The Flawed State of Broker-Dealer Regulation and the Case for an Authentic Federal Fiduciary Standard for Broker-Dealers

By Varnavides, Gary A. | Fordham Journal of Corporate & Financial Law, October 1, 2011 | Go to article overview

The Flawed State of Broker-Dealer Regulation and the Case for an Authentic Federal Fiduciary Standard for Broker-Dealers


Varnavides, Gary A., Fordham Journal of Corporate & Financial Law


I. INTRODUCTION

The 2008 financial crisis revealed that the American financial industry's regulatory scheme is broken and in desperate need of reform. The modern American financial system operates under an antiquated regulatory structure developed in the 1930s and 1940s that is illequipped to deal with the intricacies and risks of modern finance. Accordingly, reforming financial industry regulation is necessary to deal with the complexities of the 21st century financial services industry. President Obama championed financial industry reform during his campaign and stressed the importance of passing legislation during his first year in office. The House of Representatives recently passed a comprehensive piece of legislation reforming the financial industry and the Senate will begin working on its version of the bill in early 2010." Tucked into the extensive House bill is the Investor Protection Act of 2009 ("IPA"), which significantly changes the federal securities laws.2

This Note addresses a critical section of the IPA: its proposal that broker-dealers be held to a new, higher standard of conduct towards customers modeled on the Investment Advisers Act of 1940 (the '"40 Act"). Currently, broker-dealers are regulated under the Securities Exchange Act of 1934 (the '"34 Act") and sometimes held to a fiduciary standard of conduct towards customers, whereas investment advisers are regulated under the '40 Act and always held to a fiduciary standard. This bifurcated regulatory scheme - the product of another era when broker-dealers and investment advisers were distinct entities - results in two different regulatory standards and enforcement mechanisms for broker-dealers and investment advisers. Today, however, broker-dealers and investment advisers offer virtually identical services to investors, resulting in considerable confusion for both investors and regulators. Thus, the IPA seeks to harmonize the regulation of broker-dealers and investment advisers by holding both groups to a consistent standard of conduct.

Part II of this Note discusses the history of broker-dealer and investment adviser regulation, including the development of different legal duties and regulatory schemes for each group. Part ?? identifies and analyzes the different contexts in which broker-dealers and investment advisers are held to a fiduciary standard. Part IV examines the central problems within the current regulatory framework for brokerdealers and investment advisers. Part V analyzes the IPA and concludes that it is too vague and does far too little to protect broker-dealer customers. Part VI proposes an alternative to the IPA: the adoption of an authentic, federal fiduciary standard for broker-dealers that preserves a private right of action for investors. Finally, Part VII concludes that this Note's proposal is a superior alternative to the PA that would better regulate broker-dealers and offer better protection for broker-dealer customers.

II. THE FLAWED STATE OF BROKER-DEALER REGULATION: HOW WE GOT HERE

SEC Commissioner Elisse Walter describes the current federal securities laws, enacted by Congress in the 1930s and 1940s, as a "badly worn patchwork quilt" in desperate need of reform.3 Indeed, the regulation of broker-dealers and investment advisers is "balkanized" and reflects antiquated notions about the functions of broker-dealers and investment advisers that are virtually obsolete.4

A. THE ORIGINS OF BROKER-DEALER REGULATION: THE '34 ACT

The Securities Exchange Act of 19345 (the '"34 Act") and its implementing rules "comprise the most central regulatory apparatus for broker-dealers."6 Section 15(a) of the '34 Act requires broker-dealers engaged in interstate securities transactions to register with the Securities and Exchange Commission (the "SEC").7 The '34 Act gives the SEC broad authority to set rules regarding broker-dealers, including the ability to revoke or suspend broker-dealer registration if the brokerdealer violates federal law or engages in other misconduct. …

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