear whether sufficient room for high-quality, affective/generalized trust exists here in the first place. And if, in the twenty- first century, the brokerage industry relies upon primarily cognitive and specific trust (due to increased movement toward the discount-broker business model), such increased regulation could be beneficial.” Id. at 876. Prof. Colombo explained the concept of cognitive trust: “Reliance and voluntary exposure to vulnerability stemming from cognitive trust is not based upon emotions or norms, but rather ‘upon a cost-benefit analysis of the act of trusting someone.’ For this reason, Williamson rejects even calling such reliance ‘trust.’ To him, such reliance is a form of calculativeness, which serves to economize on the scarcity of one's mental energies and time. The potential vulnerabilities accepted are not due to ‘trust,’ but to rational risk management-to the fact that ‘the expected gain from placing oneself at risk to another is positive.’ Id. at 836.
[10] Tamar Frankel, “Regulation and Investors’ Trust In The Securities Markets,” 68 Brook. L. Rev. 439, 448 (2002).
[11] “Regulatory capture … describes a situation in which a whole institution becomes strategically dependent upon those it is supposed to regulate.  As a result of capture, the regulators not only represent private interests and on a short term basis but also – for purposes appraising any risks of such a strategy – are reliant on the worldview, working assumptions, datasets, ‘models’, ratings and other techniques and judgments of the private sector.”  Dorn, Nicholas, Ponzi Finance, Regulatory Capture and the Credit Crunch (March 19, 2009). Available at SSRN: http://ssrn.com/abstract=1365250.
[12] Jim Pasztor, MSF, MPASSM, CFP®, Moral Hazard & Dangers to Market Stability (April 22, 2013), College for Financial Planning White Paper No. 1302, available at http://www.cffpinfo.com/eBooks/Moral_Hazard.pdf.
[13] Simon Johnson, The Quiet Coup (2009).
[14] John R. Dos Passos, A Treatise of the Law of Stock-Brokers and Stock-Exchanges (Banks Law Publishing Co., 1905), Vol. 1, at p. 173.
[15] Id., at Vol. 1, p.176, citing Banta v. Chicago, 172 Ill. 201.
[16] Id. at at Vol. 1, pp. 180-1.
[17] As was well-known in the early case law: "The principle is undeniable that an agent to sell cannot sell to himself, for the obvious reason that the relations of agent and purchaser are inconsistent, and such a transaction will be set aside without proof of fraud.” Porter v. Wormser , 94 N. Y. 431, 447 (1884). The Investment Advisers Act of 1940 provided a specific exception to this legal principle for investment advisers who engaged in principle trades, but requiring as a safeguard in-advance disclosures and the consent of the client.
[18] Cheryl Goss Weiss, A Review of the Historic Foundations of Broker-Dealer Liability for Breach of Fiduciary Duty, 23 J. CORP. L. 65, 66 (1997) (providing a summary of the historical development of brokers and dealers before the ’33 and ’34 securities acts).
[19] See RESTATEMENT (THIRD) OF AGENCY § 1.01 cmt. e (2006) (“Any agent has power over the principal’s interests to a greater or lesser degree. This determines the scope in which fiduciary duty operates.”).
[20] Birch v. Arnold, 88 Mass. 125; 192 N.E. 591; 1934 Mass. LEXIS 1249 (Mass. 1934).
[21] Id.
[22] Birch v. Arnold, citing Reed v. A. E. Little Co., 256 Mass. 442, 152 N.E. 918, and Wendt v. Fischer, 243 N.Y. 439, 443, 444, 154 N.E. 303.
[23] Norris v. Beyer, 124 N.J. Eq. 284; 1 A.2d 460 (1938).
[24] Hazen, Thomas Lee, Stock Broker Fiduciary Duties and the Impact of the Dodd-Frank Act. North Carolina Banking Institute, Vol. 15, 2011; UNC Legal Studies Research Paper No. 1767564. Available at SSRN: http://ssrn.com/abstract=1767564See also Rhoades, Ron A., “Shhh!!! Brokers Are (Already) Fiduciaries ... Part 1: The Early Days,” available at http://scholarfp.blogspot.com/2013/04/shhh-brokers-are-already-fiduciaries.html.
[25] Matthew P. Allen, A Lesson from History, Roosevelt to Obama - The Evolution of Broker-Dealer Regulation: From Self-Regulation, Arbitration, and Suitability to Federal Regulation, Litigation, and Fiduciary Duty, Entrepreneurial Bus. Law. J. (2010), at p. 20, citing Steven A. Ramirez, The Professional Obligations ofSecurities Brokers Under Federal Law: An Antidote for Bubbles?, 70 U. Cin. L. Rev. 527 (2002), at p. 534 (quoting H.R. Rep. No. 73-85, at 1-2 (1933)).
[26] SEC Staff Study (Jan. 2011) at pp. iv, 51. See also Arleen W. Hughes, Exchange Act Release No. 4048 (Feb. 18, 1948) (Commission Opinion), aff’d sub nom. Hughes v. SEC, 174 F.2d 969 (D.C. Cir. 1949) (“Release 4048”) (noting that fiduciary requirements generally are not imposed upon broker-dealers who render investment advice as an incident to their brokerage unless they have placed themselves in a position of trust and confidence).
[27] Twentieth Century Fund, The Securities Markets (1935), p. 662. The book can be found online at http://catalog.hathitrust.org/Record/005309181.
[28] Id. at p. 673.
[29] Id. at 694.
