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Broker Fiduciary Duty

Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author

Broker fiduciary duty is a controversial topic in the securities industry. Investors should know that a “fiduciary” is held to a higher legal standard – a “fiduciary duty” is an obligation for a professional to act in a customer’s best interests.

Is a Broker a Fiduciary?

There is no broker fiduciary rule and brokers are not required to work in a customer’s best interest. If a broker recommends a risky investment that loses an investor’s money, there is some room for interpretation as to whether the investment violated securities rules and regulations.

Registered Investment Advisers (RIAs) are fiduciaries and are regulated by the SEC. Many financial professionals are registered as both brokers and investment advisers. If you are not sure if your financial professional is a Registered Investment Adviser or a broker, ask them, and make sure you understand whether they owe you a fiduciary duty.

You can also check their Central Registration Depository number (CRD number) and look them up on BrokerCheck. If they are exclusively registered as a broker (and are therefore not a fiduciary) their profile will appear on BrokerCheck. If they are Registered Investment Adviser (a fiduciary), their profile will appear on the SEC’s Investment Adviser Public Disclosure database.

It is up to the investor to do their own research on their investment professional. While regulators may provide public databases where they can look up their financial professionals to see official records of alleged misconduct or regulatory actions, many investors have no idea that this resource is available to them.

Learn the Difference Between Broker and Fiduciary Requirements

Regulation Best Interest enhances the suitability requirements of FINRA Rule 2111. This is the latest development in a series of rules and regulations meant to protect investors from deceptive practices.

The Securities Act of 1933, also known as the “Truth in Securities Act,” prohibits manipulation in deceit in the sale of securities.

In 2012, the Financial Industry Regulatory Authority (FINRA) introduced FINRA Rule 2111. FINRA Rule 2111 requires brokers to only recommend investments that suit their investors’ needs and risk profile. Their profiles include information on their age, liquidity needs, financial goals, and other investments. The investment strategy as well as the investments themselves should also suit the investor’s needs, meaning that brokers should ensure that their investor’s portfolio is appropriately diversified.

Regulation Best Interest was meant to enhance the requirements already set in place by FINRA Rule 2111.

What is Regulation Best Interest?

Under Regulation Best Interest, broker-dealers and their representatives must uphold the following duties:

  • The Duty of Care
  • The Disclosure Obligation
  • The Conflict-of-Interest Obligation

Broker-Dealers – but not their representatives – must also provide a Customer Relationship Summary (Form CRS), which is intended to serve as an easy-to-read summary of the broker’s relationship with the investor and any conflicts of interest the broker may have.

Broker-Dealer Fiduciary Duty: Retirement Plans

There is one exception. The Department of Labor requires that broker-dealers and their representatives act as fiduciaries when making recommendations regarding retirement savings accounts, such as 401k plans.

The Disclosure Obligation

The Disclosure Obligation requires brokerage firms or their representatives to provide full and fair disclosure regarding the material scope of the firm’s relationship to the customer as well as any conflicts of interest.

Form CRS

Investors may use Form CRS as a jumping-off point for more in-depth conversations with their adviser. A typical disclosure in a Form CRS looks like this:

Revenue Sharing: Certain managers, sponsors (or their affiliates), and our clearing firm share the revenue they earn when you invest in certain of their investment products, such as money market balances, bank sweep products balances, platform fees, and alternative investments through marketing money or warrants, with us. As such, we have an incentive to recommend (or to invest your assets in) products of sponsors and managers that share their revenue with us, over other products of sponsors or managers that do not share their revenue, or who share less. Click here for more information.

After reading this disclosure, an investor should ask their broker for more specific information about which products come with revenue-sharing agreements and other conflicts of interest.

Investors should know that Form CRS does not replace the need for a full material disclosure regarding an investment at the time of recommendation.

The Conflict-of-Interest Requirement

As Senator Elizabeth Warren points out, brokerage firms often have conflicts of interest. Under Regulation Best Interest, brokers are supposed to mitigate their conflicts of interest. 

