If you are a registered
representative or insurance agent and also call yourself a “financial advisor”
or “financial consultant,” is this fraud? Should you be required to adhere to a
fiduciary standard of conduct? Should you be prosecuted if you do not?
Gil Weinrich’s article, “A
Modest Proposal: Prosecute Non-Fiduciaries Using Term ‘Advisor’ (Dalbar CEO Lou
Harvey reacts to Tibergien’s lament about ‘fiduciaries in name only’) fell on
favorable ears at fi360’s 2013 Annual Conference in Scottsdale, Arizona this
week. See the article at AdvisorOne, located at http://www.advisorone.com/2013/04/08/advisors-are-you-a-fiduciary-or-a-fraud.
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,’ … .” 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, Skip Schweiss, President of TD Ameritrade Trust Company, pointed
out Lou Harvey’s suggestion during a panel discussion in which I participated.
Skip also suggested that anyone calling himself or herself a “financial
advisor” or “financial consultant” be held to the fiduciary standard of
conduct.
In this blog post, please
permit me to add some additional context to the discussion, through a review of
judicial decisions and statements by the U.S. Securities & Exchange
Commission. In the paragraphs that follow I provide the following:
- · A foundational review of the two types of relationships which exist under the law;
- · A review of the fact that the provision of advice usually results in fiduciary status to attach to the advice provider;
- · A recollection of recent academic support that calling oneself as an “advisor” while not accepting fiduciary status constitutes fraud;
- · An explanation of the maxim that “two hats” cannot be worn at the same time;
- · A review the varying positions of the SEC on this issue;
- · A survey of several recent court decisions, relating to the use of titles and imposition of fiduciary status on brokers and/or insurance agents; and
- · Recommendations for action YOU can take.
TWO DIFFERENT TYPES OF
RELATIONSHIPS EXIST UNDER THE LAW
As readers are already likely
aware, service provider – consumer relationships between two parties fall into
one of two categories. The first
category is that in which arms-length negotiations between the parties take
place. In the context of the securities
industry, the relationship is generally mapped as follows: PRODUCT
MANUFACTURERS ⇒ MANUFACTURERS’ (SALES)
REPRESENTATIVES ⇒ CUSTOMER. The
customer, in this instance, is largely responsible to protect himself or
herself. In general, the principle of caveat emptor (“let the buyer beware”)
applies.
The purchaser of an
investment product is sometimes aided by specific laws that impose additional
duties on the seller and/or the seller’s agent (i.e., broker) which do not
arise to the level of fiduciary protections. For example, upon broker-dealers
there is imposed the requirement that investment products sold to an investor
be “suitable,” at least with regard to the risks associated with that investment.
Additionally, select disclosures of information may be required of
broker-dealers under federal securities laws. Yet, even with somewhat (and, I
would argue, ineffective) additional safeguards, the arms-length relationship
of the parties involved in the sale of an investment product still exists. The
customer must still protect his or her own interests; the seller of the product
(whether an employee of the product manufacturer, or another intermediary, such
as a broker) is generally not a fiduciary to the customer (absent a
relationship of trust and confidence being formed, or the application of
ERISA’s fiduciary standards, or some other manner in which fiduciary status may
result). In non-fiduciary, arms-length relationships, the product salesperson
(broker) acts as the representative of the product manufacturer during
negotiations with a customer.
By contrast, the fiduciary
relationship arises in situations where the law has clearly recognized that
fiduciary duties attach, such as principal-agent relationships and
trustee-beneficiary 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. In these situations, mere disclosure of
material facts is thought to be inadequate as a means of consumer protection,
and hence the fiduciary standards of conduct are imposed. The relationship of
the parties in a fiduciary relationship is reversed, as follows: CLIENT ⇒ FIDUCIARY ADVISOR (CLIENT’S REPRESENTATIVE)
⇒ INVESTMENT PRODUCT PROVIDERS. In essence, the fiduciary “steps into the
shoes” of the client and adopts the client’s ends as his or her own. See , e.g., Arthur Laby, The Fiduciary
Obligation as the Adoption of Ends, 56 Buff. L. Rev. 99, 104-29 (2008) (stating
that the signature obligation of fiduciary is to adopt ends of his or her
principal). The fiduciary acts as the representative of the purchaser, and the
best interests of the client must remain paramount to the interests of the
fiduciary (excepting only agreed-to-in-advance reasonable compensation) and to
that of the product manufacturer.
THE PROVISION OF “ADVICE”: A
FIDUCIARY RELATIONSHIP USUALLY EXISTS
Under state common law, as
Professor Laby further notes, “Historically, providing advice has given rise to
a fiduciary duty owed to the recipient of the advice. Both the Restatement
(First) and Restatement (Second) of Torts state, “[a] fiduciary relation exists
between two persons when one of them is under a duty to act for or to give
advice for the benefit of another upon matters within the scope of the
relation” [citing Restatement (Second) Of Torts § 874 cmt. a (1979) (citation
omitted) (emphasis added); Restatement (First) Of Torts § 874 cmt. a (1939)
(citation omitted) (emphasis added)].”
