Erik Gerding is right when he notes the importance of yesterday's hints by Senator Collins about imposing fiduciary duties on brokers. As Erik notes, "applying investment adviser-style fiduciary duties to broker dealers would be a sea change." Barbara Black discusses and criticizes recent Congressional moves in this direction.
Not only a sea change but, in my view, a misuse of the concept of fiduciary duties. As I've written, fiduciary duties properly apply only to situations involving the open-ended delegation of discretion and control over property. In this situation it is appropriate to depart from standards for arm's length dealings and impose a duty of unselfishness, as Justice Cardozo colorfully described it in Meinhard v. Salmon. In other contexts attempts to apply fiduciary duties result in mischief and confusion. Some broker-dealer relationships may be fiduciary in nature, but clearly not all of them, and even more clearly not the relationship between Goldman, IKB and ACA in the SEC's recent case.
We have recently seen this mischief and confusion at work in Jones v. Harris (watch this space for more about my forthcoming article on that case). Jones involved the "fiduciary duty" imposed on mutual fund investment advisers under Section 36(b) of the Investment Company Act. The duty is inappropriate there because the redemption right means investors do not lock in their money under investment advisers' control, anymore than they do when placing an order with a broker.
Forty years after the adoption of 36(b), hundreds of cases have been brought imposing billions in costs without a single plaintiff victory at trial. The Supreme Court struck down Judge Easterbrook's attempt to end this debacle, noting that was Congress's job. I doubt Congress will do anything about mutual funds. Now it seems Congress is considering extending the mistake to broker-dealer duties.
A new federal broker-dealer fiduciary duty would unleash havoc that would dwarf that in the 36(b) litigation. The Jones situation involved a fairly narrow situation in which the courts were able to come up with at least some kind of standard, the Gartenberg test, which the Court reaffirmed in Jones. Even so, the costs have been large and the benefits few. A broker-dealer duty will have the courts all over the lot for decades, no one will know who owes what duties to whom, efficient transactions will be foregone, entire markets will be stunted. And Jones stands as a lesson of how much help we can expect from the Supreme Court.
And remember, this is just one little thing Congress is thinking about doing as part of financial regulation.
Update: Erik Gerding responds, noting that some clients might want fiduciary duties, and asking whether "some sort of opt-in/opt-out system [would] be better?" Yes, in some cases. But what should it be – Opt-in? Opt-out? When should each type of duty apply? These types of questions indicate why this is better left to contracts and state law, particularly in an industry as dynamic as financial services.
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