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Saturday, September 12, 2015

FINRA Seeks the Death of the Fiduciary's Duty of Loyalty

"Should retirement advisors be able to place their own profit-seeking before the best interests of their clients?" asked U.S. Rep. Ellison at the Sept. 10, 2015 Congressional Joint Hearing entitled “Preserving Retirement Security and Investment Choices for All Americans."

The President of NAIFA replied "no." Immediately thereafter all of the panelists, most of whom represented the securities industry, agreed that they were for the "best interests" standard.

BUT ... upon close examination, what Wall Street and the insurance companies advance now is an altogether new definition of "best interests." This attempt to re-define "best interests" is contrary to the common understanding of that term as it is used by jurists over hundreds of years, and by American consumers.

What Wall Street and the insurance companies really advocate for is ... the death of the fiduciary duty of loyalty.


In the United States, we often speak of the triparte duties that arise from fiduciary status – the duty of due care, the duty of loyalty, and the duty of utmost good faith. Cede & Co. v. Technicolor, 634 A.2d 345, 361 (Del. 1993).

Among the fiduciary duties the most distinctive is that of the fiduciary duty of loyalty. Indeed, some legal scholars argue that, since the duty of due care exists outside of most fiduciary relationships, that only one fiduciary duty exists – the fiduciary duty of loyalty.

Regardless of whether there is one, three, or many fiduciary duties, the fiduciary duty of loyalty, augmented by the requirement of utmost good faith, is what most separates the two major forms of business relationships:

The seller-buyer “arms-length” relationships arises when the seller or seller’s representative represents himself or herself or a product manufacturer or distributor, and in which the customer is bound to protect himself or herself through application of the doctrine of caveat emptor (“let the buyer beware”). Each party is free to be self-serving.

In fiduciary relationships the fiduciary does not represent the product manufacturer or distributor. Instead, the person upon whom fiduciary status is imposed acts instead as the “purchaser’s representative” on behalf o the client. The law requires the fiduciary to possess loyalty to the client because of the potential for abuse. In essence, the fiduciary’s acts are restricted, as a means of solving the problem of opportunism that arises in circumstances of asymmetric information.

Despite the strength of the fiduciary duty of loyalty, today – more than perhaps at any time before – this fiduciary duty of loyalty is under attack by Wall Street and its allies. SIFMA, FSI, and their members seek, with the blessing of their “self-regulator” – FINRA – to re-define the very nature of the term “best interests.”

In this article I point out the long legal tradition and historic use of the term “best interests.” I suggest that the attempt by SIFMA and FINRA and their cohorts to redefine the term “best interests” as something far less than the fiduciary duty of loyalty is an abomination. I conclude that FINRA’s apparent endorsement of SIFMA’s proposal to modify its suitability rule to include the term “best interests” should be resisted by legislators, regulators, the legal community, the financial services community, and consumers alike.


Fiduciary duties arise in many different relationships. The strictest fiduciary duties are applied in trustee-beneficiary relationship, given the often complete superiority of knowledge, sophistication, and power of the trustee. The least strict is arguably that of employer-employee; although the employee (agent) owes fiduciary duties as an agent of the principal (employer), the employer normally has the superior knowledge and power.

Lying in between are other types of fiduciary relationships. For example, fiduciary duties arise within many forms of business organizations. Majority shareholders owe fiduciary duties to minority shareholders. Officers and directors of corporations owe fiduciary duties to the corporation. And partners owe fiduciary duties to each other.

Another type of fiduciary relationship, in which stricter fiduciary duties are imposed, is that of attorney and client. Rarely in this instance can the client waive the attorney’s fiduciary duty of loyalty. At times there is an absolute prohibition on any attempted waiver of the attorney’s duty; for example, an attorney normally cannot prepare a will for which he or she is a beneficiary. In other situations, in recognition of the vast disparity of knowledge and sophistication between the attorney and his or her client, waivers of the fiduciary duty of loyalty can only occur following consultation with independent legal counsel, or at least advice to so consult. For example, an attorney cannot normally enter into a joint business with a client without, at the minimum, advising the client to seek independent legal advice prior to the formation of the relationship.

Similar to the relationship of attorney and client is that of investment adviser and client. Few would dispute that there is vast information asymmetry present between investment advisers and retail consumers – at least 99% of the time. And few would dispute that attempts to educate investors on the complexities of the capital markets are largely ineffective; it simply takes a very high level of expertise to be able to successfully navigate today’s complex world of investments. Nor do disclosures do much good. A huge body of academic research confirms what investment advisers already know – consumers don’t often read disclosures, and even when they do they don’t understand them. This academic research, especially over the past couple of decades, has uncovered the many behavioral biases humans possess which lead to this result. Disclosures don't work. Period. (If they did work, the fiduciary standard would never have arisen under the law.)

Sadly, financial consultants/advisers are trained to take advantage of these behavioral biases. Through marketing, use of titles, and client interviewing techniques they establish a relationship of trust and confidence with their customers, even in situations where the law does not impose fiduciary status. They then take advantage of that trusting by having the customer sign off on conflicts of interests through forms they don't understand, and wouldn't sign if they understood them.

The result is that most consumers today are served not by bona fide fiduciaries, but by salespeople. And even though these salespeople profess to act in their client's "best interests," they either don't understand the true nature of that term or they ignore it. 