[30] See, e.g., John Howat and Linda Reid, “Compensation Practices for Retail Sale of Mutual Funds: the Need for Transparency and Disclosure,” 12 Fordham J. of Corp. & Fin. Law 685, 692 (“The NASD grew out of the Investment Bankers Code Committee (the ‘IBCC’) formed by the investment banking business under the NIRA. When the NIRA was declared  unconstitutional, the IBCC was continued on a voluntary basis, becoming the Investment Bankers Conference Committee, its function to be one of discussion and conference with federal agencies looking toward the establishment of an organization to preserve and formalize the values of the code.  A successor organization known as the Investment Bankers Conference, Inc. (the ‘IBC’) was established to proceed more formally towards the objective of a legal entity empowered to administer rules promoting ‘high standards of commercial honor.’ An important objective of the IBC was the development of a plan of self-regulation for over-the-counter markets. By November of 1937, the SEC and an IBC governing committee prepared the draft of legislation to accomplish the self-regulatory objective. The bill, known as the Maloney Act, was signed into law in 1938. The NASD, the successor to the IBC, was registered by the SEC as a national securities association under section 15A of the 1934 Securities Exchange Act.”)
[31] Chester T. Lane, Address Before The Seattle Bond Club (Mar. 14, 1938), available at http://www.sec.gov/news/speech/1938/031438lane.pdf.
[32] George C. Matthews, A Discussion of the Maloney Act Program, before the Investment Bankers Association of America, October 23, 1938, available at http://sec.gov/news/speech/1938/102338mathews.pdf.
[33] Senator Francis T. Maloney, Regulation of the Over-the-Counter Security Markets, Address at the California Security Dealers Association, Investment Bankers Association, National Association of Securities Dealers 2 (Aug. 22, 1939) (transcript available in the SEC Library at 11 SEC Speeches, 1934-61).
[34] The Bulletin, published by the National Association of Securities Dealers, Volume I, Number 2 (June 22, 1940).
[35] N.A.S.D. News, published by the National Association of Securities Dealers, Volume II, Number 1 (Oct. 1, 1941).
[36] History of the NASD, by Wallace H. Fulton, First President [Executive Director] of the NASD, 1939 – 1964, available at http://www.nmta.us/site/DocsPosted/CFPB/HistoryoftheNASD.pdf.
[37] The Rules of Fair Practice set standards for the industry's dealings with investors. A key provision of the rules - Article III, Section 1 - read, "A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principals of trade." Id. See also Paul S. Grant, The National Association of Securities Dealers: Its Origin and Operation, 1942 WIS. L. REV. 597, 602 (1942).
[38] See Laura S. Unger, On-Line Brokerage: Keeping Apace Of Cyberspace, in Securities Law & the Internet: Doing Business in a Rapidly Changing Environment 2000, at 237, 285 (PLI Corp. Law & Practice, Course Handbook Series No. B-1189, 2000) ("In a traditional full-service brokerage relationship, a customer interested in a security visits or calls his or her registered representative ….").
[39] Certain Broker-Dealers not to be Investment Advisers, Advisers Act Release Nos. 34-51523; IA-2376, Fed. Reg. 20424, 20432 (proposed Apr. 19, 2005), vacated by Fin. Planning Ass'n v. SEC, 482 F.3d 481 (D.C. Cir. 2007).
[40] Ronald J. Colombo, Trust and the Reform of Securities Regulation, 35 Del. J. Corp. L. 829 (2010).
[41] Joseph L. Hood Jr., Arbitration and Litigation of Public Customers' Claims Against Broker-Dealers After McMahon, 19 St. Mary's L.J. 541, 561 (1988).
[42] Id.
[43] Tamar Frankel, The Maloney Act Experiment, 6 Boston Coll. L. Rev. 187, 197 (1965).
[44] The suitability standard imposes both additional substantive (fairness) and procedural (disclosure) obligations upon broker-dealers, in addition to the requirements of good faith applicable to the performance of contracts between all those in arms-length relationships. The SEC and the U.S. Consumer Futures Trading Commission (CFTC) recently summarized the broker-dealers suitability obligation as follows:
Under the federal securities laws and SRO rules, broker-dealers are required to deal fairly with their customers. This includes having a reasonable basis for recommendations given the customer’s financial situation (suitability), engaging in fair and balanced communications with the public, providing timely and adequate confirmation of transactions, providing account statement disclosures, disclosing conflicts of interest, and receiving fair compensation both in agency and principal transactions. In addition, the SEC’s suitability approach requires BDs to determine whether a particular investment recommendation is suitable for a customer, based on customer-specific factors and factors relating to the securities and investment strategy. A BD must investigate and have adequate information regarding the security it is recommending and ensure that its recommendations are suitable based on the customer’s financial situation and needs. The suitability approach in the securities industry is premised on the notion that securities have varying degrees of risk and serve different investment objectives, and that a BD is in the best position to determine the suitability of a securities transaction for a customer. Disclosure of risks alone is not sufficient to satisfy a broker-dealer’s suitability obligation.
A Joint Report of the SEC and the CFTC on Harmonization of Regulation (Oct. 2009), available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, at p.9.
[45] See, e.g., Henry T. C. Hu, Illiteracy and Intervention: Wholesale Derivatives, Retail Mutual Funds, and the Matter of Asset Class, 84 Geo. L.J. 2319, 2332 (1996).
