Breach of Fiduciary Duty in the Securities Industry
Investors often put a great deal of trust in the professionals who advise them. Because of this, U.S. laws charge investment advisers with a fiduciary duty to their clients, which requires them to put their clients’ interests before their own. Investment advisers who breach their fiduciary duty may be liable to their clients under U.S. securities laws. However, investors should be aware that not all financial professionals are held to the fiduciary standard.
The term “fiduciary duty” is used in many contexts. It generally refers to the conduct required of certain professionals when serving clients. The person charged with the duty, the fiduciary, must act solely in the interest of the beneficiary or client. Thus, fiduciaries are barred from self-dealing or other activities that place their interests before those of the client. Attorneys, real estate agents, and trustees are some examples of professionals who owe their clients a fiduciary duty.
Investment advisers also owe their clients a fiduciary duty. There is no list of specific functions that constitute an investment adviser’s fiduciary duty, but it includes the standard duties of care, loyalty, good faith, and disclosure. This means that an investment adviser must:
Use reasonable care when acting on behalf of or advising clients;
Avoid misleading clients;
Seek the best price and terms for each transaction;
Place the client’s interest above his or her own;
Avoid conflicts of interest and fully disclose potential conflicts;
Never use clients’ assets for his or her own benefit; and
Fully disclose any material facts about a transaction.
These are some examples of ways an investment adviser can comply with the fiduciary duty. Generally, any behavior that places some other interest above the client’s interest may be considered a breach of the fiduciary duty.
Brokers May Not Owe a Fiduciary Duty
Many investors may not realize that not all financial professionals owe their clients a fiduciary duty. The Investment Advisers Act of 1940 (IAA), codified at 15 U.S.C. § 80b et seq., prohibits investment advisers from engaging in fraud, deceit, or manipulation. The Supreme Court, in the case SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963), held that this provision of the IAA imposes a fiduciary duty on investment advisers.
The IAA defines “investment adviser” as a person who, for compensation, advises others about the value of securities or the advisability of investing in particular securities. However, the IAA exempts “broker-dealers” from this definition. This means that investment advisers do owe their clients a fiduciary duty, but broker-dealers do not. Other laws charge broker-dealers with a duty of suitability, which is a lesser standard.
This distinction can be confusing, even for experienced investors. Many people believe that brokers should be held to the fiduciary standard to protect investors. Others argue that such a change would discourage financial professionals from helping clients with smaller portfolios, leading to fewer clients served.
Breaching the Fiduciary Duty
Investment advisers might breach the fiduciary duty in a number of ways. Engaging in any type of securities fraud that benefits the professional at the expense of his or her clients is a breach of the fiduciary duty. Examples include churning [link to churning page], misrepresentation [link to misrepresentation page], and many instances of unauthorized trading [link to unauthorized trading page]. Even if the investment adviser’s behavior was not motivated by personal gain, any transaction or other activity detrimental to a particular client—even if performed to benefit another client—is a breach.
Negligent investment advisers have also likely breached the fiduciary duty. Professionals who owe their clients a fiduciary duty are expected to use their specialized knowledge and skill to put forth their best efforts for the benefit of their clients. Investment advisers who act negligently with regard to their clients have arguably not done so.
Remedies for Investors
Unlike Rule 10b-5, the IAA does not grant investors a private cause of action. In other words, investors cannot bring a civil claim in federal court for a breach of the fiduciary duty. This does not leave investors without a remedy, however. Investors whose advisers have breached their fiduciary duty can pursue several causes of action, depending on the circumstances. For instance, an investment adviser who breached the fiduciary duty has probably violated portions of Rule 10b-5. Furthermore, negligence [link to negligence and malpractice page] causes of action would also be appropriate in most cases. Investors should also consider state law, which may provide additional options.
Damages available to plaintiffs who bring successful claims may include out-of-pocket losses and possibly market gains. Generally, plaintiffs seek damages that would make them whole or put them back in the position they occupied before the defendant’s U.S. securities laws. However, investors should be aware that not all financial professionals are held to the fiduciary standard.