A common question I encounter from potential customer clients has to do with the level of responsibility or duty their broker owed them. It typically comes as a great surprise to these customers that not all stockbrokers are legally required to act in their customer’s best interest. In order for a broker to be held to this standard, that broker must owe the customer a fiduciary duty.
A fiduciary duty means that when a broker makes a recommendation to the customer, the broker’s motivation must, legally, 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.
If the customer owned 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.
In addition to discretionary accounts, Fee-Only brokers owe a fiduciary duty to their customers. Fee-Only brokers are Registered Investment Advisors that do not accept any fees or compensation based on account transactions or product sales. In other words, their compensation is not dictated by the activity in the account. These brokers are paid an annual fee – typically based on the size of the account – but can also charge a flat retainer or be paid an hourly for advisory services. However, there are also instances where a broker can be found to owe a fiduciary duty in non-discretionary or commission-based accounts.
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:
- Manage the account in a manner directly comporting with the needs and objectives of the customer;
- Keep informed regarding the changes in the market which affect his customer’s interests and act responsively to protect those interests;
- Keep his customer informed as to each completed transaction; and,
- 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).