[46] See 17 C.F.R. § 240.10b-5, providing: “It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”
[47] Clifford E. Kirsch, Broker-Dealer Regulation § 1:2 (2008). The suitability standard imposes both additional substantive (fairness) and procedural (disclosure) obligations upon broker-dealers, in addition to the requirements of good faith applicable to the performance of contracts between all those in arms-length relationships. The SEC and the U.S. Consumer Futures Trading Commission (CFTC) recently summarized the broker-dealers suitability obligation as follows:
Under the federal securities laws and SRO rules, broker-dealers are required to deal fairly with their customers. This includes having a reasonable basis for recommendations given the customer’s financial situation (suitability), engaging in fair and balanced communications with the public, providing timely and adequate confirmation of transactions, providing account statement disclosures, disclosing conflicts of interest, and receiving fair compensation both in agency and principal transactions. In addition, the SEC’s suitability approach requires BDs to determine whether a particular investment recommendation is suitable for a customer, based on customer-specific factors and factors relating to the securities and investment strategy. A BD must investigate and have adequate information regarding the security it is recommending and ensure that its recommendations are suitable based on the customer’s financial situation and needs. The suitability approach in the securities industry is premised on the notion that securities have varying degrees of risk and serve different investment objectives, and that a BD is in the best position to determine the suitability of a securities transaction for a customer. Disclosure of risks alone is not sufficient to satisfy a broker-dealer’s suitability obligation.
A Joint Report of the SEC and the CFTC on Harmonization of Regulation (Oct. 2009), available at http://www.sec.gov/news/press/2009/cftcjointreport101609.pdf, at p.9.
[48] 60 Am. U.L. Rev. 1265, 1275
[49] “In 1980 there were 564 funds with assets totaling $134.8 billion.”  John Howat and Linda Reid, 12 Fordham J. of Corp. & Fin. Law 685, 686 (2007).  The combined assets of U.S. mutual funds were $13.8 trillion dollars in April 2013, according to the Investment Company Institute (“Trends in Mutual Fund Investing: April 2013” per May 30, 2013 release by the I.C.I. available at http://www.ici.org/research/stats/trends/trends_04_13.
[50] Generally, FINRA rules only impose the ill-defined duties to engage in fair and balanced communications with the public, and to receive “fair compensation.” However, the SEC and FINRA have required disclosure of certain compensation arrangements in certain circumstances. See, e.g., SEC Staff Study (2011), at pp.52-57. Yet, even then, rather than specific disclosures of the amount or percentage of compensation received in a particular transaction by or with a client, only “casual disclosure” is often mandated. See, e.g., Edward Jones, “Understanding How We Are Compensated When We Provide Financial Services” (https://www.edwardjones.com/groups/ejw_content/@ejw/documents/web_content/web223333.pdf, retrieved 6/22/13), listing a wide variety of sources of revenue, and stating “Fees, commissions and other payments should be fully disclosed” [emphasis added], yet by use of its aspirational language (“should”) not actually mandating specific disclosure of the amount of disclosures.
The Edward Jones disclosure form also states, “Although some investments provide more compensation to financial advisors than others, this should not influence our financial advisors. Your financial advisor should explain all commissions, sales charges, markups and fees when discussing investment options with you.” [Emphasis added.] Again, the duty of disclosure – while appearing to the customer (assuming the customer accessed this document on Edward Jones’ web site and read it) appears comprehensive, but the aspirational language (i.e., using “should” instead of “must”) fails to impose any duty to quantify fees and costs for the individual investor, nor any affirmative duty to disclose all of the sources of remuneration with respect to any particular product.
Moreover, Edward Jones’ statement that variable compensation “should not influence our financial advisors” flies in the face of the fact that variable compensation arrangements have an insidious effect on most financial advisors’ recommendations, as was known early in the history of securities regulation [see, e.g. SEC vs. Capital Gains Research Bureau, 275 U.S. 180 (1963) (“[T]he [Securities Exchange] Commission made an exhaustive study and report which included consideration of investment counsel and investment advisory services. This aspect of the study and report culminated in the Investment Advisers Act of 1940. The report reflects the attitude -- shared by investment advisers and the Commission -- that investment advisers could not ‘completely perform their basic function -- furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments -- unless all conflicts of interest between the investment counsel and the client were removed.’ The report stressed that affiliations by investment advisers with investment bankers, or corporations might be “an impediment to a disinterested, objective, or critical attitude toward an investment by clients ….’ This concern was not limited to deliberate or conscious impediments to objectivity. Both the advisers and the Commission were well aware that whenever advice to a client might result in financial benefit to the adviser -- other than the fee for his advice – ‘that advice to a client might in some way be tinged with that pecuniary interest [whether consciously or] subconsciously motivated ….’ The report quoted one leading investment adviser who said that he ‘would put the emphasis . . . on subconscious’ motivation in such situations. It quoted a member of the Commission staff who suggested that a significant part of the problem was not the existence of a ‘deliberate intent’ to obtain a financial advantage, but rather the existence ‘subconsciously [of] a prejudice’ in favor of one's own financial interests.” Id.] and as more recently confirmed by various academic research by behavioral scientists. See, e.g., Cain, Daylian M., Loewenstein, George F. and Moore, Don A., The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest (December 1, 2003). Available at SSRN: http://ssrn.com/abstract=480121(“Conflicts of interest can lead experts to give biased and corrupt advice. Although disclosure is often proposed as a potential solution to these problems, we show that it can have perverse effects. First, people generally do not discount advice from biased advisors as much as they should, even when advisors’ conflicts of interest are honestly disclosed. Second, disclosure can increase the bias in advice because it leads advisors to feel morally licensed and strategically encouraged to exaggerate their advice even further. As a result, disclosure may fail to solve the problems created by conflicts of interest and may sometimes even make matters worse.”) Id. (abstract). Query whether Edward Jones’ statement, to the effect that differential or variable compensation arrangements should not affect financial advisors’ recommendations, is misleading to investors, given the long-standing recognition that differential compensation does influence an advisor’s judgment.
