A fiduciary duty means that when a broker makes a recommendation to the customer, the broker’s motivation must be in the customer’s “best interest”. For most brokers, that is their motivation. Where it is not, trouble can ensue. The extent to which such a duty continues after the purchase of a recommended security has resulted in decades of court decisions.
A common question I encounter from potential customer clients has to do with the level of responsibility or duty their broker owed them. While they may not know the legalese, these potential clients are trying to find out if their brokers owed them a fiduciary duty. If the inquiry involves a discretionary or “managed account,” where the broker does not need the customer’s approval before each transaction – where it is the broker making the ultimate investment decision – a fiduciary duty most likely exists for the duration of the relationship. Most courts and arbitrators hold that in the case of discretionary accounts, the broker and the brokerage firm have taken it upon themselves to have a continuing fiduciary duty to the customer. The question gets more interesting in cases involving non-discretionary accounts, which make up most brokerage accounts.
While arbitration is primarily a forum of equity, there are certain securities law standards and securities industry codes of conduct that allow us to better judge the issues. One thing to keep in mind, however, is that while a broker may be considered a fiduciary to her client, it does not mean that she and her firm are guarantors of performance – just because an account lost money does not necessarily mean the broker acted inappropriately. But when a fiduciary duty exists, the reasoning behind the broker’s actions is held to a higher level of scrutiny.
In the New York Supreme Court case of Daniel C. Gascoyne v. Frank J. Avellino,[i] the court set forth the three elements of a claim for breach of fiduciary duty: (1) the existence of a fiduciary relationship between the plaintiff and defendant; (2) misconduct by the defendant; and, (3) damages that were directly caused by defendant’s misconduct.[ii]
To establish a fiduciary relationship, courts have said that a customer must show that the broker was “under a duty to act for or to give advice for the benefit” of the customer “upon matters within the scope of the relation.”[iii] This standard does not require that there be a formal contract or agreement, like one would have in opening a discretionary account, so there are circumstances where a broker would owe a customer a fiduciary duty for a non-discretionary account. This is partially why breach of fiduciary duty claims continue to represent a substantial percentage of FINRA customer arbitration claims. In order to find that such a duty existed and was breached turns on a determination of the facts particular to each claim.
In Leib v. Merrill Lynch, Pierce, Fenner & Smith, a frequently cited decision concerning a broker’s fiduciary duty, the court held that when a broker takes control over a non-discretionary account, “the broker owes his customer the same fiduciary duties as he would have had the account been discretionary from the moment of its creation.” The Leib court listed four fiduciary duties that are often used as guidelines by customer attorneys and defense attorneys alike:
1. Manage the account in a manner directly comporting with the needs and objectives of the customer;
2. Keep informed regarding the changes in the market which affect his customer’s interests and act responsively to protect those interests;
3. Keep his customer informed as to each completed transaction; and,
4. Explain forthrightly the practical impact and potential risks of the course of dealing in which the broker is engaged.
In De Kwiatkowski v. Bear Stearns & Co, the Federal Second Circuit Court of Appeals in New York (in a case involving a non-discretionary customer account) drew a distinction between a broker’s obligation when he recommends an investment and any obligation thereafter. The obligation of a broker, said the Appeals Court, depends on his decision to extend his legal obligation beyond that which he would otherwise be responsible for. When the broker assumes that greater responsibility, he has become the customer’s fiduciary, with the litany of responsibilities that continue as long as that special relationship exists.
Court rulings show that when determining if a broker owes a fiduciary duty, the question is far more nuanced than whether or not the account was discretionary in nature. In order to get a clear picture of your rights and the obligations your broker owes/owed to you, contact us and speak with attorneys with over 30 years of experience specializing in securities matters.
[i] 2013 WL 5228093 (N.Y.Sup. Sept. 2013).
[ii] See Kurtzman v. Bergstol, 40 A.D.3d 588, 590, 835 N.Y.S.2d 644 (2d Dept 2007).