The phrase “act in the best interests of the client” is used to explain, in language the lay person would understand, the core aspect of the fiduciary duty of loyalty. This use of the term “best interests” to describe the fiduciary duty of loyalty is frequently found in judicial decisions. For example:

In explaining the duty of loyalty owed by a board of directors to the corporation, the instruction to a lay jury reads: “Each member of the … board of directors is required to act in good faith and in a manner the director reasonably believes to be in the best interests of the corporation when discharging his or her duties.” Schultz v. Scandrett, #27158, Supreme Court of South Dakota, 2015 SD 52; 866 N.W.2d 128; 2015 S.D. LEXIS 85 (June 24, 2015).

In describing the fiduciary duty of the director of a corporation to the corporation and its shareholders, a court opined: “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.’ Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 362 (Del. 1993) (citing Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984) and Aronson v. Lewis, 473 A.2d 805, 816 (Del. 1984)); see also Diedrick v. Helm, 217 Minn. 483, 14 N.W.2d 913, 919 (Minn. 1944). The classic example is when a fiduciary either appears on both sides of a transaction or receives a substantial personal benefit not shared by all shareholders. Id.” DQ Wind-Up, Inc. v. Kohler, Court File No. 27-CV-10-27509, Minnesota District Court, County Of Hennepin, Fourth Judicial District, 2013 Minn. Dist. LEXIS 118 (2013).

Similarly, “[t]he duty of loyalty requires that the best interests of the corporation and its shareholders take precedence over any self-interest of a director, officer, or controlling shareholder that is not shared by the stockholders generally.” Rales v. Blasband, 634 A.2d 927, 936 (Del. 1993).

Also, "”n dealing with corporate assets [the corporate officer] was required to act in the best interests of the corporation and he was prohibited from using either his position or the corporation's funds for his private gain.” Levin v. Levin, 43 Md. App. 380, 390, 405 A.2d 770 (1979).

A court, recently opining on ERISA’s fiduciary duty of loyalty, stated: “ERISA imposes a duty of loyalty on fiduciaries. Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir.), cert. denied, 459 U.S. 1069, 74 L. Ed. 2d 631, 103 S. Ct. 488 (1982) (Friendly, J.). A trustee violates his duty of loyalty when he enters into substantial competition with the interests of trust beneficiaries. Restatement (Second) of Trusts, § 170, comment p … under the law of trusts, a fiduciary is generally prohibited, not just from acting disloyally, but also from assuming a position in which a temptation to act contrary to the best interests of the beneficiaries is likely to arise. Grynberg at 1319; 2 Scott on Trusts § 170, pp. 1297-98 (1967).” Salovaara v. Eckert, 94 Civ. 3430 (KMW), U.S. D.C. SDNY,  1996 U.S. Dist. LEXIS 323 (1996).

In describing an attorney’s fiduciary duty of loyalty to a client, a court stated: “public policy requires that he not be subjected to any possible conflict of interest which may deter him from determining the best interests of the client a client's right to the undivided loyalty of his or her attorneys must be protected … The duty of both the associate and the successor attorney is the same: to serve the best interests of the client." Beck v. Wecht, No. S099665. , Supreme Court Of California, 28 Cal. 4th 289; 48 P.3d 417; 121 Cal. Rptr. 2d 384; 2002 Cal. LEXIS 4197; 2002 Cal. Daily Op. Service 5812; 2002 Daily Journal DAR 7326 (2002).

Numerous law review articles and academic texts also reflect on the fiduciary’s obligation to act in the client’s (entrustor’s) “best interests”:

“Tracing this doctrine back into the womb of equity, whence it sprang, the foundation becomes plain. Wherever one man or a group of men entrusted another man or group with the management of property, the second group became fiduciaries. As such they were obliged to act conscionably, which meant in fidelity to the interests of the persons whose wealth they had undertaken to handle. In this respect, the corporation stands on precisely the same footing as the common-law trust.” Adolf A. Berle, Jr. & Gardiner C. Means, The Modern Corporation and Private Property 336 (1939).

“The underlying purpose of the duty of loyalty, which the sole interest rule is meant to serve, is to advance the best interest of the beneficiaries … There can be no quibble with the core policy that motivates the duty of loyalty. Any conflict of interest in trust administration, that is, any opportunity for the trustee to benefit personally from the trust, is potentially harmful to the beneficiary. The danger, according to the treatise writer Bogert, is that a trustee ‘placed under temptation’ will allow ‘selfishness’ to prevail over the duty to benefit the beneficiaries. ‘Between two conflicting interests,’ said the Illinois Supreme Court in an oft-quoted opinion dating from 1844, ‘it is easy to foresee, and all experience has shown, whose interests will be neglected and sacrificed’ …

“The law is accustomed to requiring that attorneys zealously pursue their clients' interests and that they not indulge interests that may conflict with those of a particular client without first disclosing the potential conflict to the client and receiving the client's approval. There are some conflicts that cannot be overcome by the client's permission where the conflicted attorney would have to avoid the conflict entirely or quit the representation of the client. Law firms vigorously monitor potential conflicts between attorneys and clients. The rules of professional responsibility go to great lengths to define the appropriate standard of conduct for attorneys and describe what constitutes a conflict and how an attorney, law firm, and client should handle it. These strictly enforced standards of conduct cover every facet of the attorney-client relationship and leave very little to chance in a court's ex post determination of whether an attorney has breached her fiduciary duties. While fiduciary duties may apply to the relationship and zealous advocacy is clearly required, the obligation an attorney owes a client is not left to vague, unpredictable ex post judicial review. It is quite thoroughly described in codes of conduct that have grown ever more complete and sophisticated over time.” John H. Langbein, Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest?, 114 Yale L.J. 929 (March 2005).

