On Friday, February 3, 2017, President Trump directed the Department of Labor to halt implementation of the Obama administration’s 1,000-page “Fiduciary Rule” which sought to impose a more demanding “fiduciary” standard on retirement advisers and brokers who make investment recommendations. The Fiduciary Rule was expected take effect in April 2017, but a Trump administration official said the rule was a “complete mess” with a litany of unintended consequences.
Stockbrokers should not take too much solace in President Trump’s actions. Courts across the country have recognized that stockbrokers always owe a fiduciary duty to their clients with or without a 1000-page law saying as much. As one court explained, “the question is not whether there is a fiduciary duty – which there is in every stockbroker-customer relationship – rather, it is the scope or extent of the fiduciary obligation, which depends on the facts of the case.” The scope of this duty will depend on a number of factors, including: 1) the relative sophistication and experience of the customer; 2) the customer’s ability to evaluate the broker’s recommendations and exercise an independent judgment thereon; 3) the nature of the account, whether discretionary or non-discretionary; and 4) the actual financial needs of the customer. Thus, President Trump’s recent action should cause investment advisers to carefully evaluate what their duty entails in each case.
Included in this reevaluation should be an analysis of not only what stockbrokers are required to do but also what they should do when a company that they recommend to their clients plummets in share price, is the subject of a federal investigation, or is named as a defendant in a class action lawsuit alleging that officers and directors of the company violated federal securities laws. A number of courts have held that stockbrokers have an affirmative duty to continually monitor accounts and disclose to clients material events that may affect a company’s solvency or future prosperity. Even if the account has been labeled as “non-discretionary,” courts have still found that “ongoing duties may be triggered, such as a duty to monitor.”
How does a stockbroker keep informed about federal investigations and lawsuits affecting what could be hundreds, if not thousands, of different companies in which clients are invested? Pension fund trustees, who owe a fiduciary duty to beneficiaries, face a similar dilemma when a pension fund own thousands of different securities, any one of which may be the subject of a federal investigation or a private securities class action. To help fulfill their fiduciary duties, money managers and trustees often turn to portfolio-monitoring arrangements offered by law firms. The pension fund discloses to the law firm its securities holdings and the law firm alerts the institution whenever there appears to be fraudulent activity relating to any of its holdings and recommends a course of conduct.
There are a number of benefits that result from keeping clients informed of federal investigations and lawsuits against a company. First, a court may conclude that based upon the circumstances, the broker has a duty to monitor and inform at risk of being found liable for breach of fiduciary duty.
Second, it decreases the likelihood that a client will file a complaint against the stockbroker. All too often, clients look to sue their stockbroker when a company the stockbroker recommends loses significant value. However, the stock drop is usually not the fault of the stockbroker. When executive management gives positive statements about the company, the stock price often rises and, like all investors, stockbrokers are entitled to rely on the truthfulness of the representations made. As the United States Supreme Court has made clear, any “misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.” By being proactive and informing a client that a company is the subject of a federal investigation or a class action lawsuit, stockbrokers can help direct a client’s ire in the right direction.
Third, it makes good business sense. The success of stockbrokers’ business often rises or falls with the health of their relationships with their clients. And it has been said that trust and communication are two vital components of a healthy relationship. Consistently informing clients of any material news when it happens, good and bad, helps foster the relationship, increase trust, and grow the business.
In sum, financial advisers should view today’s presidential action as an invitation to reevaluate the scope of their duties and have a proactive plan to keep clients informed about any material events affecting their holdings.
Should you have any questions about your duties or would like further information, please contact Frank Johnson at email@example.com.