[51] In re Morgan Stanley & Van Kampen Mutual Fund Securities Litigation, 2005 U.S. Dist. LEXIS 20758 (SDNY, 2006); see also Hoffman v. UBS-AG, 591 F. Supp. 2d 522 (S.D.N.Y. 2008); In re UBS Auction Rate Securities Litigation, 2010 U.S. Dist. LEXIS 59024 (SDNY, 2010).
[52] Castillo v. Dean Witter Discover & Co., No. 97 Civ. 1272, 1998 U.S. Dist. LEXIS 9489, 1998 WL 342050, at *9 (finding no violation of antifraud provisions of securities laws where firm did not have a duty to disclose that account executives received more compensation for selling proprietary mutual funds than other funds.)
[53] While disclosure of material facts, such as compensation, is important, securities regulation’s often blind reliance on disclosure remains misplaced. See, e.g., Paredes, Troy A., Blinded by the Light: Information Overload and its Consequences for Securities Regulation (June 1, 2003). Washington University Law Quarterly, Forthcoming. Available at SSRN: http://ssrn.com/abstract=413180 or http://dx.doi.org/10.2139/ssrn.413180 (“[I]f the users do not process information effectively, it is not clear what good mandating disclosure does … The federal securities laws generally assume that investors and other capital market participants are perfectly rational, from which it follows that more disclosure is always better than less. However, investors are not perfectly rational. Herbert Simon was among the first to point out that people are boundedly rational, and numerous studies have since supported Simon’s claim. Simon recognized that people have limited cognitive abilities to process information … .”). See also Davidoff, Steven M. and Hill, Claire A., Limits of Disclosure (October 29, 2012). Seattle University Law Review, Forthcoming; Minnesota Legal Studies Research Paper 12-63; Ohio State Public Law Working Paper 205. Available at SSRN: http://ssrn.com/abstract=2168427. (“The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions.”) Id. at p.6.
[54] Tamar Frankel, f/k/a Tamar Hed-Hoffman, “The Maloney Act Experiment,” 6 Boston College L.R. 186, 217 (1965).
[55] Paul Krugman, Op-Ed., Rewarding Bad Actors, N.Y. Times, Aug. 3, 2009, at A21.
[56] Id. at 674 (“No individual or firm doing a commission business in securities should be permitted to act as a dealer in securities; or to trade in securities, either on margin or otherwise, for his or its own account, except in the form of an “error accounts,” which, however, must be liquidated without unnecessary delay.”) Id.
[57] “An aspect of exchange trading which gave Congress considerable concern ... was the frequent combination in one man of the functions of a broker acting for clients and of a dealer acting for his own profit. The SEC was given the power, under Section 11(b) of the Exchange Act of 1934, to deal with this problem. The SEC conducted a study and published a report in 1936, in which it recommended further study and no immediate action. The report dealt with segregation of the dealer function from the broker function. It did not consider additional segregation in the sense that a dealer could deal with the public through a broker, thereby segregating the dealer from the public. The report concedes that some of the abuses in the securities industry are the direct result of the combination of broker and dealer functions: namely, the inducement of brokerage customers to buy the securities which the broker dealer had underwritten or in which he has a trading position; the persuasion of a customer to sell good securities in order to buy securities in which the dealer has an interest; and the difficulty for the unsophisticated customer in distinguishing between the two functions and their implications … It. is clear that the segregation of functions is either meaningless or of very little value if the dealer, though not allowed to act as a broker, is nonetheless permitted to create a fiduciary relationship between himself and the customer. The' report points to the danger of an underwriter inducing brokerage customers to 'buy the securities which he has an interest in selling. But the same danger exists if, instead of brokerage customers, the dealer has buying customers, who have the same trust in him as they would have in an agent. It therefore would seem that the segregation of functions is not very effective if the dealer is permitted to deal directly with the public. Yet, in the 'United States the system of a dealer selling to customers directly, rather than through a broker, is well entrenched. Talk of segregation, therefore, is completely unrealistic.” Tamar Frankel (p/k/a Tamar Hed-Hoffman), The Maloney Act Experiment, 6 Boston Coll. L. Rev. 188, at pp.195-6 (1965).
[58] Tamar Frankel, The Maloney Act Experiment, at pp. 195-6.
[59] CEO Lloyd Blankfein, in his prewritten statement to the U.S. Senate before hearings on April 26, 2010, denied any wrongdoing by his firm. “We have been a client-centered firm for 140 years, and if our clients believe that we don’t deserve their trust, we cannot survive,” he said. “We certainly did not bet against our clients.” Yet Democratic Senator Carl Levin, chairman of the Senate investigative committee, pointed out an email in which execs described one of their failing investments as a “shitty deal.” Senator Carl Levin later said that federal prosecutors should review whether to bring perjury charges against Goldman Sachs CEO Lloyd Blankfein and other current and former employees who testified in Congress last year. Senator Levin said they denied under oath that Goldman Sachs took a financial position against the mortgage market solely for its own profit, statements the senator said were untrue. See, e.g., Robert Schmidt, Clea Benson & Phil Mattingly, “Goldman Sachs Misled Congress After Duping Clients Over CDOs, Levin Says,” Bloomberg (Apr. 14, 2011), available at http://www.bloomberg.com/news/2011-04-14/goldman-sachs-misled-congress-after-duping-clients-over-cdos-levin-says.html.
[60] Tamar Frankel, The Maloney Act Experiment, at p.195.
[61] Arthur Levitt, Securities and Exchange Commission press conference regarding NASD, 1996.
