Advisers likely fiduciaries under state common law

Attorney Jon Drucker’s letter to the editor in the April 7 issue pointed out that fiduciary status attaches in several different ways.

Whether regulated as a broker, investment adviser or insurance agent, one such way is the application of state common law to hold financial advisers to broad fiduciary duties of due care, loyalty and utmost good faith when they enter into relationships based upon trust and confidence with their clients.

Under state common law, a variety of circumstances may indicate that a fiduciary relationship exists (with broad fiduciary duties attached to the adviser), as opposed to an arm’s-length relationship. Such indicia or evidential factors include influence, placement of trust, vulnerability or dependency, substantial disparity in knowledge, the ability to exert influence, and placement of confidence.

No contract is needed that accepts fiduciary status, and indeed, contractual terms that deny the existence of broad fiduciary duties are ineffective. This is because fiduciary status is imposed by the law and can’t be negated by the agreement between the parties.

A variety of facts might give rise to a finding of fiduciary status for a financial planner. Actually providing financial advisory services to a non-sophisticated client is a key factor, especially when such services are provided over a period of time.

However, nearly as important in some of the decisions is the use of titles such as financial planner, financial adviser, investment planner, investment counselor and estate planner which denote the existence of a relationship based upon trust and confidence. Hence, the use of titles such as financial consultant or certified financial planner are significant factors in finding a registered representative to be a fiduciary under state common law.

Should brokers think that they are immune from findings of fiduciary status, they should read the relatively recent case of Western Reserve Life Assurance Company of Ohio v. Graben, No. 2-05-328-CV (Tex. App. 6/28/2007) (Tex. App., 2007), finding that “when a person … is acting as a financial adviser, that role extends well beyond a simple arm’s-length business transaction.” As in Graben, there is no requirement that discretion (either actual or de facto) exists with respect to underlying accounts.

Over-reliance by brokers on Securities and Exchange Commission rules in this area is dangerous. The SEC sets a floor, not the ceiling, as to determining when fiduciary status results.

As a general rule, federal securities laws don’t preempt state common law as to when broad fiduciary standards of conduct are applicable. Moreover, since fiduciary status attaches to relationships under state common law, not to accounts, and since the application of fiduciary status results from public-policy considerations, attempts by a dual registrant to “switch hats” or “remove the fiduciary hat,” as the SEC’s proposed “special rule” of September 2007 would seem to permit, wouldn’t be effective to circumvent state common-law application of broad fiduciary duties.

It is also true, as Mr. Drucker pointed out, that all registered representatives also possess limited fiduciary duties. A registered rep is always under specific fiduciary obligations as to each individual brokerage transaction.

These duties include recommending a stock only after becoming familiar with its nature, price and fundamental prognosis; carrying out the customer’s order in a manner that is the best execution for the customer; informing the customer of the risks of an investment; transaction of business only after receiving authorization; refraining from self-dealing or non-disclosure of personal interests; and not to misrepresent material facts. But these specific duties aren’t equivalent to the broad fiduciary duties of due care, loyalty and utmost good faith, which are applicable, under state common law, to relationships based upon trust and confidence, and which also apply under specific federal and state laws (Employee Retirement Income
Security Act, Investment Advisers Act of 1940, etc.).

Ron A. Rhoades

Editor

FiduciaryNow

Lecanto, Fla.

Related Topics: Letters To The Editor