But what about the Investment
Advisers Act of 1940? Does the Advisers Act modify state common law? No. It has
long be recognized that the Advisers Act (unlike ERISA) does not preempt the
application of state common law. In other words, the SEC may establish a floor,
as to the limits of the fiduciary standard of conduct, but it does not set the
ceiling.
Indeed, the basis for holding
registered representatives to a fiduciary standard of conduct, under state common
law, is through application of fiduciary duties under state common law. This
“common law” has been developed over the centuries and may be thought of as
“judge-made law.” Throughout nearly all of the United States (except Louisiana,
a “civil law” and not a “common law” jurisdiction), the obligations of parties
to each other in a commercial relationship are often determined by reference to
principles of law, as applied through the centuries, looking at cases decided
in the United States of America and, before then, to cases decided in England.
RECENT ACADEMIC SUPPORT: USE
OF “ADVISOR” AS POTENTIAL FRAUD
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.”
James J. Angel, Ph.D., CFA and Douglas McCabe Ph.D., “Ethical Standards for
Stockbrokers: Fiduciary or Suitability?” (Sept. 30, 2010). Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686756.
Professor Arthur Laby has
also opined on this issue, stating: “If a broker holds itself out as an adviser
and suggests it is seeking a long-term relationship with the customer, a
fiduciary duty imposed on the broker would be broader in scope than the
broker’s current obligation.”
I do not suggest, however,
that all service provider-customer relationships arise to the level of a
fiduciary relationship. A plumber may provide some aspect of advice, but the
consumer is still in an arms-length relationship with the client. But the
delivery of personalized investment advice is quite different from the situation
involving the fixing of a leaky pipe. Indeed, public policy considerations come
into play as to when fiduciary duties are applied in various service
provider-consumer relationships. In the context of personalized investment
advice regarding securities, the public policy considerations are substantial –
neigh, overwhelming, as to why fiduciary status should be imposed. Please refer
to my prior blog post on this topic, located at http://scholarfp.blogspot.com/2013/04/public-policy-considerations-which.html.
THE FALLACY OF TWO HATS:
EMPTOR EMIT QUAM MINIMO POTEST, VENDITOR VENDIT QUAM MAXIMO POTEST
Can you be both a fiduciary
and a non-fiduciary, with respect to the same client / customer, at the same
time? No. Dual registration (i.e., registration as both an investment adviser
and a registered representative) does not confer upon one the ability, under
state common law, to wear “two hats” at the same time.
It must be first understood
that fiduciary duties attach to the relationship. “Fiduciary” is, in effect, a
“status” that arises from a variety of factors under state common law. It flows
from the establishment of a relationship of trust and confidence with the
client. And, as a general rule, the fiduciary obligations extend to the
entirety of the relationship.
Time and again our courts
have enumerated the fiduciary maxim: “No man can serve two masters.” See, e.g.,
Carter v. Harris, 25 Va. 199; 1826 Va. LEXIS 26; 4 Rand. 199 (Va. 826),
stating: “It is well settled as a general principle, that trustees, agents,
auctioneers, and all persons acting in a confidential character, are
disqualified from purchasing. 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, as was
strongly observed in the case of the York Buildings Company v. M'Kenzie, 8 Bro.
Parl. Cas. 63, 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.” Id. at 204.
The observation that a person
cannot wear two hats and continue to adhere to his or her fiduciary duties was
echoed 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.”]
Why should an advisor not attempt
to wear two hats? Simply put, because persons are weak. We are unable to not
have our advice be affected by temptations (such as for additional
compensation) which might exist. As the U.S. Supreme Court 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) (“This Court, in discussing conflicts of
interest, has said: ‘The reason of the rule inhibiting a party who occupies
confidential and fiduciary relations toward another from assuming antagonistic
positions to his principal in matters involving the subject matter of the trust
is sometimes said to rest in a sound public policy, but it also is justified in
a recognition of the authoritative declaration that no man can serve two
masters; and considering that human nature must be dealt with, the rule does
not stop with actual violations of such trust relations, but includes within
its purpose the removal of any temptation to violate them … In Hazelton v.
Sheckells, 202 U.S. 71, 79, we said: ‘The objection . . . rests in their
tendency, not in what was done in the particular case. . . . The court will not
inquire what was done. If that should be improper it probably would be hidden
and would not appear.’ United States v. Mississippi Valley Co., 364 U.S. 520,
550, n. 14.” Id. at p. 249 (fn.50).