[62] Gil Weinrich, “A Modest Proposal: Prosecute Non-Fiduciaries Using Term ‘Advisor’ (Dalbar CEO Lou Harvey reacts to Tibergien’s lament about ‘fiduciaries in name only”, located at http://www.advisorone.com/2013/04/08/advisors-are-you-a-fiduciary-or-a-fraud.
[63] James J. Angel and Douglas M. McCabe, Georgetown University, Ethical Standards for Stockbrokers: Fiduciary or Suitability? Sept. 30, 2010.
[64] Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158, citing Earll v. Picken (1940) 113 F. 2d 150.
[65] 1963 SEC Special Study, citing various SEC Releases. See also Arthur B. Laby, Reforming the Regulation of Broker-Dealers and Investment Advisers, 65 Bus. Law. 395, 400, 413-17 (2010) (arguing that the broker-dealer exclusion from the definition of "investment adviser" in 15 U.S.C. § 80b-2(a)(11)(C) should be lost if a broker-dealer markets itself or otherwise holds itself out as an "adviser" in light of the connotation of the word).
[67] Financial Planning Ass’n vs. SEC, 482 F.3d 481 (D.C. Circuit 2007).
[68] Professionals, bound by a true fiduciary standard, deserve protection as well. Why? The answer can be found in economic principles, as set forth in the classic thesis for which George Akerlof won a Nobel Prize: “There are many markets in which buyers use some market statistic to judge the quality of prospective purchases. In this case there is incentive for sellers to market poor quality merchandise, since the returns for good quality accrue mainly to the entire group whose statistic is affected rather than to the individual seller. As a result there tends to be a reduction in the average quality of goods and also in the size of the market.” George A. Akerloff, The Market for "Lemons": Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), p.488. George Akerloff demonstrated “how in situations of asymmetric information (where the seller has information about product quality unavailable to the buyer), ‘dishonest dealings tend to drive honest dealings out of the market.’ Beyond the unfairness of the dishonesty that can occur, this process results in less overall dealing and less efficient market transactions.” Frank B. Cross and Robert A. Prentice, The Economic Value of Securities Regulation, 28 Cardoza L.Rev. 334, 366 (2006). As George Akerloff explained: “[T]he presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.” Akerloff at p. 495.
[70] United States Governmental Accountability Office (GAO): Report to Congressional Committees, Securities Research: Additional Actions Could Improve Regulatory Oversight of Analyst Conflicts of Interest, January 2012.
[71] SEC Comment Letter, dated Feb. 11, 2005, from Elisse B. Walter, Executive Vice President, NASD (“Under the Proposed Amendments, a broker-dealer would not have to register as an investment adviser under the Advisers Act provided that the broker-dealer’s investment advice is non-discretionary and solely incidental to its brokerage services, and the broker-dealer makes certain disclosure to its customers. NASD generally supports the Proposed Amendments. Many NASD-regulated securities firms increasingly rely upon asset-based fees for brokerage services ….”), available at
[72] SEC Comment Letter, April 4, 2005, from Mary L. Schapiro, Vice Chairman and President, Regulatory Policy and Oversight, and Elisse B. Walter, Executive Vice President, Regulatory Policy and Oversight, available at http://www.sec.gov/rules/proposed/s72599/ebwalter021105.pdf.
[73] “One of the recent revelations about large financial institutions’ role in creating the ‘perfect storm’ in the global financial market is that a number of them, including Goldman Sachs, Morgan Stanley, and Bank of America, may have sold certain complex financial instruments while knowing that the mortgages and other assets backing them were likely to default. See Joanna Chung & Francesco Guerrera, US Regulators Subpoena Big Banks over CDOs, FIN. TIMES (London), Jan. 16, 2010, at 6 (discussing the SEC investigation). In April 2010, the SEC brought a lawsuit against Goldman Sachs, accusing the firm of intentionally misleading investors about the true risk profile of a synthetic collateralized debt obligation (CDO) tied to the performance of a portfolio of subprime residential mortgage-backed securities. Press Release, U.S. Sec. & Exch. Comm’n, Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO (July 15, 2010), available at http://www.sec.gov/news/press/2010/2010-123.htm.”
[74] “Securities Regulatory Reform: Addressing FINRA’s Inherent Conflict and Moral Hazard,” a Report of the Alliance for Economic Security Jan. 4, 2010 (hereafter “EAS 2010 Report”).
[75] FINRA, “Report of the 2009 Special Review Committee on FINRA’s Examination Program in Light of the Stanford and Madoff Schemes” September 2009.
[76] Testimony of Stephen Luparello, interim chief executive of FINRA, before the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, Feb. 4, 2009.
[77] Id.
[78] “The Madoff Investment Securities Fraud: Regulatory and Oversight Concerns and the Need for Reform,” Testimony of John C. Coffee Jr., Adolf A. Berle professor of law, Columbia University Law School, before the Senate Banking Committee, Jan. 27, 2009.
[79] Id.
[80] This author has argued that sales of Class C shares, with their often-high 12b-1 fees, is likely the next scandal to hit the brokerage industry. See http://scholarfp.blogspot.com/2013/03/12b-1-fees-rias-and-registered.html.
[81] SEC Press Release 2011-277.
[82] See testimony of Denise Voigt Crawford, Texas securities commissioner and president, North American Securities Administrators Association Inc., before the House Financial Services Committee, Oct. 6, 2009.