We also see the term “best interests” used to describe the legal obligations arising for those who provide personalized investment advice to retail customers. On January 22, 2011, the SEC's Staff, fulfilling the mandate under § 913 of the Dodd-Frank Act, released its Study on the regulation of broker-dealers and investment advisers. The overarching recommendation made in the Study is that the SEC should adopt a uniform fiduciary standard for investment advisers and broker-dealers that is no less stringent than the standard under the Advisers Act. Specifically, the Staff recommended the following: “[T]he 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.” EC Staff, Study on Investment Advisers and Broker-Dealers ii (2011) [hereinafter SEC Staff Study], available at

While the SEC Staff’s recommendation was a strong one, an observer might argue that any confusion regarding the meaning of “best interests” has arisen from the acts of the SEC itself. The SEC began using the term to not describe the fiduciary duty of loyalty, but rather the fiduciary duty of due care – i.e., to manage the client's portfolio in the best interest of the client-rather than part of an adviser's duty of loyalty to disclose and thereafter properly manage any unavoidable conflicts of interest. See Barbara Black, How to Improve Investor Protection After the Dodd-Frank Wall Street Reform and Consumer Protection Act, 13 U. Pa. J. Bus. L. 59, 86 (2010). However, any review of the history of the fiduciary standard and its legal underpinnings results in the only logical conclusion regarding the best interest standard – that it is part of a fiduciary’s duty of loyalty, not duty of care. This is because the essence of the fiduciary’s duty of loyalty requires that the fiduciary acts not out of self-interest, but rather in the best interests of the fiduciary. The fiduciary steps into the shoes of the client, with all of the fiduciary’s superior knowledge and skills, and acts as if the client would then act. As Judge Posner has written, "[a] fiduciary is required to treat his principal as if the principal were he, and therefore he may not take advantage of the principal's incapacity, ignorance, inexperience, or even naiveté ...." Market St. Assoc. v. Frey, 941 F. 2d 588, 593 (7th Cir. 1991). In summary, the fiduciary is required to act as if the fiduciary were the client – i.e., in the client’s interests. By acquiring the duty of loyalty, the only “self-interest” the fiduciary is permitted to consider is the self-interest of the client, into whose shoes the fiduciary is now firmly planted.


“Goldman's arguments in this respect are Orwellian. Words such as ‘honesty,’ ‘integrity,’ and ‘fair dealing’ apparently [in Goldman’s eyes] do not mean what they say; [Goldman says] they do not set standards; they are mere shibboleths. If Goldman's claim of ‘honesty’ and ‘integrity’ are simply puffery, the world of finance may be in more trouble than we recognize.” – Judge Paul Crotty, Richman v. Goldman Sachs Group, Inc., 868 F. Supp. 2d 261 (S.D.N.Y. 2012).

On June 3, 2015, SIFMA’s released its draft of a “Proposed Best Interests of the Customer Standard for Broker-Dealers.” (See Appendix A hereto.) SIFMA described this as “comprehensive, investor-focused, regulatory solution” and noted that “[f]or over six years – predating the passage of the Dodd-Frank Act – SIFMA has strongly supported SEC action to establish a uniform fiduciary standard for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.” Yet, upon close inspection, SIFMA’s proposal does not encompass, as its use of the phrase “best interest of the customer” would lead one to reasonably conclude – a true, bona fide fiduciary duty of loyalty by broker-dealers and their registered representatives to their customers.

While FINRA has not (as of the date of this writing) announced formally any revision to its rules to apply a “best interests” standard, FINRA’s July 17, 2015 comment letter to the DOL first opined: "FINRA has publicly advocated for a fiduciary duty for years and agrees with the Department that all financial intermediaries, including broker-dealers, should be subject to a fiduciary “best interest” standard."

FINRA then outlined its own version of a “best interests” standard. In this comment letter, FINRA stated that “any best interest standard for intermediaries should meet the following criteria”:

   “The standard should require financial institutions and their advisers to:

act in their customers’ best interest;

adopt procedures reasonably designed to detect potential conflicts;

eliminate those conflicts of interest whenever possible;

adopt written supervisory procedures reasonably designed to ensure that any remaining conflicts, such as differential compensation, do not encourage financial advisers to provide any service or recommend any product that is not in the customer’s best interest;

obtain retail customer consent to any conflict of interest related to recommendations or services provided; and

provide retail customers with disclosure in plain English concerning recommendations and services provided, the products offered and all related fees and expenses.”

However, upon close inspection, FINRA’s proposal demonstrates FINRA’s continued inability to substantially raise the standards of conduct of brokers to the highest levels, as was contemplated by Senator Maloney and others at the time of FINRA’s inception (when it was called the NASD).

