Fiduciary Duties of Brokers

Stock Broker Fiduciary Duty

An effect of the 2008-2009 market meltdown was that many customers were greatly upset and disappointed that their brokers did not call them with advice on how to weather the financial storms. As I fielded telephone calls from potential customer clients, the most frequent subject of discussion (besides the size of their losses) was a stock broker’s fiduciary duty after point-of-sale in a typical non-discretionary account (where the broker has no authority to enter trades without the customer’s permission beforehand). When those customers are told that, in most instances, a broker’s fiduciary duty ends after the transactions, many of them are surprised and switch to “financial advisors” who say they will manage the customer’s portfolio (and charge a management fee instead of commissions).

If such an account is opened, most courts and arbitrators hold that the broker and her firm have taken it upon themselves to have a continuing fiduciary duty to the customer. In other instances, without such a formal agreement (or management fees), a broker may tell his customer that it is his practice to routinely review accounts and make recommendations to adjust them to conform to the vagaries of the market and the customer’s risk tolerance and investment objective. When such a relationship exists over time, and customers reasonably rely on the broker’s vigilance and advice, courts and arbitrators often impose a continuing fiduciary duty on those brokers, beyond point-of-sale.

According to FINRA statistics, in 2008 there were 2,836 arbitration Statements of Claim filed by customers who alleged that brokers had breached their fiduciary duty (of the total of 4,982 filings). In 2009, there were 4,481 fiduciary duty case filings.

How should such cases be argued and defended? 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 conduct at issue. 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.

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 usurps 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 as stated in the authorization papers or as apparent from the customer’s investment and trading history;

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 United States v. Frank Skelly and Craig Gross, the Federal Second Circuit Court of Appeals recognized that while “there is no general fiduciary duty inherent in an ordinary broker/customer relationship …. a relationship of trust and confidence does exist with respect to those matters that have been entrusted to the broker.” Most commonly, said the court, this relationship exists in situations in which a broker has discretionary authority over the customer’s account. In De Kwiatkowski v. Bear Stearns & Co, the Second Circuit (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.

More recently, in Ciccone v. Hersh, a federal court held that a financial advisor did not have a fiduciary relationship with investors, despite the fact that he had been the personal investment and financial advisor for the plaintiffs for many years. The investment in question was in a non-discretionary account and, said the court, there was no continuing fiduciary duty beyond point-of-sale.

In the 2008 case of Muller-Paisner v. TIIA-CREF, the Second Circuit found that fiduciary duties can exist under certain circumstances. To state a claim for breach of stock broker fiduciary duty in New York, said the appeals court, a plaintiff need only allege that the duty existed and that it was breached. “A fiduciary relationship exists under New York law when one person is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.” A fiduciary duty may arise in the context of a commercial transaction upon a requisite showing of trust and confidence. In Muller-Paisner, the court ruled that such a relationship had been alleged, noting that ” the complaint alleges that the defendants target these advertisements to a specific class of people, retired educators. Moreover, in her reply brief Muller-Paisner cites public statements of employees of the defendants including statements in congressional testimony and on the defendants’ website, to the effect that they offer a wide range of investment products, that they will help their customers choose among those products, and that trust is a crucial dimension of the relationship between the defendants and their customers. We conclude that under the applicable standards Muller-Paisner’s allegations regarding the existence of a duty, for the purposes of both the fiduciary duty and negligence claims, are sufficient to withstand the defendants’ motion to dismiss.”

In New York, is a breach of a stock broker fiduciary duty claim preempted by New York’s Martin Act? New York’s securities statute makes it unlawful to, among other things, use or employ “any fraud … where engaged in to induce or promote the issuance, distribution, exchange, sale, negotiation or purchase within or from this state of any securities or commodities.” The New York Court of Appeals has held that there is no implied private right of action under the Martin Act. Other New York courts have determined that sustaining a cause of action for breach of fiduciary duty in the context of securities fraud would effectively permit a private action under the Martin Act, which would be inconsistent with the Attorney General’s exclusive enforcement powers. In 2011, the New York Court of Appeals struck down the Mafia Act Preemption defense for claims of breach of fiduciary duty and gross negligence.