[83] Is FINRA unduly influenced by its own broker-dealer firm members? Witness this recent letter from the Financial Services Institute, a lobbyist organization for small broker-dealers, in describing its influence over FINRA’s rule-making processes: “FSI has a good working relationship with FINRA. There is an FSI member on the FINRA Board, there are 20 FSI members on FINRA district committees, and FSI senior staff has a close working relationship with FINRA senior staff. Certainly, we don't always get what we work for with FINRA --we wish we could say we had a perfect record, but we don't. But we do have many wins in terms of changing proposed rules and regulations coming from FINRA to our members' benefit that we can hang our hat on.” FSI, “FSI Uncut: SRO for RIAs – A Message from FSI Chair Joe Russo” (May 29, 2012), available at http://www.financialservices.org/page.aspx?id=3692.
Some commentators are more direct. One stated: “FINRA is a dummy regulator, an industry lobbying group masquerading as a regulator looking out for the interests of investors. And that’s putting it as nicely as I possibly can.” Jordan Terry, “Financial Regulation: One Step Forward, Twelve Steps Back – FINRA’s Bid for More Power.” Also see Stephen J. Nelson, “Commentary: The Magic of Self-Regulation” (“The investor protection role for FINRA is a bit like the fox guarding the hen house. As a general proposition, the financial services industry dislikes fraud and unfair practices because they are bad for business. But this is a far cry from enforcing rules that reduce industry profits by mandating costly reporting to enhance transparency.”)
[84] Recently FINRA opined: “In interpreting FINRA’s suitability rule, numerous cases explicitly state that ‘a broker’s recommendations must be consistent with his customers’ best interests.’  The suitability requirement that a broker make only those recommendations that are consistent with the customer’s best interests prohibits a broker from placing his or her interests ahead of the customer’s interests.” FINRA, Notice to Members 12-25,“Frequently Asked Questions  FINRA Rule 2111 (Suitability)” (Dec. 20, 2012), citing: Raghavan Sathianathan, Exchange Act Rel. No. 54722, 2006 SEC LEXIS 2572, at *21 (Nov. 8, 2006)      [, aff’d, 304 F. App’x 883 (D.C. Cir. 2008)]; see also Scott Epstein, Exchange Act Rel. No. 59328, 2009 SEC LEXIS 217, at *40 n.24 (Jan. 30, 2009) (“In interpreting the suitability rule, we have stated that a [broker’s] ‘recommendations must be consistent with his customer’s best interests.’”)[, aff’d, 416 F. App’x 142 (3d Cir. 2010)]; Dane S. Faber, 57 S.E.C. 297, 310, 2004 SEC LEXIS 277, at *23-24 (2004) (stating that a “broker’s recommendations must be consistent with his customer’s best interests” and are “not suitable merely because the customer acquiesces in [them]”); Wendell D. Belden, 56 S.E.C. 496, 503, 2003 SEC LEXIS 1154, at *10-11 (2003) (“As we have frequently pointed out, a broker’s recommendations must be consistent with his customer’s best interests.”); Daniel R. Howard, 55 S.E.C. 1096, 1100, 2002 SEC LEXIS 1909, at *5-6 (2002) (same), aff’d, 77 F. App’x 2 (1st Cir. 2003); Powell & McGowan, Inc., 41 S.E.C. 933, 935, 1964 SEC LEXIS 497, at *3-4 (1964) (same); Dep’t of Enforcement v. Evans, No. 20006005977901, 2011 FINRA Discip. LEXIS 36, at *22 (NAC Oct. 3, 2011) (same); Dep’t of Enforcement v. Cody, No. 2005003188901, 2010 FINRA Discip. LEXIS 8, at *19 (NAC May 10, 2010) (same), aff’d, Exchange Act Rel. No. 64565, 2011 SEC LEXIS 1862 (May 27, 2011); Dep’t of Enforcement v. Bendetsen, No. C01020025, 2004 NASD Discip. LEXIS 13, at *12 (NAC Aug. 9, 2004) (“[A] broker’s recommendations must serve his client’s best interests[,]” and the “test for whether a broker’s recommendation[s are] suitable is not whether the client acquiesced in them, but whether the broker’s recommendations were consistent with the client’s financial situation and needs.”); IA/BD Study, supra note [68], at 59 (“[A] central aspect of a broker-dealer’s duty of fair dealing is the suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the best interests of his customer.”); also See Epstein, 2009 SEC LEXIS 217, at *42 (stating that the broker’s “mutual fund switch recommendations served his own interest by generating substantial production credits, but did not serve the interests of his customers” and emphasizing that the broker violated the suitability rule “when he put his own self-interest ahead of the interests of his customers”).
[85] Dodd Frank Act of 2010, Section 913(g)(1) states that: “The Commission may promulgate rules to provide that the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.”)
[86] Some commentators appear to believe FINRA’s revised suitability rule imposes a fiduciary duty upon brokers. See, e.g., Robert Wayne Pearce, “FINRA Rule 2111 Expands Stockbroker Duties Owed to Customers”), available at http://seekingalpha.com/instablog/5396101-robert-wayne-pearce/1443081-financial-industry-regulatory-authority-finra-rule-2111-expands-stockbroker-duties-owed-to-customers (“The hallmark of a fiduciary is the requirement to always put the client's interests first. Thus, according to FINRA, brokerage firms and their registered representatives are subject to a fiduciary standard of care when they recommend an investment or investment strategy.”)
But see Matthew P. Allen, A Lesson from History, Roosevelt to Obama - The Evolution of Broker-Dealer Regulation: From Self-Regulation, Arbitration, and Suitability to Federal Regulation, Litigation, and Fiduciary Duty, 5 Entrepreneurial Bus. L.J. 1 (2010) (“The suitability rule, on its face, does not impose fiduciary duties on broker-dealers. In other words, broker-dealers can effect securities transactions for customers that pose conflicts of interest or are not in the customer's best interest, but only if the securities are suitable for the customer given the customer's background and risk tolerance, and then only if the broker-dealer recommends the security.”) Id. at 23. [Emphasis added.]