THE SEC’S FAILURE TO PREVENT
FRAUD: NON-FIDUCIARIES HOLDING OUT AS “ADVISORS”
As a result of regulatory
missteps by the SEC (and FINRA) over many decades, substantial consumer
confusion now abounds as to the standard of conduct consumers can expect from
their providers of investment advice.
Section 913 of the Dodd-Frank Act provides the SEC with the legal
authority to correct this situation through the imposition of fiduciary
standards upon broker-dealers. Aside from the fact that fiduciary status
already attaches to the majority of broker-customer relationships under state
common law (which I will write about in later blog posts), permit me to focus
on actions by the SEC, and their ill-advised reversal of position regarding the
use of titles over the nearly eight decades of the SEC’s existence.
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 '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.] 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.
In its 1963 comprehensive
report on the securities industry, the SEC also 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.] 1963 SEC Study, citing various SEC Releases.
Yet, and despite the
substantial authority already existing (under previous SEC pronouncements, as
well as case law), in 2005 the SEC, in the ill-fated “Merrill Lynch Rule” final
rule (subsequently overturned by the courts on other grounds), declined to
police the use of titles by non-fiduciaries.
The SEC stated, in its 2005 issuing release:
“[W]e
share the concern that there is confusion about the differences between broker-dealers
and investment advisers, and … we believe that some of that confusion may be a
result of broker dealer marketing (including the titles broker-dealers use) …
We
have decided not to include in rule 202(a)(11)-1 any other limitations on how
a
broker-dealer may hold itself out or titles it may employ without complying
with the Advisers Act.”
SEC Release No. 34-51523, IA-2376:
Certain Broker-Dealers Deemed Not To Be Investment Advisers (Apr. 12, 2005).
I find the SEC’s statement,
above, simply astonishing. While acknowledging that a major source of confusion
is broker’s use of titles, the SEC abrogated one of its core functions – the
prevention of fraud – by declining to address the use of such titles. In
essence, the SEC sanctioned fraud.
RECENT COURT DECISIONS
INVOLVING THE USE OF TITLES AS EVIDENCE OF EXISTENCE OF FIDUCIARY RELATIONSHIP
State common law also
reflects the fact that the use of titles such as “advisor” or “planner” (or
similar terms) often results in THE imposition of fiduciary status. Several
cases are summarized below.
Koehler (1985). A U.S. District Court in 1985 held that a
fiduciary relationship existed in part because of a defendant's status as
financial planner to a client. In
Koehler v. Pulvers, 614 F. Supp. 829 (USDC, Cal, 1985) the defendant, CSCC, was
primarily in the business of real estate syndication, but also in business
under the name Creative Financial Planning.
As stated in the decision, “The developer defendants obtained investment
capital from the public by posing as financial planners ... The financial
planners typically had a background in either insurance or real estate sales
… As an alleged financial planning
company, CSCC, dba Creative Financial Planners, contacted potential investors
by conducting Creative Financial Planning seminars open to the public.
Utilizing a slick presentation… CSCC attempted to lure investment capital out
of savings accounts, home equity, insurance policies, and other conservative
investment vehicles and into the speculative real estate ventures it controlled
… At the seminars, CSCC offered to draft a ‘Coordinated Financial Plan’ for
attendees at little or no charge. Individuals who accepted this offer received
recommendations to purchase limited partnership or trust deed interests in CSCC
controlled partnerships and project ....” The court also noted, “Most of the
plaintiffs are and were unsophisticated investors. Few had a preexisting
relationship with the developer defendants at the time they purchased their
securities ... [the investors] relied upon the misrepresentations discussed in
detail below. This reliance was reasonable in part because of the developer
defendants' purported disinterested financial planner status.”
Cunningham (1990). Insurance
agents who introduced themselves as “investment counselors or enrollers” and
who tailored retirement plans for each person depending on the individual’s
financial position, and who led the customers to believe that an investment
plan was being drafted for each customer according to each customer’s needs,
was held by a federal court, apply Iowa state common law, to lead to the
possible imposition of fiduciary status.
Cunningham vs. PLI Life Insurance
Company, 42 F.Supp.2d 872 (1990).
Mathias (2002). “In the fall of 1985, plaintiff, having recently
divorced and relocated to Columbus, Ohio, sought investment advice from Thomas
J. Rosser. At the time, Rosser was a licensed salesman for Great Lakes
Securities Company and held himself out as a financial advisor … [T]he evidence
established that Rosser was a licensed stockbroker and held himself out as a
financial advisor, and that plaintiff was an unsophisticated investor who
sought investment advice from Rosser precisely because of his alleged expertise
as a broker and investment advisor. Further, Rosser testified that plaintiff
had relied upon his experience, knowledge, and expertise in seeking his advice.