In the table below I summarize the flaws in SIFMA’s and FINRA’s recent “best interests” proposals and demonstrate why SIFMA’s proposed changes to FINRA’s suitability rule do not come even close to the protections provided by the fiduciary standard:

A Concise Comparison: Bona Fide Fiduciary Standard
vs. SIFMA’s and FINRA’s “Best Interests” Proposals
What requirements are imposed upon the person providing personalized investment advice?
Bona Fide Fiduciary Standard
SIFMA’s “Best Interest”      Proposal (as outlined in its         June 2015 release)
FINRA’S “Best Interest”          Proposal (as outlined in its           July 17, 2015 comment letter)
Who does the financial representative represent?
The client.
The brokerage firm, and, through the firm, various product manufacturers. The financial representative functions as a “seller’s representative” with no substantial allegiance required to the purchaser (customer).
The brokerage firm, and, through the firm, various product manufacturers. The financial representative functions as a “seller’s representative” with no substantial allegiance required to the purchaser (customer).
Does a duty exist upon the representative to clearly and fully disclose all compensation received by the person providing advice, and by his/her firm?
No. While annual disclosure occurs of “a good faith summary of the investment-related fees” associated with an investment, there is no requirement in SIFMA’s proposal that the compensation of the broker-dealer or its registered representative be affirmatively quantified and then disclosed. As a result, customers will remain uninformed of the precise amount of the compensation of the broker and its registered representative. Hence, the client will not possess the means to assess the reasonableness of the compensation so provided, and the receipt of only “reasonable compensation” is a requirement for a fiduciary actor.
No. While annual disclosure occurs of a product’s “fees and all related expenses,” there is no requirement in FINRA’s proposal that the compensation of the broker-dealer or its registered representative be affirmatively quantified and then disclosed. As a result, customers will remain uninformed of the precise amount of the compensation of the broker and its registered representative. Hence, the client will not possess the means to assess the reasonableness of the compensation so provided, and the receipt of only “reasonable compensation” is a requirement for a fiduciary actor. Why do broker-dealer firms resist the fiduciary requirement to fully disclosure a material fact – their compensation – to their customers? Because a large proportion of these customers believe that their registered representative and brokerage firm is acting gratuitously, given broker-dealers’ ability to hide compensation from the customers.
Is there a duty upon the representative to ensure client understanding of material facts, including material conflicts of interest?
No. Under SIFMA’s proposal disclosures must only be “designed to ensure client understanding.” There is no requirement, as exists for a fiduciary, that client understanding of conflicts of interest, and their ramification, actually occur.
No. Under FINRA’s proposal disclosures relating to products must only be provided to the customer. There is no requirement, as exists for a fiduciary, that client understanding of conflicts of interest, and their ramification, actually occur by means of affirmative obligations placed upon the registered representative.
Is informed consent of the client required prior to the client undertaking each and every recommended transaction?
No. There is no requirement in SIFMA’s proposal that the client’s consent be “informed” – a key requirement of fiduciary law before client waiver of a conflict of interest can take place. Nor is there a requirement that the client provide informed consent prior to each and every transaction. Rather, SIFMA would only require: “Customer consent to material conflicts of interest or for other purposes as appropriate may be provided at account opening.” Of course, consent “at client opening” often involves a customer briefly initialing a line, as one of many initials or signatures provided in account opening forms which are often dozens of pages long. The result of SIFMA’s proposal is that clients can and will consent to be harmed – an outcome which cannot exist under a bona fide fiduciary standard. And such “consent” will hardly ever be “informed.”
No. There is no requirement in FINRA’s proposal that the client’s consent be “informed” – a key requirement of fiduciary law before client waiver of a conflict of interest can take place. Nor is there a requirement that the client provide informed consent prior to each and every transaction. Rather, FINRA would only require brokers to “obtain client consent” to conflicts of interest. Such consent, often given with little or no understanding by the customer of the broker, creates an estoppel defense for the broker, who is in an arms-length relationship with the customer. As explained in this comment letter, the role of estoppel is very limited in fiduciary relationships, and much more than “simple consent” is required for the fiduciary to proceed when a conflict of interest is present.
Must the transaction remain, at all times, substantively fair to the client?
No. There is only a requirement that the transaction be in accord with the client’s “best interest” – a new SIFMA-proposed standard that is ill defined and which remains subject to much interpretation. Such interpretations will primarily occur through FINRA’s much-maligned system of mandatory arbitration. In contrast, the fiduciary standard possesses centuries of interpretation and application. Under a bona fide fiduciary standard, clients are unable to waive core fiduciary duties; the role of estoppel is quite limited. This is enforced by the courts by requiring both informed consent of the client and that the transaction remain substantively fair to the client.
No. There is only a requirement that the transaction be in accord with the client’s “best interest” – a new FINRA-proposed standard that is ill defined and which remains subject to much interpretation. Such interpretations will primarily occur through FINRA’s much-maligned system of mandatory arbitration. In contrast, the fiduciary standard possesses centuries of interpretation and application. Under a bona fide fiduciary standard, clients are unable to waive core fiduciary duties; the role of estoppel is quite limited. This is enforced by the courts by requiring both informed consent of the client and that the transaction remain substantively fair to the client.
Does there exist a duty to properly manage investment-related fees and costs that the client will incur at all times?
No. SIFMA expressly states: “Managing investment-related fees does not require recommending the least expensive alternative, nor should it interfere with making recommendations from among an array of services, securities and other investment products consistent with the customer’s investment profile.” These caveats leave the door wide open for the broker to recommend highly expensive products, including products which pay the broker more, in which the total fees and costs incurred by the customer will substantially lower the long-term returns of the investor.
No. FINRA does not appear to recognize that, under fiduciary law, there is an obligation imposed upon the fiduciary to ensure that any expenditures of the client’s funds, through payment of product-related fees and costs, be undertaken with close scrutiny. FINRA appears to desire that high-cost products could still be recommended compared with lower-cost products that possess nearly the same risk and other characteristics. The fiduciary standard of due care requires that the client’s expenses be controlled and that avoidable expenses be avoided. The fiduciary is permitted to obtain reasonable, professional-level compensation, through agreement with the client at the inception of the relationship, and with full disclosure of same.
Does there exist a duty to properly manage the design, implementation and management of the portfolio, in order to reduce the tax drag upon the customer’s investment returns?
No. There is no express duty under SIFMA’s proposal to properly manage the tax consequences of investment decisions. Far too often under the suitability standard, and under this proposed “best interests” standard, customers of broker-dealers have and will possess substantial tax drag upon their investment returns that otherwise could have been avoided through expert advice.
No. Nothing in FINRA’s proposal addresses portfolio management. FINRA is mired in the ancient practice of providing products under the suitability standard. Today’s investors deserve expert advice from true fiduciaries, not the sale of products which generate high profits for the broker without proper consideration of how the product fits into the client’s overall portfolio.

