Massachusetts Scores a Victory for Fiduciary Advice

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On August 25, Massachusetts’ highest court shocked the investment world by unanimously ruling against Robinhood and for the state’s fiduciary rule. Robinhood must change its ways to remain in business.

The case was brought by Massachusetts Secretary of State William Galvin. He asserted that Robinhood, a broker-dealer, was misleading its customers and not acting as a fiduciary. Galvin argued that Massachusetts’ state fiduciary rule should govern Robinhood’s behavior, not Reg BI, which is enforced by FINRA.

The ruling’s very first sentence puts the case against Robinhood into sharp relief:

Unlike the fabled “Prince of Theves,” who took from the rich to give to the poor, the plaintiff Robin-hood LLC (Robinhood) is accused by the Secretary of the Commonwealth (Secretary) of taking advantage of unsophisticated investors to fill its own coffers by dispensing ill-suited investment advice to these customers and by encouraging them to engage in risky trading practices using its online trading platform.

The issue, according to the court, was whether

… the Secretary overstepped the bounds of authority granted to him under MUSA [Massachusetts state law]. We conclude that he did not….

We further conclude that the fiduciary rule does not override the common law protections available to investors … and the rule is not preempted by the Securities and Exchange Commission’s determination to impose a national “best interest” standard of care on broker-dealers.

Two issues deserve special attention.

The first is the issue of preemption, which has been widely highlighted in stories. This regards the authority of states to “preempt” a federal regulation.

Robinhood asserted that the SEC intended Reg BI to be a minimum requirement for a BD standard; according to Robinhood, a BD needed to only conform to Reg BI. The court replied ”nope” and proceeded to reject Robinhood’s entire case: “Preemption fundamentally is a question of congressional intent.”

The court explained why Robinhood’s preemption argument, the core of its case, was weak. The court concluded with a point that will get the attention of many state regulators, “Regulation Best Interest constitutes a regulatory floor that does not foreclose state regulation to more clearly protect investors.” (Page 46).

The second issue was how Galvin explained broker-dealers. His position is that the broker-dealer suitability standard should be replaced by a uniform fiduciary standard, and that Reg BI is feckless. My organization, The Institute for the Fiduciary Standard, the Consumer Federation and other fiduciary focused groups made similar points.

Galvin stated that “best interest” is not defined, and Reg BI is, “for all intent and purposes substantially the same as the current suitability standard.” As a state regulator, he sees first-hand the severe financial harm investors suffer at the hands of broker-dealers.

Galvin’s words and actions on fiduciary advice and Reg BI are a world apart from those of the brokerage industry – and the SEC.

On industry complaints that fiduciary duties reduce customer choice, Galvin shot back. “Preserving the option to choose opaque, poorly understood products that are sold via heavily conflicted advice, the benefits of such ‘choice’ are illusory.” (page17)

“Choice” is a brokerage industry contrivance, just as is pretending broker-dealers are advisors.

Broker-dealers hold themselves out as ”trusted advisors” while the brokerage industry associations argue in legal proceedings they only offer “retirement assistance, products, and services” or “commercial sales relationships.” This is blatantly misleading. Indeed, the Consumer Federation of America has exposed how broker-dealers talk “advice” but deliver sales.

Broker-dealer websites, product offerings and soothing words don’t turn sales pitches into fiduciary advice. They can’t.

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Their legal obligations, business practices, product focus, culture, compensation methods and opaqueness in fees, costs and services assure they can’t. Their sales recommendations are just that – not trusted advice.

Broker-dealers are sales firms and independent advisers are fiduciaries.

Galvin’s blunt talk on broker-dealers is a vivid reminder that being a fiduciary is a differentiator.

The Massachusetts highest court delivered a clear message to the investment industry. Centuries of common law can’t be erased. The Commonwealth again has a special role in history. Like the battles in Lexington and Concord in 1775, “the shot heard round the world” has again been fired.

Knut A. Rostad, MBA, is the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard through research, education and advocacy.

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