The Ethical Rep: Responsibility Issues

I underwent a grueling arbitration hearing this year. The complainant's attorney claimed I'd acted in a fiduciary capacity by purchasing and allocating a variable annuity for my clients. I maintained I had no fiduciary responsibility but had merely recommended and sold an appropriate product to meet this client's needs. When is a broker or a financial planner a fiduciary? A: More often than not, fiduciary

I underwent a grueling arbitration hearing this year. The complainant's attorney claimed I'd acted in a fiduciary capacity by purchasing and allocating a variable annuity for my clients. I maintained I had no fiduciary responsibility but had merely recommended and sold an appropriate product to meet this client's needs. When is a broker or a financial planner a fiduciary?

A:

More often than not, fiduciary relationships do not exist.

Fiduciary relationships exist when one party places trust or confidence in another based upon the honesty of that person. If there is such a relationship, the law requires that neither party may exert influence or pressure upon the other, pursue selfish goals based upon this trust or self-deal to the detriment of the other party, unless the party is acting in the utmost good faith. Courts and arbitration panels award substantial sums to aggrieved parties if they find that these duties were first acquired and then abused.

Although some jurisdictions permit a court or arbitration panel to find a fiduciary relationship between licensed securities brokers and their customers, by the very nature of the relationship, many jurisdictions consider the existence and scope of the fiduciary relationship a factual question dependent on several factors. Thus, the simple execution of a customer account agreement generally does not create a fiduciary relationship. Instead, a fiduciary relationship often arises based upon prior business dealings where confidence is transferred to the broker.

Courts generally categorize the broker-customer relationship as an arm's length business relationship. Reliance alone does not create a fiduciary obligation. A fiduciary relationship exists between the broker and customer if the broker has control over the actual placement of transactions in an account. Frequent communication or consultation concerning investment strategy is simply not enough to demonstrate control. However, when a broker acts as an investment advisor, and, particularly, if the customer has almost invariably followed the broker's advice, such control may be indicated and a fiduciary relationship, thus, exists. Nonetheless, short-term relationships — where the dealings were not marked by any special circumstances — are usually insufficient to establish a fiduciary relationship.

Some jurisdictions waver on the issue of whether nondiscretionary trading authority even gives rise to a fiduciary obligation. One court in Missouri held that discretionary authority is merely a factor to examine, while New York courts have been clear that fiduciary duties only arise when a customer delegates discretionary trading authority to the broker. That is, the client grants the broker control over the account. Thus, if there is no such discretion, there is no fiduciary relationship unless there is a matter entrusted to the broker, such as the completion of transactions.

Breaches of fiduciary duty occur only when the broker has heightened and accurate knowledge or expertise of a topic and either misleads or lies to a customer about this information. However, there is no breach if the customer's trust is misplaced.
Ernest E. Badway
Saiber Schlesinger Satz & Goldstein
Newark, N.J.
973-622-3333
[email protected]

A:

The simple answer is that brokers and financial planners always are considered fiduciaries and are required to exercise the care and prudence not to their best ability but as is expected of brokers and financial planners in their industry.

Brokers and financial planners are held to an objective, not subjective, standard. In Broker Dealer Law and Regulation (Third Edition, 2002 Supplement), professor Norman Poser states:

“Since the fiduciary duties of brokers [or financial advisors] includes the duty to use the skill and diligence necessary to protect his customer's interests, negligent conduct may be a breach of fiduciary duty. In this regard, it is normally not sufficient for a broker to exercise ordinary care and judgment in discharging his duties; he must employ such care, skill prudence, diligence and judgment as might reasonably be expected of persons skilled in his calling. If his customer's money is lost because the broker undertakes his duties without possessing the requisite skills, or because of his negligence, the broker is liable for the loss.”

It is well stated in most states that brokerage firms, brokers and financial planners owe a fiduciary duty to their clients, which requires the professional to act with utmost good faith toward the customer. This duty encompasses the duty to render diligent and faithful service (as would a trustee) and to advise a client when the client's investment objectives or investments are improper or unsuitable. As fiduciaries, brokers and financial planners have a legal duty to:

  • Know all of the essential facts concerning the client's financial situation and needs and to faithfully consider these in recommending investments

  • Ensure the client's investments are suitable and to keep clients fairly informed of risks on an ongoing basis and to give the customer full disclosure of all relevant facts, particularly any compensation that will be earned by the broker or financial planner from the recommendation and purchase of an investment.

In actions against broker and planners for breach of fiduciary duty, courts and arbitration panels routinely look to industry customs and practice to determine whether the challenged conduct was reasonable and to determine the appropriate standard of care.
Erwin J. Shustak
Shustak Jalil & Heller
New York and San Diego, Calif.
619-696-9500
[email protected]

Ethical Rep is a monthly feature in which more than 30 prominent securities attorneys, experts and law school professors help Rep. readers deal with work-related ethical quandaries. Have you encountered a situation at work that makes you uncomfortable? Are you confused about how your responsibilities to clients might change as regulations continue to evolve? Drop a line to Rep.'s contributing editor, Ann Therese Palmer, and our group of experts will help you work through the problem.
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