Breach of Fiduciary Duty

Investors put a great deal of trust in the professionals who advise them. A financial service firm owes a fiduciary duty to its customer. The duty arises by way of the relationship between the agent (brokerage firm) and principal (customer). The term “fiduciary duty” is used in many contexts. It generally refers to the conduct required of certain professionals when serving clients. The person charged with the duty, the fiduciary, must act solely in the interest of the beneficiary or client. Thus, fiduciaries are barred from self-dealing or other activities that place their interests before those of the client. Attorneys, real estate agents, and trustees are some examples of professionals who owe their clients a fiduciary duty.

Investment advisers owe their clients a fiduciary duty which includes the standard duties of care, loyalty, good faith, and disclosure. This means that an investment adviser must:

• Use reasonable care when acting on behalf of or advising clients;
• Avoid misleading clients;
• Seek the best price and terms for each transaction;
• Place the client’s interest above his or her own;
• Avoid conflicts of interest and fully disclose potential conflicts;
• Never use clients’ assets for his or her own benefit; and
• Fully disclose any material facts about a transaction.

Courts, including those in California have reiterated that the fiduciary nature of the relationship between a stockbroker and customer “imposes on the former the duty to act in the highest good faith toward the customer.”

A fiduciary duty also requires a brokerage firm to comply with industry standards, rules, and regulations. The duty also requires brokerage firms to supervise and monitor the activities of the firm’s employees, perform pre-sale due diligence and after-sale monitoring of investments. The failure to meet the firm’s obligations can be a breach of the firm’s fiduciary duty and result in liability.

Recently, the Securities and Exchange Commission’s Regulation Best Interest known as “Reg BI” imposed a heightened best interest standard on broker-dealers when recommending securities transactions or investment strategies. Broker-dealers were required to begin complying with the regulation on June 30, 2020.

Regulation Best Interest—or Reg. BI—imposes a new standard of conduct specifically for broker-dealers that substantially enhances their obligations beyond the current “suitability” requirements. The Regulation BI standard can be viewed as having two components. First, it establishes a general obligation that draws from key fiduciary principles, requiring broker-dealers to act in the best interest of their retail customers and not place their own interest ahead of the retail customer’s interest. Second, it includes specific requirements to address aspects of the broker-dealer relationship where our experience indicated that focused attention was appropriate. Regulation BI is satisfied only if the broker-dealer complies with four specified component obligations: Disclosure, Care, Conflict of Interest, and Compliance. Each of these obligations includes a number of prescriptive requirements, all of which must be satisfied to comply with the rule.

Wall Street firms may also have statutory fiduciary duties. The most common is codified in The Employee Retirement Income Security Act (ERISA) contains four requirements for 401(k) plan fiduciaries often referred to as the obligation to operate plans for the “exclusive benefit” of the participants. These requirements are the duty of loyalty; the duty of prudence, the duty to diversify investments; and the duty to follow plan documents.

These are some examples of ways a financial adviser can comply with the fiduciary duty. Behavior that places some other interest above the client’s interest may be considered a breach of the fiduciary duty.