Securities Arbitration Lawyer Blog
The global campaign promoting investor education and protection kicked off this week. Securities regulators in the U.S. issued a joint investor bulleting highlighting key themes for investors. Among them, the benefits of holding long-term investments, the rise of COVID-19 scams, the need for investors to use resources available to confirm that they are dealing with a reputable firm, and the importance of asking questions to financial professionals.
All sensible topics, to be sure. However, given the campaign’s scope and the multitude of stakeholders involved, the campaign misses an opportunity to have a meaningful impact where it matters most: enhancing investor protections for Main Street.
FINRA’s 2019 statistics show that it imposed $39.5 million in fines to member firms and ordered $27.9 million in restitution to investors. FINRA imposes monetary fines to member firms when it identifies misconduct. These fines also have the added goal of discouraging further misconduct. Restitution is used to address the issue of an investor unjustly suffering a monetary loss. Luckily for those investors, FINRA was able to make them whole. But what about cases that did not involve action by the regulator or went unreported?
According to the Securities Industry and Financial Markets Association (SIFMA), seniors in the U.S. lose an estimated $2.9 billion every year due to financial exploitation. It is estimated that only 1 in 44 cases ever get reported. Suddenly, the sums doled out in fines and restitution look like a drop in the bucket.
For investors who do pursue a claim, arbitration is often the only avenue to attempt to obtain a financial recovery – which is by no means guaranteed. Through August 2020, arbitration panels awarded customer damages in only 34% of cases. Monetary awards vary greatly, and arbitrators have broad discretion to adjudicate an investor’s claim. The most common types of controversy brought in customer arbitration claims before FINRA include breach of fiduciary duty, negligence, misrepresentation, and failure to supervise. The reality is that no education campaign will prepare investors to deal with securities violations that are preventable only through regulatory enforcement and increased supervision within the industry. That includes an ongoing fiduciary duty standard for financial advisors in the United States. A financial advisor should have a continuing obligation to act in the best interest of their customers.
Even though a breach of fiduciary duty is the leading type of claim brought before FINRA, broker-dealers are not held to the same fiduciary duty standard that investment advisers are obligated to uphold.
The Securities and Exchange Commission’s (SEC’s) recent adoption of Regulation Best Interest (Reg BI) draws from the investment adviser fiduciary duty principles but falls short of this standard of care, applying the “best interest” standard of care only to certain triggering events.
For instance, the “best interest” standard is triggered when a financial advisor makes a recommendation, such as a recommendation to purchase an investment. The recommendation must be in the customer’s “best interest,” but after the transaction is executed, the financial advisor arguably no longer has a duty to act in the investor’s best interest. That should not be the case. Financial advisors should have an ongoing duty to act in the customer’s best interest, which would require, among other things, for the financial advisor to keep clients informed regarding the changes in the market, which affect the investor’s interests and to act responsively to protect those interests.
The distinction between an ongoing fiduciary duty standard of care and the “best interest” standard of care implemented by Reg BI can be difficult to understand without a hypothetical example:
A financial advisor recommends that a customer buys a municipal bond that is rated “investment grade” by credit rating agencies. The customer accepts the recommendation and makes the purchase. Subsequently, the bond is downgraded by credit rating agencies and is no longer classified as “investment grade.” Instead, the bond is now classified as “non-investment grade” or “junk.” Now, the investor holds a junk bond.
Suppose the financial advisor had an ongoing fiduciary duty to act in the client’s best interest. In that case, there is no question that the financial advisor has an obligation to notify the customer of the downgrade and make a recommendation about what the client should do at that point. However, under Reg BI, it can be argued that the financial advisor’s obligation to act in the client’s best interest ended after the financial advisor made the initial purchase recommendation. The argument goes that the financial advisor owes no additional duties to the client until the financial advisor makes another recommendation. This argument is not new. Broker-dealers have been taking this position for decades.
Until financial advisors and brokerage firms have an ongoing fiduciary duty to act in a customer’s best interest, investors in the United States will not be adequately protected, and the statistics identified above will not change.