As seen, SIFMA’s and FINRA’s proposed “Best Interests” standards fall far short of the protections afforded by ERISA’s fiduciary standard. The fact of the matter is that Wall Street wants to eat its cake and have it too. It wants to be perceived as acting in customer's "best interests," but enjoy the freedom to act in its own interests. Wall Street’s new “Best Interests of the Consumer” proposal is, in reality, only “Wall Street’s Self-Interest.”
As alluded to in the chart above, by its “Best Interests” proposal SIFMA and FINRA do not turn brokers from sell-side merchandizers into buy-side purchaser’s representatives and fiduciaries. Rather, SIFMA’s and FINRA’s proposal are nothing more than an attempt to obfuscate into some kind of obscene and confusing hybrid between the two. In fact, the enhancement to the inherently weak suitability standard under these proposals is extremely modest.
This begs the question – who does the broker under SIFMA’s and FINRA’s proposed “best interests” standards represent? This is a key question, for the following is well known in the law:
The characters of buyer and seller are incompatible, and cannot safely be exercised by the same person. Emptor emit quam minimo potest; venditor vendit quam maximo potest. The disqualification rests … on no other than that principle which dictates that a person cannot be both judge and party. No man can serve two masters. He that it interested with the interests of others, cannot be allowed to make the business an object of interest to himself; for, the frailty of our nature is such, that the power will too readily beget the inclination to serve our own interests at the expense of those who have trusted us.
Carter v. Harris, 25 Va. 199, 204 (1826); 1826 Va. LEXIS 26; 4 Rand. 199 (Va. 1826).

It is obvious that under SIFMA’s and FINRA’s proposed “best interest” standards the registered representative would continue, by a simple waiver form signed by a customer (while signing 40-70 pages of other documents the customer also does not understand) to act as sellers of products, thereby representing the broker-dealer firm and product manufacturers. This is a far, far cry from acting as a fiduciary, and acting as the representative of the purchaser.

The danger apparent is in FINRA moving forward to enact a "best interests" standard that does not include the fiduciary duty of loyalty. FINRA seeks to do such, as FINRA noted in its comment letter to the DOL: "We recognize that imposing a best interest standard requires rule making beyond what is presently in place for broker-dealers. We stand ready to work with the Department [of Labor] and the SEC to develop this additional rule-making."

As I've written about in this blog before, for over seven decades FINRA (formerly called NASD) has refused to recognize in its rules of conduct that brokers, when in a relationship of trust and confidence with their customers, possess broad fiduciary duties to such customers. Now, on the eve of DOL rule-making, FINRA seeks to adopt, in its own rules, not a fiduciary standard - but rather an abomination of the "best interests" standard that would reverse centuries of understanding of that legal term. In so doing, FINRA is again acting to protect its self-interests, and the interests of its broker-dealer members. FINRA's utter failure to protect consumers, augmented by this recent colossal failure in proposing a deceptive new "best interests" standard that is anything but adherence to the fiduciary duty of loyalty, is good cause for removing from FINRA its ability to regulate any market conduct. The SEC should act forthwith to remove FINRA's authority to protect consumers, as it continues to fail at such task in an abysmal manner.


To more fully understand the deficiencies of SIFMA’s and FINRA’s proposal, the stark difference between arms-length and fiduciary relationships must be examined, as to how the doctrines of waiver and estoppel differ.

In arms-length relationship consent by a customer to proceed, when a conflict of interest is present, is generally permitted. Caveat emptor (“let the buyer beware”) applies to such merchandiser-customer relationships. The customer is not represented by the merchandiser but is rather in an adverse relationship - that of seller and purchaser.

In such arms-length relationships, it is a fundamental principle of the common law that volenti non fit injuria – to one who is willing, no wrong is done. Customer consent to the transaction generally gives rise to estoppel – i.e., the customer cannot later state that he or she can escape from the transaction because a conflict of interest was present, or because full awareness of the ramifications of the conflict of interest were absent. The customer, in such instances, bears the duty of negotiating a fair bargain. The law permits customers, in arms-length relationships, to enter into “dumb bargains.” Generally, jurists will not set aside unfair bargains unless fraud, misrepresentation, mutual mistake of fact exists or unless the contract is so unjust and burdensome that it is deemed unconscionable.

