SJC Holds Broker-Dealers Serving Massachusetts Customers to a Fiduciary Standard
by Marley Ann Brumme
In Robinhood Financial LLC v. Galvin, 492 Mass. 696 (2023), the SJC approved a 2020 regulation promulgated by the Secretary of the Commonwealth (“Secretary”) requiring broker-dealers that provide investment recommendations to retail customers to adhere to fiduciary duties of care and loyalty. This so-called “Fiduciary Rule” raises the standard of conduct applicable to broker-dealers serving Massachusetts customers—even if the broker-dealer is located outside Massachusetts or the recommendation is made outside Massachusetts (i.e., online)—to a fiduciary standard like that applies to investment advisers.
Regulatory Framework
Historically, retail customers have relied on two primary sources of investment advice: (i) investment advisers and (ii) broker-dealers. Investment advisers traditionally provide ongoing portfolio monitoring and management, and generally have full discretion over investment decisions. Because investment advisers provide ongoing services, they are compensated through a fee-based structure—i.e., they charge a periodic fee, usually calculated as a percentage of the amount of the customer’s assets under management. In contrast, the primary responsibilities of broker-dealers are to execute trades and sell/distribute securities. Many brokerage firms also offer transaction-specific investment recommendations incidental to their brokerage services. In other words, before buying or selling a security, a customer can receive a recommendation about that transaction. Broker-dealers are generally compensated via a commission per transaction, with no additional fee for any incidental investment advice provided.
In recognition of the different models of advice, federal and Massachusetts law have traditionally imposed different standards of conduct on investment advisers and broker-dealers. Investment advisers generally must comply with a traditional fiduciary duty standard, owing duties of care and loyalty to their clients. In contrast, broker-dealers historically have been held only to a “suitability” standard when providing investment recommendations, which requires them to have a reasonable basis to believe that the recommended investment is suitable for the customer based on information obtained from the customer.
Following the 2007–2008 financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act, which charged the U.S. Securities and Exchange Commission (“SEC”) with studying whether the standard of conduct for broker-dealers should be changed, considering the various costs and benefits of doing so. Following its study, in 2019 the SEC adopted Regulation Best Interest (“Reg BI”), which raised the standard of conduct for broker-dealers to a “best interest” standard—deliberately stopping short of imposing a general fiduciary standard on broker-dealers.
During the rulemaking process for Reg BI, the Secretary was a vocal proponent of the adoption of a universal fiduciary standard. Among other things, relying on a 2008 study by the RAND Corporation, the Secretary asserted that retail investors were fundamentally confused about the differences between investment advisers and broker-dealers. The Secretary noted that investors were harmed because they (i) mistakenly believed that broker-dealers are required to (and do) act in the customer’s best interest and (ii) do not read or understand the types of disclosures that Reg BI proposed to address such confusion by explaining that a broker-dealer may have certain conflicts of interest.
After the SEC instead adopted the best interest standard in Reg BI, the Secretary, under his authority to promulgate regulations implementing the Massachusetts Uniform Securities Act, G.L. c. 110A (“MUSA”), issued the Massachusetts Fiduciary Rule, which deems it an “unethical or dishonest conduct or practice[]” under MUSA for a broker-dealer to “fail[ ] to act in accordance with a fiduciary duty to a customer when providing investment advice or recommending an investment strategy, the opening or transferring of assets to any type of account, or the purchase, sale, or exchange of any security.” 950 CMR § 12.207(1)(a).
Case Background
Robinhood Financial LLC (“Robinhood”) is a web- and app-based investment platform that offers commission-free trading of stocks, exchange-traded funds, and other financial instruments. In 2020, the Secretary brought an administrative proceeding alleging that Robinhood violated the Fiduciary Rule. In particular, the Secretary alleged that Robinhood took advantage of unsophisticated retail investors by encouraging frequent, risky, and unsuitable trading in a manner tantamount to making investment recommendations without first assessing whether those recommendations were in the investors’ best interest.