[87] Steven D. Irwin, Scott A. Lane, and Carolyn W. Mendelson, Wasn’t My Broker Always Looking Out For My Best Interests? The Road To Become A Fiduciary, 12 Duquesne Bus. L. J. 41, 50 (2009). If the “best interests” standard were already imposed upon brokers, as FINRA suggests in its 2012 document, there would be little need for rule-making under the Dodd Frank Act. See, e.g., SEC Staff Study at vi (“Specifically, the Staff recommends that the uniform fiduciary standard of conduct established by the Commission should provide that … the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.”)
[88] See, e.g., June 2012 post by IMCA, “Legislative Intelligence Update | New FINRA Suitability Rule: Fiduciary Duty in the Making?”, available at  http://www.imca.org/sites/default/files/Legislative%20Intelligence%20June%202012_web.html  (“Rule 2111 seems to implicitly suggest a comparable ‘best interest’ standard without mentioning the ‘F’ word or describing its components. FINRA states flatly, in an FAQ on the rule, that ‘a broker make only those recommendations that are consistent with the customer’s best interests.’ While the FAQ does not offer examples consistent with a duty of loyalty or care, it provides a number of examples of not acting in the customer’s best interest, such as recommending one product over another to receive larger commissions, use of margin to increase the number of securities purchased, or, according to the FAQ, recommending new issues ‘pushed by his firm so that he could keep his job.’”)
[89] Despite the emphasis by FINRA on the requirement that its member firms act in the “best interests” of their customers, FINRA tried to provide reassurance to members that their current business practices would not be forced to change. In its Notice to Members 12-25, FINRA stated:: “FINRA reiterates, however, that many of the obligations under the new rule are the same as those under the predecessor rule and related case law. Existing guidance and interpretations regarding suitability obligations continue to apply to the extent that they are not inconsistent with the new rule. Furthermore, FINRA appreciates that no two firms are exactly alike. Firms have different business models; offer divergent services, products and investment strategies; and employ distinct approaches to complying with applicable regulatory requirements. FINRA’s guidance is not intended to influence any firm’s choice of a particular business model or reasonable approach to ensuring compliance with suitability or other regulatory requirements.”
[90] See, e.g., Melanie Waddell, “FINRA’s Ketchum to SEC: Act Now on Fiduciary, or We’ll Make Our Own Disclosure Rules” (AdvisorOne, May 21, 2013) (“Richard Ketchum, CEO of the Financial Industry Regulatory Authority, called on the SEC Tuesday to ‘act quickly’ to finalize its rule to put brokers and advisors under a uniform fiduciary standard, but noted that in the absence of SEC action, FINRA would ‘look hard’ at issuing ‘an additional disclosure rule with respect to broker-dealer firms.’”) Yet, as will be discussed in Part Five of this series of articles, complying with the fiduciary standard of conduct is not just about disclosure; much more is required.
[91] See, e.g., Letter to SED of Donald W. Nicholson & Associates, Ltd., dated June 4, 2013, re: File No. 4-606, stating: “FINRA states that the broker must act in the ‘best interests of the client,’ but offers nothing in the rule itself to confirm that a fiduciary standard exists … Nor does FINRA's vague ‘best interests’ standard in a question-and-answer format provide sufficient guidance. The adviser's fiduciary duty, in contrast, would require him or her to fully and fairly disclose third-party compensation received as a consequence of a recommendation (and consider whether there is a better alternative), while a broker is able to avoid disclosure and fully comply with Rule 2111 while making a conflicted recommendation because often times there is no explicit disclosure requirement of compensation incentives that may result in biased advice.”
[92] See, e.g., Belmont vs.. MB Investment Partners, Inc, 708 f.3R. 370 (3rd Cit. 2013) [“’15 U.S.C. § 80b-6 imposes a fiduciary duty on investment advisers to act at all times in the ‘best interest” of the fund and its investors.’ Under the ‘best interest’ test, an adviser may benefit from a transaction recommended to a client if, and only if, that benefit and all related details of the transaction are fully disclosed. See Capital Gains Research, 375 U.S. at 191-92. (stating that the Advisers Act was meant to ‘eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser — consciously or unconsciously — to render advise which was not disinterested’). In addition to the clear statutory prohibition on fraud, the federal fiduciary standard thus focuses on the avoidance or disclosure of conflicts of interest between the investment adviser and the advisory client. See 17 C.F.R. § 275.204A-1 (describing the required investment adviser code of ethics, and its focus on conflicts of interest); cf. Capital Gains Research, 375 U.S. at 191-92 (discussing the obligations of investment advisers.)”] (citations omitted). Id. at 502.
[93] Contrast the general fiduciary duties of corporate directors and officers. See, e.g., Michael v. Citizens Bank and Trust Company of Chicago, 687 F.3d 337 (7th Cir. 2012) (“Directors and officers owe a duty of good faith and loyalty to their bank … They should act in "good faith … with the care an ordinarily prudent person in a like position would exercise under similar circumstances … and in a manner he reasonably believes to be in the best interests of the corporation" … The duty of loyalty includes a duty to avoid conflicts of interests and self-dealing. "Self-dealing, conflicts of interest, or even divided loyalties are inconsistent with fiduciary responsibilities.”) (citations omitted). Id. at 349. See also SEC v. Bankosky, 2013 U.S. App. LEXIS 9669 (2ND Cir. Ct. App. 2nd Cir., May 14, 2013) (“The duty of loyalty mandates that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the stockholders generally."). Note, however, that under the business judgment rule, there is often a presumption (not found in the Advisers Act nor under state common law as applied to relationships of trust and confidence when personalized investment advice is provided) that actions taken by directors and officers are in the best interests of the corporation. See, e.g., Lampe v. Lampe, 665 F.3d 506 (3rd Cir. 2011).
