A longstanding debate in the securities industry is the standard of care owed by brokers to their clients. Based on the type of account and the state where the client lives, it may be without question that the broker owes the client a fiduciary duty. A fiduciary duty means that the broker must act in the best interest of their client and is the highest standard of conduct recognized under the law.
Brokers who have trading authority in a client’s account owe fiduciary duties to their clients. These are accounts in which the broker can purchase, sell, and otherwise trade in the client’s account without speaking with the client first about each trade. There must be formal paperwork in a client’s account in order for a broker to act in this manner. If the broker trades without the approval of the client, and he does not have formal authority to do that, then the broker and firm may be liable for unauthorized trading. If the broker has proper trading authority, but transacts in a manner that is not in the best interest of the client, then the broker and the broker-dealer may be liable for breaching their fiduciary duties. Financial advisors who are “Registered Investment Advisors” (RIA) with the Securities and Exchange Commission (SEC) also owe per se fiduciary duties to their clients. Some states, such as California, also have strong legal authority mandating that all brokers, regardless of their trading authority, owe fiduciary duties to their clients.
There is more of a debate about traditional brokers who do not have trading authority in a client’s account. As of June 30, 2020, all brokers are required to act in the best interest of their clients and to identify conflicts of interest when presenting an investment and their services to a client. This was passed through “Regulation Best Interest” (Reg BI). It does not officially hold brokers to a fiduciary standard, but it is effectively the same. Some of the requirements under Reg BI are:
- Broker dealers must disclose the capacity in which they are acting on behalf of the client, which includes to scope of their services and their compensation;
- Broker dealers must recommend investments that are in the client’s best interest;
- Brokers dealers must disclose all materials risks about the investments, their trading strategies, and services; and
- Broker dealers must identify and mitigate conflicts of interest
Prior the Reg BI, broker dealers defended cases by arguing that they only owed a suitability standard of care, meaning that the investment needed to only be suitable for a client, not necessarily in their best interest. This is an important distinction. An investment may be suitable for a client, meaning that it is in-line with their investor profile, objectives, risk tolerance, etc., but it may not be in their best interest. For example, an investor may be interested in investing in oil and gas. A brokerage firm could recommend to client a low-risk diversified mutual fund with nominal fees that is allocated across several oil and gas companies and sectors of the oil and gas industry. Alternatively, the brokerage firm will argue that it could also recommend a high-risk oil and gas limited partnership that pays a 12% commission to the brokerage firm. Under a “suitability” standard, the brokerage firm will argue that either of these investments are suitable for a client because they both meet the client’s objective to invest in the oil and gas industry. However, under a fiduciary, or “best interest” standard, the brokerage firm should not recommend the private placement because of the excessive fees, high level of risk, and because the client will be concentrated in one company. The brokerage firm would obviously rather recommend the latter investment because it benefits their own bottom line, but if they do recommend it, they would be breaching their fiduciary duties. At a minimum, Reg BI would require the brokerage firm to disclose to the client the conflict of interest that the fees present, along with the risk compared to the less risky mutual fund.
In order to recover for breach of fiduciary duty, the claimant must prove that the brokerage firm owed them a fiduciary duty, the duty was breached, and the breach of this duty caused the client’s damages. A negligence cause of action is also typically pled alongside a claim for breach of fiduciary duty. The elements are essentially the same, the difference being that breach of fiduciary duty requires a fiduciary relationship, whereas negligence requires that the broker and broker-dealer owed the client any standard of care, including the suitability or the “best interest” standards.
If you have suffered damages at the hands of any financial advisor, broker, investment advisors, or any other financial professional, contact Stoltmann Law Offices immediately for a free evaluation. We work on a contingency fee basis, so we don’t make any money until you do.
 Circuit Sys. v. Mescalero Sales, 925 F. Supp. 546 (N.D. Ill. 1996)
 820 ILCS 120/1(3)
 820 ILCS 120/1 (2)