IN THE WORLD of finance, only those who offer specific investment advice have been held to the highest standard of care for their clients. When Secretary of State Bill Galvin decided that the fiduciary standard – broadly, acting in the best interest of clients and trying to address conflicts of interest – should apply to more accessible broker-dealer services, outcry was swift in investment circles. But the state’s highest court has come down on Galvin’s side.
Fiduciary duty advocates say the decision flings open the door for other states to reconsider their broker-dealer rules and possibly transform the investment ecosystem.
The Supreme Judicial Court waded into the world of online stock trading earlier this year, hearing a challenge from the commission-free trading platform Robinhood to Galvin’s 2020 decision to impose a fiduciary duty on broker-dealers. In its opinion last Friday, the SJC reversed a lower court’s finding that Galvin did not have authority to adopt the rule.
“Unlike the fabled ‘Prince of Thieves,’ who took from the rich to give to the poor,” Robinhood is accused “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 platform,” Justice Dalila Wendlandt wrote for a unanimous court.
Galvin’s rule defined “unethical” and “dishonest” conduct in the Massachusetts Uniform Security Act as broker-dealers failing to act as a fiduciary when recommending trades. This reflects a departure from the traditional understanding of broker-dealers, who typically offer cheaper facilitated trades with limited or no investment advice.
Robinhood, a California-based company with a relatively young client base, said Galvin went beyond state powers in defining these terms, conflicted with national “Regulation Best Interest” (Reg BI) standards for broker-dealers, and ran afoul of US Securities and Exchange Commission decisions considering similar questions. This definition, Robinhood’s attorney argued, could dramatically disrupt the personal investment market.
But the court determined that those national standards are a floor, not a ceiling. It found broad authority for Galvin’s action under state law, which emphasizes consumer protection, and concluded that the broker-dealer marketplace has changed in a way that could endanger investors.
Services like Robinhood, Wendlandt wrote, are moving away from a commission model and toward a competitive model where the broker-dealer is incentivized to push high numbers of trades with the best rate per trade for the broker. The client may not be paying the broker-dealer directly, but the broker is still profiting off of the client’s trades through transaction fees.
Justices signaled serious skepticism about Robinhood’s argument before the court in May. When broker-dealers “dip their toe into some sort of advice,” Wendlandt wondered at the time, would that not mean they are acting more like investment advisors? More people than ever are using these services on mobile devices, ushering in a new world of personal investment.
“These industry transformations have made the securities markets more readily available to more investors; however, the changes also have caused consumer confusion and investor harm,” she wrote in the opinion. Galvin has “expansive authority” to clarify the Legislature’s intent in writing the security act, she said. The secretary undertook a “comprehensive investigation at the national level,” and concluded that this definition would best align the state law with “investors’ expectations in the evolving investment landscape.”
“This landmark decision affirms the fiduciary duty of brokers to their customers and vindicates the role of my Securities Division to principally, but aggressively, protect investors and police broker-dealer misconduct,” Galvin said in a statement.
The SJC sent the case back to the Suffolk Superior Court to reconsider Galvin’s actions enforcing the rule in light of this new decision.
“We are disappointed in today’s decision and remain committed to providing access to the markets for our Massachusetts customers,” Lucas Moskowitz, deputy general counsel and head of government affairs at Robinhood Markets Inc., said in a statement. “We are in the process of reviewing the opinion and assessing next steps in this matter.”
While the financial services industry grapples with the ruling, advocates of the fiduciary standard in trades are celebrating. If Reg BI is the floor, other states may reconsider their security laws to impose a higher standard of care on broker-dealers.
“The decision is an overwhelming victory for investors,” Knut Rostad, president of the Institute for the Fiduciary Standard, said in a statement. “It is a Fenway Park Red Sox grand slam home run that will be reviewed by many other state securities administrators in the months and years ahead.”
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