But the fiduciary relationship is altogether different. The entrustor (client) and fiduciary actor have formed a relationship based upon trust and confidence. In such a form of relationship, the law guards against the fiduciary taking advantage of such trust. As a result, judicial scrutiny of aspects of the relationship occurs with a sharp eye toward any transgressions that might be committed by the fiduciary.

Hence, mere consent by a client in writing to a breach of the fiduciary obligation is not, in itself, sufficient to create waiver or estoppel. If this were the case, fiduciary obligations – even core obligations of the fiduciary – would be easily subject to waiver. Instead, to create an estoppel situation, preventing the client from later challenging the validity of the transaction that occurred, the fiduciary is required to undertake a series of steps:

First, disclosure of all material facts to the client must occur. [For some commentators on the fiduciary obligations of investment advisers, this is all that is required. Often this erroneous conclusion is derived from misinterpretations of the landmark decision of SEC v. Capital Gains Research Bureau.]

Second, the disclosure must be affirmatively made and timely undertaken. In a fiduciary relationship, the client’s “duty of inquiry” and the client’s “duty to read” are limited; the burden of ensuring disclosure is received is largely borne by the fiduciary. Disclosure must also occur in advance of the contemplated transaction. For example, receipt of a prospectus following a transaction is insufficient, as it does not constitute timely disclosure.

Third, the disclosure must lead to the client’s understanding. The fiduciary must be aware of the client’s capacity to understand, and match the extent and form of the disclosure to the client’s knowledge base and cognitive abilities.

Fourth, the informed consent of the client must be affirmatively secured. Silence is not consent. Also, consent cannot be obtained through coercion nor sales pressure.

Fifth, at all times, the transaction must be substantively fair to the client. If an alternative exists which would result in a more favorable outcome to the client, this would be a material fact which would be required to be disclosed, and a client who truly understands the situation would likely never gratuitously make a gift to the advisor where the client would be, in essence, harmed.

These requirements of the common law – derived from judicial decisions over hundreds of years – have found their way into our statutes. For example, ERISA’s exclusive benefit rule unyieldingly commands employee benefit plan fiduciaries to discharge their duties with respect to a plan solely in the interest of the plan’s participants and for the exclusive purpose of providing benefits to them and their beneficiaries. And the Investment Advisers Act of 1940 was widely known to impose fiduciary duties upon investment advisers from its very inception, and it contains an important provision that prevents waiver by the client of the investment adviser’s duties to that client. (However, SEC enforcement of Section 215 of the Advisers Act, prohibiting waivers of the duties of investment advisers, is sorely lacking.)

We must also ask, when would the client of a fiduciary every knowingly consent to a conflict of interest that was otherwise unavoidable? In essence, when would a client ever provide informed consent to transform the key aspect of the relationship away from that of fiduciary-client and to an arms-length relationship in which the advisor  permitted to act out of self-interest.

To answer this question it is important to first realize that disclosure is neither a fiduciary duty nor a cure (without much more) to the breach of one’s fiduciary obligations. In other words, it must be understood that, quite frankly, there exists no fiduciary duty of disclosure. While disclosure may be imposed by other law or regulation, or by contractual obligations created between the parties, disclosure is not, itself, a core fiduciary obligation found in the common law.

Rather, fiduciaries owe the obligation to their client to not be in a position where there is a substantial possibility of conflict between self-interest and duty. This is called the “no-conflict” rule, derived from English law. Fiduciaries also possess the obligation not to derive unauthorized profits from the fiduciary position. This is called the “no profit” rule, also derived from English law.

While there is no fiduciary duty of disclosure, questions of disclosure are often central in the jurisprudence discussing fiduciary law, as many cases involve claims for breach of the fiduciary duty due to the presence of a conflict of interest. In essence, a breach of fiduciary obligation – either the obligation not to be in a position of conflict of interest and the duty to not make unauthorized profits – may be averted or cured by the informed consent of the client (provided all material information is disclosed to the client, the adviser reasonably expects client understanding to result given all of the facts and circumstances, the informed consent of the client is affirmatively secured, and the transaction remains in all circumstances substantially fair to the client).

In essence, asking a client to consent to a conflict of interest by the fiduciary is requesting that the client waive the no conflict rule, the no profit rule, or both rules. It is asking the client to not trust the adviser. Again, clients would only do so in circumstances where the client is not harmed. It would be difficult to believe that client is so gratuitous to his or her investment adviser that the client would incur a detriment, beyond reasonable compensation previously agreed to, in order to provide the adviser with more lucre or other benefits.

Hence, disclosure, alone, is not a cure. And disclosure is only one of the five important requirements, all of which must be met, for a client’s waiver of a fiduciary obligation to be valid. Such waivers, while they may be required for unavoidable conflicts of interest, should be rare indeed. And even then the conflict of interest to which consent to proceed is given must be properly managed, for no client would ever knowingly consent to be harmed.


"All financial advisors should be held to act in the best interests of their clients." ICI testimony before the hearing, "Preserving Retirement Security and Investment Choices for All Americans." Sept. 10, 2015.

"NAIFA does not oppose a 'best interest' fiduciary standard for its members. However, any new standard must be operationalized in a fashion that is workable for Main Street advisors and their clients." Statement of Juli McNeely President National Association of Insurance and Financial Advisors before Congress in the hearing, "Preserving Retirement Security and Investment Choices for All Americans." Sept. 10, 2015.