  • Brokerage firms often have a financial incentive to offer their proprietary products instead of other products that may come with lower fees for the investor.
  • Other products, like mutual funds, often come with ongoing payments for the brokerage firm.
  • Offerors of certain products may pay for brokers to attend presentations on their products. This friendly relationship between offerors and brokers may not always work in the client’s best interest.

Duty of Care Obligation

Under the Duty of Care obligation, brokers must exercise reasonable diligence, care, and skill in making a recommendation. The “diligence” requirements means that brokers must take care to understand how an investment works before they recommend it to customers.

Why is There No Broker Fiduciary Duty?

The SEC has repeatedly refused to codify broker fiduciary responsibility. Regulations claim that this requirement would lead to broker-dealers offering fewer choices to investors. According to some critics, this failure to identify broker fiduciary duties creates unnecessary dangers for investors. William Nelson stated in a paper published by Fordham Journal of Corporate & Financial Law, “Having two different standards of care regulating identical conduct is harmful to consumers.” RIAs and brokers being held to different legal standards is unnecessarily confusing and places the burden on investors to understand their broker’s obligations and the risks associated with investments.  

Further, critics of Regulation Best Interest claim that the rule should more clearly define the concept of “Best Interest.” Unscrupulous brokerage firms and their representatives more easily exploit vague language. Broker-dealers are still allowed to consider their interests in making recommendations, but they are not allowed to place their interests ahead of their customers’.

Questions for Investors to Ask their Brokers

Under the requirements of Regulation Best Interest, it is still up to the investor to carefully inquire regarding their broker’s possible conflicts. Less-experienced investors should speak with their brokers to ensure they understand all the disclosures made in Form CRS and the written disclosures provided regarding certain investments.

In certain cases, brokers might face pressure from their brokerage firms to meet sales quotas. They might have other internal incentives to sell certain securities over others. Instead of highlighting these conflicts of interest, many firms suggest in their Form CRS that customers should pose the following questions to their broker:

  • “What are your legal obligations to me when providing recommendations as my broker-dealer or when acting as my investment adviser?”
  • “How does your firm make money and what conflicts of interest do you have?”
  • “Given my financial situation, should I choose an investment advisory service? Should I choose a brokerage service? Should I choose both types of services? Why or why not?”
  • “How will you choose investments to recommend to me?

Without a broker fiduciary standard, questions like these remain an essential part of the broker-investor relationship.

Are Broker-Dealers Fiduciaries?

Investors may be surprised to know there is also no broker-dealer fiduciary standard. There are, however, a few additional requirements under Regulation Best Interest. In addition to the Disclosure Obligation, the Care Obligation, and the Conflict-of-Interest Obligation, broker-dealers must also uphold the Compliance Obligation and Record-Making and Record-Keeping Obligations.

The Compliance Obligation simply refers to the firm’s obligation to maintain written supervisory procedures designed to ensure compliance with Regulation Best Interest. Brokerage firms must also keep adequate records to demonstrate compliance.

Frequently Asked Questions

Kurta Law frequently fields the following questions related to financial professionals and their fiduciary responsibilities.

When Does Fiduciary Duty End?

The fiduciary duty lasts as long as the Registered Investment Adviser’s services are engaged. This typically begins when the investor signs an investment contract. Investors can end their relationship with an investment adviser at any point.

Can I Sue My Broker?

Recommendations of overly risky investments can end up in FINRA arbitration instead of civil court. Brokerage firms protect their representatives from lawsuits by requiring investors to use FINRA arbitration in order to settle any disputes they may have with their brokers. Instead of suing in civil court, investors pursue the niche arbitration process – a process that is often wholly unfamiliar to even the most sophisticated investors. FINRA arbitration proceedings are non-public, which may offer firms some advantage if they want to obscure their representatives’ alleged misconduct.

One study from 2022 suggests that FINRA arbitration panels are often stacked against investors, making it often difficult to overcome industry bias with the help of a securities attorney.

I Lost Money Because of My Broker’s Recommendations. Now What?

Contact Kurta Law for a free case evaluation. Even if your broker did not owe you a fiduciary duty, their recommendation of a risky investment may still have violated securities laws. Our attorneys provide no-feel consultations and do not collect any payment unless we win your case. Call (877) 600-0098 or email info@kurtalawfirm.com.

Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.