Selling Advice and Creating Expectations: Why Brokers Should Be Fiduciaries

By Laby, Arthur B. | Washington Law Review, October 2012 | Go to article overview

Selling Advice and Creating Expectations: Why Brokers Should Be Fiduciaries


Laby, Arthur B., Washington Law Review


Abstract: Investors face a dizzying array of choices regarding where to invest their funds and increasingly rely on experts for advice. Most advice about securities is provided by investment advisers or broker-dealers, legal categories with little meaning to most people but fraught with consequences. Although advisers and brokers often perform the same function, advisers are subject to a strict fiduciary standard to act in their clients' best interest while brokers are subject to a less rigorous standard of suitability to ensure that their recommendations are suitable for customers. In 2010, the Dodd-Frank Act authorized the U.S. Securities and Exchange Commission (SEC) to harmonize the regulation of advisers and brokers and impose a fiduciary duty on brokers that give advice. This Article is about whether the SEC should exercise its authority. After explaining the historical context of the debate over a fiduciary standard, the Article critiques common arguments for a fiduciary duty, concluding that they are incomplete and do not alone justify a change in the law. The Article then puts forth a better justification, based on the reasonable expectations of investors. Reasonable expectations arise from brokers marketing their services as advisory and using titles, such as financial advisor and financial consultant. Reasonable expectations provide a stronger justification for a fiduciary standard than the conventional arguments.

I. DISPARATE REGULATION OF INVESTMENT ADVISERS AND BROKER-DEALERS THAT PROVIDE ADVICE IS ROOTED IN HISTORY ..................................................................716

A. Early State Regulation of Brokers and Advisers Was Minimal ..................................................................716

B. Federal Securities Regulation Was First Enacted During the Great Depression ..................................................................718

1 . Broker-Dealer Regulation Was Enacted in 1934 .................718

2. Investment Adviser Regulation Was Enacted in 1940 . 720

3. Certain Broker-Dealers Were Excluded from the Advisers Act ..................................................................723

C. The Regulation of Brokers and Advisers Differs ................ 724

D. Changes in the Securities Industry Disrupted the Coherency of Broker and Adviser Regulation .............................. 726

1 . The Elimination of Fixed Commissions Resulted in Two-Tier Pricing ..................................................................727

2. Certain Broker-Dealers Began to Charge AssetBased Fees ..................................................................728

3. The Focus of Brokerage Services Moved from Execution to Advice ..................................................................729

E. The SEC Addressed Changes in Compensation Through an Administrative Rule ..................................................................731

F. The Obama Administration and Congress Sought a Political Solution to Changes in the Securities Industry .... 733

II. CONVENTIONAL ARGUMENTS THAT SUPPORT A FIDUCIARY DUTY FOR BROKERS ARE INADEQUATE .... 736

A. Investor Confusion Is an Insufficient Basis to Support a Fiduciary Standard ..................................................................737

1 . Advocates of a Fiduciary Standard Claim Investor Confusion Justifies Regulatory Harmonization ................737

2. Investor Confusion Is Not a Compelling Argument for Regulatory Harmonization ..................................................................739

B. Inconsistent Standards Are an Insufficient Basis to Support Regulatory Harmonization .................................... 741

1 . Advocates of a Fiduciary Duty Claim Inconsistent Standards Justify Regulatory Harmonization ....................... 741

2. Existence of Inconsistent Standards Is Not a Compelling Argument for Regulatory Harmonization . …

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