The entire securities world is anxiously awaiting the implementation of the fiduciary standard over retirement accounts, and, by most accounts, the eventual spread of that standard to ordinary investment accounts. I am not prepared to argue that this is not a big deal, and will cost the industry a ton of time and money to get its collective head around it. But, I am of the view that the trip to fiduciary land from where we were, and where we are now, is shorter than many people suggest. Over the years, FINRA has given plenty of signals that while broker-dealers operate under the transactionally oriented suitability standard, under the right set of facts, that standard already looks a lot like a fiduciary duty.
In support of this, I often cite a 2001 FINRA case out of the Dallas District office. Wendell Belden ran a small broker-dealer. One day, a retired pilot approached him to invest his $2.1 million account. Belden put the customer in Class B shares of certain mutual funds, knowing that this would result in him receiving more commissions than if he had used Class A shares. In a rather startling display of candor, Belden admitted at the hearing that, basically, he felt he had to charge his bigger accounts higher commissions in order to earn enough money to be able to service his smaller accounts, which represented the lion’s share of his book.
Well, not surprisingly, the NASD frowned on that, observing that “a registered representative has an obligation to avoid increasing the costs that his or her customers pay.” What is interesting about this statement is that the focus was not on the quality of the underlying security – the mutual funds – but, rather, on the cost to the customer. Essentially, NASD concluded that when faced with two essentially equally alternatives, a registered rep must pick the one that is cheaper for the customer. In other words, he must pick the one that is in the customer’s best interest, not his own. Remember, that was 2001 (affirmed by the National Adjudicatory Council in 2002, and the SEC in 2003).
And, really, that concept is not altogether different from that displayed in the rash of “reverse churning” cases that FINRA has brought over the years (and which one of my former colleagues at a prior law firm believes are about to resume). Reverse churning occurs, of course, when a customer is put into a fee-based account but there is little or no trading in the customer’s account. In that circumstance, according to FINRA, the customer ought to be in a commission account, since if no trades are made, the customer will pay no commissions, and, therefore, less, perhaps way less, than the annual fee he will pay in a fee-based account, regardless of the fact there is no trading activity. Again, the issue is not on the quality of the securities themselves, or the suitability of each recommendation made which resulted in the securities being purchased, but, rather, on achieving the lowest cost to the customer, as in the Belden case. In other words, the cases are about doing what is in the customer’s best interest, here, the customer’s financial interest.
What these cases tell me is that regardless of what the rules actually say, or what they used to say, in FINRA’s mind, brokers were always subject to an unstated, informal standard that required them to put their customers’ interests ahead of their own. FINRA never called it a fiduciary standard, however; it just called it suitability, and then found a way to cram the facts of any given case into the language of its existing rules. If and when a fiduciary standard is implemented over all brokerage activities, of course, FINRA won’t have to be so creative anymore.
Until then, however, brokers and broker-dealers who think that they are going to have to learn to act in some dramatically different way when they become fiduciaries, ought to wake up and smell the coffee, and acknowledge that FINRA’s expectations in a pre-fiduciary vs. post-fiduciary world are really not that different at all.