Robinhood sued in the Superior Court, challenging the validity of the Secretary’s Fiduciary Rule. Robinhood alleged that (i) the Secretary exceeded his authority in enacting the Fiduciary Rule, (ii) the Fiduciary Rule impermissibly sought to override the common law standard of conduct for broker-dealers set forth in Patsos v. First Albany Corp., 433 Mass. 323 (2001), and (iii) the Fiduciary Rule was preempted by Reg BI. On cross-motions for judgment on the pleadings, the Superior Court held that the Secretary had exceeded his authority under MUSA to promulgate the Fiduciary Rule, and impermissibly overrode the common law.1
The SJC’s Opinion
On direct appellate review, and considering the issues de novo, the SJC reversed and held that the Secretary acted within his statutory authority in adopting the Fiduciary Rule. Beginning with the proposition that agency rules are presumptively valid, the Court first analyzed the authority granted to the Secretary by the Legislature in MUSA. The Court noted that MUSA grants the Secretary “extensive investigative and enforcement powers,” as well as the power to make rules—including rules that “defin[e] any term” whether or not used in MUSA—that “are necessary to carry out the provisions of” MUSA. This rulemaking authority gives the Secretary discretion to promulgate “regulations ‘necessary or appropriate in the public interest or for the protection of investors and consistent with the purposes fairly intended by the policy and provisions of’ MUSA.”
Against this backdrop, the Court held that the Secretary had not acted ultra vires in adopting the Fiduciary Rule. After describing the investigation conducted by the Secretary prior to adoption of the rule, the Court noted that the Secretary thereafter “determined that the fiduciary duty rule was necessary to fulfill MUSA’s broad investor protection purpose, consistent with the Secretary’s obligation to police ‘unethical or dishonest conduct or practices.’” Because “unethical or dishonest conduct or practices” are not defined in MUSA and the MUSA gives the Secretary the authority to “defin[e] any term” in MUSA, the Court held that the Fiduciary Rule fell within the Secretary’s “broad-ranging,” “extensive,” and “flexib[le]” authority.
The Court also rejected Robinhood’s other theories of invalidity. First, the Court held that the Fiduciary Rule could exist alongside the common law (and, indeed, was “of equal status” with the common law). Illustrating that the two can coexist, the Court held that an investor injured by the conduct of a broker-dealer may have a claim under Patsos, but that the Fiduciary Rule gives the Secretary a distinct regulatory enforcement tool to protect investors. Second, the Court held that the Fiduciary Rule was not preempted by Reg BI. Beginning with the presumption against preemption and the “long history” of concurrent regulation of broker-dealers by both state and federal law, the Court noted that the SEC (i) was aware when it adopted Reg BI that certain states already imposed a fiduciary standard on broker-dealers, but (ii) specifically declined to express any intent to preempt such laws. Accordingly, the Court held that Reg BI sets a floor for the standard of conduct for broker-dealers, but permits states to impose a higher standard for the purposes of enhanced investor protection.
Implications
With the SJC’s blessing of the Fiduciary Rule, Massachusetts is now one of several states that impose a fiduciary standard on broker-dealers when they provide investment advice or recommendations to retail customers. Notably, these standards vary from state to state. Broker-dealers operating nationally will thus need to ensure that their sales and other practices comply with the small patchwork of legal requirements created by the coexistence of Reg BI and state standards like the Fiduciary Rule. While the full effect of the Fiduciary Rule on broker-dealers is yet to be seen, compliance is likely to be costly. Whatever the final effect on broker-dealers, however, Massachusetts consumers are officially owed fiduciary duties when receiving investment advice or recommendations—no matter whether they come from an investment adviser or a broker-dealer.
- The Superior Court did not consider Robinhood’s preemption argument.
Marley Ann Brumme is Counsel at Skadden, Arps, Slate, Meagher & Flom LLP. Ms. Brumme and colleagues represented amici the U.S. Chamber of Commerce and Greater Boston Chamber of Commerce in Robinhood Financial LLC v. Galvin but did not represent any party to the case.