See also, e.g., Colgate-Palmolive Company vs. Tadem Industries, 485 Fed. Appx. 516 (3rd Cit. 2012) (“A fiduciary duty includes both a duty of loyalty - conducting the employer's business in the employer's best interest instead of one's own - and a duty of care - conducting the employer's business attentively and responsibly … There can be no doubt that an agent owes a duty of loyalty to his principal and in all matters, affecting the subject of his agency, he must act with the utmost good faith in the furtherance and advancement of the interests of his principal.”) (citations omitted) Id. at 517.
See also, e.g., U.S. V. Nelson, 712 F.3d 498 (11th Cir. Ct. App.) 2013) (“[p]ublic officials inherently owe a fiduciary duty to the public to make governmental decisions in the public's best interest.”).
[94] Comment Letter to SEC from FINRA’s Marc Menchel, dated August 25, 2010, re: File Number 4-606, “Study Regarding Obligations of Brokers, Dealers and Investment Advisers”
[95] Jonathan R. Macey, “Regulation of Financial Planners,” 2002 white paper prepared for the Financial Planning Association, p.2.
[96] Halah Touryalai, Can’t We All Just Get Along? FPA says FINRA Won’t Do for NYSE/NASD, WealthManagement.com (Jul. 18, 2007), available at http://wealthmanagement.com/regulation/can-t-we-all-just-get-along-fpa-says-finra-won-t-do-nysenasd.
[97] Saule T. Omarova, Wall Street as Community of Fate: Toward Financial Industry Self-Regulation, 159 U. Penn. L. Rev. 411, 416 (2011).
[98] The 1998 English (U.K.) case of Bristol and West Building Society v. Matthew.
Other courts have focused on the key attribute of the fiduciary principle – the fiduciary duty of loyalty. Time and again our courts have enumerated the fiduciary maxim:No man can serve two masters.”[98] As stated early on by the U.S. Supreme Court, “The two characters of buyer and seller are inconsistent: Emptor emit quam minimo potest, venditor vendit quam maximo potest.Wormley v. Wormley, 21 U.S. 421; 5 L. Ed. 651; 1823 U.S. LEXIS 290; 8 Wheat. 421 (1823). See also Michoud v. Girod, 45 U.S. 503; 11 L. Ed. 1076; 1846 U.S. LEXIS 412; 4 HOW 503 (1846) (“[I}f persons having a confidential character were permitted to avail themselves of any knowledge acquired in that capacity, they might be induced to conceal their information, and not to exercise it for the benefit of the persons relying upon their integrity. The characters are inconsistent. Emptor emit quam minimo potest, venditor vendit quam maximo potest.”] As the U.S. Supreme Court has also opined, “the rule … includes within its purpose the removal of any temptation to violate them….” SEC v. Capital Gains Research Bureau, 375 U.S. 180; 84 S. Ct. 275; 11 L. Ed. 2d 237; 1963 U.S. LEXIS 2446 (1963)
Through elaboration in English law and U.S. law, fiduciary duties find their origin in a mix of the laws of trust law, tort law, contract law, and agency law. And, through the gradual expansion of the situations in which fiduciary duties are required as our society evolves, today fiduciary status attaches to many different situations. In each instance fiduciary duties are calibrated to meet the needs of the entrustors, taking into account the asymmetry of power, knowledge and sophistication of the two parties to the relationship.
[99] POGO letter to Congress calling for increased oversight of financial self-regulators (Feb. 23, 2010).
[100] Statement of NASD Chairman Robert W. Baird in an address before the convention of the National Association of Securities Commissioners, as quoted in N.A.S.D. News, published by the National Association of Securities Dealers, Volume II, Number 1 (Nov. 15, 1941).
[101] Grandfathering might occur for prior entrants into the profession possessing of substantial work experience and knowledge accumulated over years, provided a competency test would be passed by same.
[102] 78 U.S.C. § 78s(g)-(h).
[103] For an example of a more comprehensive elicitation of the fiduciary standard of conduct, see Rhoades, Comment Letter to DOL/EBSA dated April 11, 2011 re: “Definition of Fiduciary” proposed rule, at pp. 49 ff.
[104] By way of explanation, in the employer-employee context, the employer or entrustor is nearly always in a position of greater power and knowledge and sophistication. In contrast, the employee (the fiduciary) usually possesses limited power and weaker knowledge. Hence, a weak form of fiduciary obligations exist in which the consent of the employer may easily occur to an employee’s casting off of fiduciary obligations through “waiver.” In contrast, in an advisory-client relationship, in which the asymmetry of information strongly favors the advisor, and the client is placed at great risk of abuse by the fiduciary of his, her or its powers, the fiduciary duty is calibrated and is much more strictly applied. In such circumstances, the doctrine of informed consent if enforced robustly, and courts invalidate consents if the client is shown to have consented to a harmful action (for what client, if any, would be gratuitous toward their advisor).
[105] See Rhoades, Public Policy Considerations Which Underlie the Imposition of Fiduciary Status (2013), at http://scholarfp.blogspot.com/2013/04/public-policy-considerations-which.html.