"Raymond James has long been a supporter of a common fiduciary standard. Long before the DOL first proposed a rule, we instituted a client bill of rights that is given to every client of Raymond James. Amongst these rights is the right to expect recommendations based solely upon the client's unique needs and goals ...." Statement of Scott Stolz, before Congress in the hearing, "Preserving Retirement Security and Investment Choices for All Americans." Sept. 10, 2015.

SIFMA, FSI, and other groups representing broker-dealer firms often professor their support for a "uniform fiduciary standard" or a "new federal fiduciary duty." Yet, they oppose regulations that would impose such a fiduciary standard. Instead, they desire a new "best interests" standard that, upon close examination, is nothing more than a "suitability" standard that maintains the self-interest of the broker-dealer firm or the insurance company.

As Professors Angel and McCabe observed some five years ago: “[T]o give biased advice with the aura of advice in the customer’s best interest – is fraud.” FINRA, SIFMA, broker-dealers and insurance companies want to profess to act in their customers "best interests" - but only if that term is redefined so that it does not involve an obligation of loyalty. In seeking such a redefinition, they seek to perpetuate a fraud on the American people.

Judge Cardozo in Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928) famously wrote: “Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the "disintegrating erosion' of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court.”

The "best interests" standard is not difficult to understand, nor difficult to apply. It just requires common sense. Avoid conflicts of interest wherever possible. When conflicts of interest remain, take the proper series of actions to secure the informed consent of the client and ensure that the client is treated substantively fair.

Fiduciaries - whether attorneys, doctors, trustees, corporate directors, or otherwise - should resist any attempt to erode the fiduciary duty of loyalty. We need to stand up to Wall Street and the insurance companies and say, "This has gone on long enough. We are tired of you taking advantage at every opportunity of the American people."

There exists simple solutions to the application of the fiduciary standard. The DOL can simply write a rule that states that retirement advisors must comply with ERISA's even stricter "sole interests" standard as well as its prohibited transaction rules, without any exemptions therefrom. The SEC can follow by simply stating that any provision of "personalized investment advice shall be subject to the fiduciary standards of conduct applicable to registered investment advisers."

But the broker-dealer and insurance industries, despite their pronouncements that they embrace the "best interests" of their customers, complain loudly whenever such a simple rule is advanced. They clamor for exceptions. And then they complain that these exceptions (initiated at their behest) are too complex and unwieldy, and they argue for simplicity.


S U R V I V A L !!!

There exists a stark reality facing the broker-dealer and insurance industries. It is found in the truths confirmed by academic researchers around the world and widely known by fiduciary investment advisers:
  1. Fees and costs matter. The higher the fees and costs, the less the returns of the capital markets flow to the contributors of capital - the owners of stocks, bonds, mutual funds, and other pooled investment vehicles and securities.
  2. Wall Street extracts excessively high rents. It is commonly known that many broker-dealer firms possess a target for client revenue equal to 2% a year of the investment assets upon which they provide advice. For insurance company products, such as variable annuities with GMWB and similar riders, the fees and costs often amount to 4% a year or greater. Yet, the broker-dealers and insurance companies do not add sufficient value for these high fees. 99% of the products they promote and sell under the weak "suitability" standard won't survive the cost-benefit analysis undertaken by a true fiduciary.
  3. Economic incentives matter. If either firms or their employees possess incentives to promote a product that pays higher compensation, these incentives are too tempting. Higher-cost products are sold, far too often, when far better products are available. The fallacies of human nature are well known - hence, the reason for the strict application of the fiduciary duty of loyalty.
  4. Commission-based compensation is usually unreasonable compensation. A person rolls over a $400,000 401(k) account to an IRA, and is sold a variable annuity which provides the broker/insurance agent's firm a 5% (or higher) commission (in addition to other fees). $20,000 commission, for a product that fails to survive due diligence in most instances. The fee is wholly unreasonable. And the fiduciary standard of conduct requires that the fiduciary's compensation be reasonable.
  5. Wall Street's business model cannot survive the fiduciary standard. Because a fiduciary has the legal duty to ensure that any fees and costs expended by the client are reasonable, Wall Street's current business model, built upon high, multi-million dollar compensation to a home office full of executives, is doomed. As are the business models of most insurance companies. Should fiduciary standards be applied broadly and correctly to the provision of all investment advice, the revenues of broker-dealer firms and the insurance industries will plummet. The shake-out will occur.
  6. Investment banking becomes less profitable. If investment bankers have to market their products to true fiduciaries, rather than rely upon product sales forces to hype IPOs, the greater scrutiny will result in far greater evaluation of the merits of IPOs, and more efficient pricing of these offerings in the marketplace. Without the ability to secure high (and often unwarranted) pricing, investment banking fees will fall. This major source of the revenue of Wall Street's warehouses further seals their doom.
  7. Wall Street has no real advantage over independent, fiduciary investment advisers today. In fact, independent investment advisers can access nearly any investment product today. Brokers at a warehouse? Only the (usually high-cost) investments approved for their "platform." And the support given to brokers is often terrible and burdensome - poor software solutions, marketing programs hindered by news of settlement after settlement resulting in customer distrust of the firm and its advisers, and burdensome FINRA-imposed compliance requirements. In contrast, even small, independent firms can access competitively priced software and other solutions. [Of course, let's also note the desperate attempts by firms to preserve their market share by restrictive non-compete and non-solicitation agreements, coupled with deferred comp arrangements to further incentivize brokers to stay. But, wiser brokers will realize that they will build more equity, and have greater freedom, and greater income over time, by going independent.]
  8. Being an independent fiduciary advisor is enjoyable. No fears of liability - because you act as an expert and avoid the many conflicts of interest that get Wall Street's firms (and their representatives) in trouble. Much deeper relationships with clients. Going to work is not about selling, but rather is acting as a trusted advisor. The stature of being a true professional, not a product salesperson. It's a great way to spend a day.
There are major reasons Wall Street is pulling out all of the stops to stop the DOL from issuing rules which apply fiduciary standards of conduct to retirement accounts. There are major reasons Wall Street is attempting to eliminate the fiduciary's duty of loyalty by redefining "best interests."