Therefore, we conclude that plaintiff presented sufficient evidence to
establish that she and Rosser were in a fiduciary relationship.” Mathias
v. Rosser, 2002 OH 2531 (OHCA, 2002).
The court further noted, that under Ohio law, a fiduciary relationship
is “a relationship in which one party to the relationship places a special
confidence and trust in the integrity and fidelity of the other party to the
relationship, and there is a resulting position of superiority or influence,
acquired by virtue of the special trust.” Id.
Williams (2006). In a case
arising from Oregon, a self-employed insurance seller and licensed financial
planner took advantage of his position as a financial advisor to gain the trust
of an 87-year-old man, Stubbs, convincing the elderly man to grant him a power
of attorney, with which the financial planner stole about $400,000. The court held that the licensed financial planner
was employed as a fiduciary, specifically noting that the elderly man relied
upon the fiduciary as a financial advisor and estate planner. U.S. v.
Williams, 441 F.3d 716, 724 (9th Cir. 2006).
Hatleberg (2005). When a bank held out as either an “investment
planner,” “financial planner,” or “financial advisor,” the Wisconsin Supreme
Court held that a fiduciary duty may arise in such circumstances. Hatleberg v. Norwest Bank Wisconsin,
2005 WI 109, 700 N.W.2d 15 (WI, 2005).
Graben (2007). A dual registrant crossed the line in
"holding out" as a financial advisor, and in stating that ongoing
advice would be provided, and other representations, and in so doing the dual
registrant, who sold a variable annuity, and was found to have formed a
relationship of trust and confidence with the customers to which fiduciary
status attached. "Obviously, when a person such as Hutton is acting as a
financial advisor, that role extends well beyond a simple arms'-length business
transaction. An unsophisticated investor is necessarily entrusting his funds to
one who is representing that he will place the funds in a suitable investment
and manage the funds appropriately for the benefit of his investor/entrustor.
The relationship goes well beyond a traditional arms'-length business
transaction that provides 'mutual benefit' for both parties." Western Reserve Life Assurance Company of
Ohio vs. Graben, No. 2-05-328-CV (Tex. App. 6/28/2007) (Tex. App., 2007).
RECOMMENDATIONS FOR ACTION
If we are going to protect
the consumers of personalized investment advice (which should be the primary
goal of any action to be undertaken by our regulatory agencies), then we should
take action. We simply desire us all to: “Say what you do; do what you say.”
If a person uses a title
denoting a relationship of trust and confidence – i.e., a fiduciary relationship – without accepting at all times the
fiduciary duties which flow therefrom, that person should be held to account.
The use of such a title in such instances is a misrepresentation – i.e.,
designed to mislead the consumer. And the use of such title is intentional –
i.e., it is designed to result in a commercial advantage to the user of the
title. There is another name for “intentional misrepresentation” under the law
– “fraud.”
I thank Dalbar’s CEO Lou
Harvey, journalist Gil Weinrich, and TD Ameritrade Trust Company’s President
Skip Schweiss for calling attention to this issue. And today, at the fi360
Annual Conference, Skip Schweiss issued a challenge – that firms and the media
stop using the term “advisor” except when the person involved is registered as,
and acting as, an investment adviser.
Practitioners and members of the
media – do not stand idly by and let fraud go unnoticed and unchecked - TAKE ACTION. Fraud
should not be tolerated. Call attention to these untruths. How?
- Write to the firm or registered representative to express your concerns.
- Write to the SEC (such as by posting a comment to the SEC's web site in connection with its request for comment on fiduciary rule-making - it's easy to do via http://www.sec.gov/cgi-bin/ruling-comments?ruling=4-606&rule_path=/comments/4-606&file_num=4-606&action=Show_Form&title=Duties%20of%20Brokers,%20Dealers,%20and%20Investment%20Advisers.
- Write to your state securities administrator - and point out the fraud.
- Write to your state's Attorney General - and point out the fraud.
- Practitioners - if you see members of the media utilize the term "advisor" to describe someone other than a fiduciary advisor - correct them!
- Members of the media - please take care to describe actors in the securities industry correctly.
It is time to hold those who hold themselves out as “advisors”
– or by similar names (“financial advisor,” “financial consultant,” “wealth
manager,” etc.) – to the fiduciary standard of conduct. Or, as Lou Harvey
suggested, we should demand our federal and state securities regulators, and
states attorney general, and other agencies, to take action to stop this
persistent and pervasive fraud. Only by taking collective action can we, together, restore the trust of the consumer in those who choose to utilize the term "advisor" and adhere to their fiduciary obligations.
If you’ve read this far,
thanks for the read. As always, please follow me on Twitter (@140ltd) or connect
with me on LinkedIn, to receive word of new posts to this blog, in the crucial
months ahead. Thank you – Ron.
