August 24th, 2015
Have you been presented with this question: “The bank has handled the investments for dad’s trust under his will for the past 10 years since he died. I don’t think that they have done a very good job, have they?”
Quite often we are contacted by litigation attorneys involved with a dispute resolution question similar to the one above concerning the duties, responsibilities and possible liabilities of a bank acting in some capacity for their client’s estate and/ or financial planning/wealth management needs. To a great extent, the duties, responsibilities and potential liability of the bank will depend on the actual capacity under which the bank is acting. This can often be ascertained by referencing the language in the underlying document, i.e. trust agreement, will (typically prepared by an attorney), investment management agreement, agency agreement, custody agreement, brokerage agreement, etc. (typically on bank prototype forms).
The bank may be acting in one of several capacities:
- Trustee or Cotrustee: Depending on the specific language in the underlying trust instrument (will or agreement), the bank will assume fiduciary duties and responsibilities.
- Investment Agent/Managing Agent: Under this account relationship, typically administered in the bank’s Trust Department, the bank would also assume fiduciary duties and responsibilities.
- Custodian: Again, this account relationship would typically be administered in the bank’s Trust Department. Tthe bank would generally not assume fiduciary duties and responsibilities being primarily responsible only for the safekeeping of the assets in the account and following the account principal’s directions as spelled out in the Custody Agreement form.
- Investment Agent/Managing Agent – administered by a Registered Investment Advisor (“RIA”) subsidiary of the bank or the bank holding company: The bank would assume fiduciary duties and responsibilities with it’s affiliate RIA being regulated by the Securities Exchange Commission (“SEC”) under the Investment Advisors Act of 1940.(“Act”)
- Broker: Under an account maintained at the bank’s, or the bank holding company’s, registered broker/dealer (“BD”) firm regulated by the Financial Industry Regulatory Authority (“ FINRA”) ,formerly the National Association of Securities Dealers (“NASD”), the bank currently has no fiduciary duty or responsibilities being held only to “suitability” rules governing the brokerage industry.Accordingly, the duties, responsibilities and potential liability of the bank are determined, to a great extent, by the exact capacity under which they are acting.
Advice versus Transactions: Fiduciary Duties versus Suitability Requirements
Blacks Law Dictionary describes a fiduciary relationship as founded on trust or confidence reposed by one person in the integrity and fidelity of another. Law.com defines a fiduciary as, “ A person who has the power and obligation to act for another under circumstances which require total trust, good faith and honesty”. A fiduciary has both ethical and legal responsibility to act for another’s best interest at all times.
A RIA under the Act is required to act as a fiduciary , putting the clients interest above the RIA and to declare any conflicts of interest that may arise. A Broker, or a Registered Representative of a broker-dealer firm, regulated by the Securities Exchange Act of 1934, is required only to recommend investments that are “suitable” for the client. Thus, a broker can legally put his/her own interest above the client’s when recommending investments as suitable for the situation.
Brokers/Registered Representatives are typically paid by commission on products sold through transactions. In addition, many broker/dealer firms manufacture investment products and utilize their brokers as a prime distribution channel to sell their proprietary in house investment products. RIAs typically do not take marketing incentives or commissions from investment product providers. RIAs receive advisory fees generally based on the size of the account.
Registered Representatives of broker-dealer firms must provide the client with suitable investment products. However, the “suitability standard” is very broad and often difficult to impose. A suitable investment recommendation may mean that the investment has to fit the client’s needs and tolerance for risk. However, the suitability standard permits the Registered Representative to recommend an inferior investment fund because it gives them a higher commission, as long as it is still a suitable investment.
Fiduciary Responsibilities and Duties
Under common law Agency rules an investment advisor, as agent, owes fiduciary duties to its client, as principal. See Restatement (Third) of Agency, Section 1.01 (2006). The investment advisor’s fiduciary duty also comes from Section 206 of the Act , 75 U.S.C. Section 80b-1 et seq. and the rules there under, Title 17,Part 275 of the Code of Federal Regulations, also see Section 36(a) of the Act. Section 206 is an anti fraud provision securities section that prohibits an advisor from engaging in fraudulent or deceptive acts or manipulation. In addition, the SEC, and its Division of Investment Management, provide interpretive guidance. Also see SEC v. Capital Gains Research Bureau, 375 US 180 (1963) holding that Section 206 of the Act imposes a fiduciary duty on investment advisors by operation of law. It is implied that every violation of Section 206 would also ground a breach of fiduciary duty claim under common law. Section 202(a)(ii) of the Act sets forth who is required to register.
Fiduciary duties owed to the client by the advisor require care, loyalty, obedience, as well as acting in good faith and disclosure.
Broker-Dealer Registered Representatives may be subject to RIA fiduciary responsibilities
In March 2015 Mary Jo White, Chairman of the SEC, stated that she would propose , pursuant to Section 913(a) of Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), that a uniform fiduciary duty should be imposed on broker-dealer firms transactions, the same as on RIAs. Also see Section 913(g) of Dodd-Frank. indicating that when providing personalized investment advice about securities to retail customers, the standard of conduct shall be to act in the best interest of the customer without regard to the financial or other interest of the broker-dealer or investment advisor providing the advice. This process would be somewhat similar to the recently announced Department of Labor (“DOL”) rules amending it’s definition of a fiduciary under the Employee Retirement Income Security Act (“ERISA”).
Chairman White’s position was stated shortly after the Obama Administration advanced a plan through the Labor Department to impose the higher standard on brokers who manage retirement accounts. White’s plan would make all financial advisors follow the same rules.
Securities regulators agree that the fiduciary duty should not apply to all brokerage services, but only to those services that fall within a reasonable definition of personalized investment advice to retail customers. The regulators further state that personalized investment advice to retail customers should be governed by a fiduciary duty regardless of whether that advice is provided by an investment advisor or a broker-dealer.
Finally, J.P. Morgan Chase is currently in advanced talks with the SEC to pay more than $150 million to resolve allegations that it inappropriately steered investment clients to its own proprietary in house investment products, typically its mutual funds, without proper disclosure generating excessive fees for the bank.
In analyzing the duties and responsibilities taken on by the trustee or investment advisor of a trust, one must ascertain the exact nature of the appointment or engagement. Potential future regulatory changes could impact the duties and potential liability of the trustee/investment advisor.