Let's act, together, to oppose Wall Street's flailing self-interest, as it seeks to avoid, similar to the dinosaurs of old, its own extinction-level event. Let's act, together, to preserve the bona fide "best interests" standard as an essential protection for clients of fiduciaries everywhere.

WHAT CAN YOU DO? Visit "Save Our Retirement" today, and use the simple tool on that web site to contact both of your U.S. Senators, as well as your U.S. Representative. (As of Fall 2015, the battle over the DOL's proposal continues in the halls of Congress - it is not too late to make your feelings known.) Let them know that the fiduciary duty of loyalty, and its true "best interests" requirement, is important - to you, to your fellow neighbors, and to America itself.


On June 3, 2015, SIFMA provided this mark-up (modification to) FINRA’s rules, as part of its proposal:

2111. Suitability The Best Interests of the Customer

a. A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for in the best interests of the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.

i. The best interests standard. A best interests recommendation shall:

1. Reflect the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person would exercise based on the customer’s investment profile (defined above). The sale of only proprietary or other limited range of products by the member shall not be considered a violation of this standard.

2. Appropriately disclose and manage investment-related fees. See Manage investment-related fees below.

3. Avoid, or otherwise appropriately manage, disclose, and obtain consents to, material conflicts of interest, and otherwise ensure that the recommendation is not materially compromised by such material conflicts. See Manage material conflicts of interest below.

ii. Manage investment-related fees. A member shall ensure that investment-related fees incurred by the customer from the member are reasonable, fair, and consistent with the customer’s best interests. Managing investment-related fees does not require recommending the least expensive alternative, nor should it interfere with making recommendations from among an array of services, securities and other investment products consistent with the customer’s investment profile.

iii. Manage material conflicts of interests. A member or associated person shall avoid, if practicable, and/or mitigate material conflicts of interest with the customer. A member or associated person shall disclose material conflicts of interest to the customer in a clear and concise manner designed to ensure that the customer understands the implications of the conflict. The customer shall be given the choice of whether or not to waive the conflict, and must provide consent, as provided in Rule 2260 (Disclosure). Notwithstanding the disclosure of, and customer consent to, any material conflict, a recommended transaction or investment strategy must nevertheless be in the best interests of the customer.

iv. Provide required disclosures. A member or associated person shall provide and/or otherwise make available to the customer, among other things: 1) account opening disclosure, 2) annual disclosure, and 3) webpage disclosure, as provided in Rule 2260 (Disclosure).

b. A member or associated person fulfills the customer-specific suitability obligation for an institutional account, as defined in Rule 4512(c), if (1) the member or associated person has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a security or securities and (2) the institutional customer affirmatively indicates that it is exercising independent judgment in evaluating the member’s or associated person’s recommendations. Where an institutional customer has delegated decision making authority to an agent, such as an investment adviser or a bank trust department, these factors shall be applied to the agent.

2260. Disclosures

a. Account opening disclosure. A member or associated person shall disclose to the customer, at or prior to the opening of the customer account, or prior to recommending a transaction or investment strategy, if earlier, the following:
• the type of relationships available from the broker-dealer and the standard of conduct that would apply to those relationships;

• the services that would be available as part of the relationships, and information about applicable direct and indirect investment-related, fees;

• material conflicts of interest that apply to these relationships, including material conflicts arising from compensation arrangements, proprietary products, underwritten new issues, types of principal transactions, and customer consents thereto; and

• disclosure about the background of the firm and its associated persons generally, including referring the customer to existing systems, such as FINRA’s BrokerCheck database.

b. Annual disclosure. A member shall disclose to the customer annually a good faith summary of investment related fees incurred by the customer from the member or associated person with respect to all products and services provided during the prior year (or such shorter period as applicable).

c. Webpage disclosure. A member’s webpage shall provide disclosure that is concise, direct and in plain English, following a layered approach that provides supplemental information to the customer. A member’s webpage shall include access to all account opening disclosure. Paper disclosure shall be provided to customers that lack effective Internet access or that otherwise so request.

d. Customer consent. Customer consent to material conflicts of interest or for other purposes as appropriate may be provided at account opening.(FN1) Existing customers with accounts established prior to the effective date of the best interests standard shall be deemed to have consented to the material conflicts of interest, if any, disclosed to the customer, upon continuing to accept or use account services.

e. Disclosure updates. Updates to disclosures, if necessary or appropriate, may be made through an annual notification that provides a website address where specific changes to a member’s disclosure are highlighted.

FN1. Customer consent to principal transactions, for example, could be provided at account opening.

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