Online broker-dealers can breathe easily in the Commonwealth of Massachusetts once more, as a Massachusetts court last week found a recent regulation imposing a fiduciary duty standard upon brokerage firms to be unlawful. On March 30, 2022, Suffolk Superior Court Judge Michael Ricciuti declared the new Fiduciary Duty Rule, championed by Massachusetts Secretary of the Commonwealth William Galvin, invalid, holding that the Secretary lacked the authority to adopt the rule.

The Fiduciary Duty Rule, adopted in the Commonwealth in March 2020, would hold broker-dealers to the fiduciary standard to which investment advisors are held. In the rule, Secretary Galvin defined “unethical or dishonest conduct” to include a broker-dealer making investment recommendations without “act[ing] in accordance with a fiduciary duty to a customer.”

In December 2020, Secretary Galvin accused Robinhood of gamifying investing to attract young, inexperienced investors, and failing to protect their interests in violation of the Fiduciary Duty Rule. In response, Robinhood Financial LLC (“Robinhood”) sued Secretary Galvin and the Massachusetts Securities Division in Superior Court (Civil Action No. 2184CV00884). Robinhood challenged the validity of the Fiduciary Duty Rule, lodging both a facial and an as-applied challenge. Last week, Robinhood’s challenge was met with success.

The Administrative Action and The Fiduciary Duty Rule

In December 2020, Secretary Galvin filed an administrative complaint against Robinhood, claiming that the broker-dealer violated the Massachusetts Uniform Securities Act (“MUSA”). See In the Matter of: Robinhood Financial LLC (Docket No. E-2020-0047). Secretary Galvin claims Robinhood violated MUSA by breaching its supposed fiduciary duty to customers in its provision of investment recommendations and/or advice. That fiduciary duty, however, exists only under the Fiduciary Duty Rule, 950 C.M.R. § 12.207(1)(a), adopted by Secretary Galvin in March 2020.

MUSA prohibits broker-dealers from engaging in “unethical or dishonest conduct or practices.” The Fiduciary Duty Rule defines “unethical or dishonest conduct or practice” for purposes of MUSA to include a broker-dealer “failing to act in accordance with a fiduciary duty to a customer when providing investment advice or recommending an investment strategy, the opening of or transferring of assets to any type of account, or the purchase, sale, or exchange of any security.” When the rule was adopted, Secretary Galvin also amended and added additional regulations to implement the rule. Among other things, these regulations make it a “dishonest or unethical practice” to recommend an investment strategy, open accounts, transfer assets, or buy, sell, or exchange securities without meeting certain suitability requirements. See 950 C.M.R. § 12.207(1)(a)(4).

In 2019, the United States Securities and Exchange Commission (“SEC”) implemented “Reg BI,” a regulation creating a “best interest” standard of conduct for broker-dealers. In doing so, Reg BI explicitly rejected the application of a fiduciary duty standard to broker-dealers, noting that “it is not appropriately tailored to the structure and characteristics of the broker-dealer business model . . . and would not take into account, and build upon, existing obligations that apply to broker-dealers.” The SEC further opined that imposing a fiduciary duty standard would have a negative effect on retail investors’ access, choices, and costs in investing and receiving recommendations.

During the SEC’s comment period for Reg BI, Secretary Galvin was an outspoken proponent of adopting a fiduciary standard for broker-dealers. The Secretary promulgated the Commonwealth’s Fiduciary Duty Rule less than two weeks after the SEC decided not to do so. During its own comment period, the Fiduciary Duty Rule received some criticism, including from Massachusetts Governor Charlie Baker. Governor Baker observed that the rule “does not seem to appear to sufficiently account for differences in the industry . . . and departs from federal regulations and regulations adopted in other states[,]”expressing his fear that the rule would create confusion.

In the administrative complaint, in addition to violation of the Fiduciary Duty Rule, Secretary Galvin brought claims against Robinhood for failure to supervise and for engaging in unethical and dishonest conduct. In particular, the Secretary argued that Robinhood’s violations included encouraging trading by providing customers with lists of popular securities, which the Secretary alleged was akin to providing recommendations, and failing to properly screen customers, thus allowing inexperienced investors to take on outsized risk.

Robinhood’s Lawsuit

Robinhood is a no-fee online stockbroker with no account minimums. Users may engage with Robinhood through its website or mobile app. The firm targets investors with fewer assets to invest than the typical clientele of traditional commission-based brokerages. Importantly, Robinhood is a registered broker-dealer, not an investment advisor.

Following the Secretary’s administrative complaint, Robinhood filed its own lawsuit. Robinhood argued that the Fiduciary Duty Rule improperly overrides Massachusetts common law, that Secretary Galvin did not have the authority to adopt the rule, and that the rule is preempted by Reg BI. The broker-dealer initially sought a preliminary injunction to block enforcement of the Fiduciary Duty Rule but was unsuccessful. The case proceeded, however, for questions of law to be decided even while the administrative action remains pending.

Last week, Judge Ricciuti granted Robinhood’s motion for judgment on the pleadings, finding that the Fiduciary Duty Rule conflicts with common law. In particular, the court compared the rule with the Massachusetts Supreme Judicial Court’s (“SJC”) decision in Patsos v. First Albany Corp., 433 Mass. 323 (2001). In Patsos, the SJC held that brokers are not fiduciaries just because they execute trades for customers. In that case, quoted extensively in Judge Ricciuti’s Robinhood decision, the SJC examined the degree of discretion given to a broker on its customer’s behalf. The Court held that non-discretionary accounts do not create a fiduciary relationship, a result consistent with the standard in other states. The Patsos court recognized only limited exceptions to this rule—specifically, fiduciary obligations may be imposed only on stockbrokers who can (and do) make most of their customers’ investment decisions.

Although Secretary Galvin argued that the Fiduciary Duty Rule is not inconsistent with Patsos, the Robinhood court disagreed because the rule imposes the duty on a general basis, the opposite of the result in Patsos. The court then found that an executive agency cannot override common law set forth by the SJC and thus found that Secretary Galvin lacked the authority to promulgate the Fiduciary Duty Rule. The court therefore held that the rule and the provisions implementing it are all unlawful.

The judge did, however, stay his order for 30 days in order to allow Secretary Galvin time to appeal, “in light of the significant public policy concerns at issue in this case[.]” In addition, Secretary Galvin may still pursue his other claims against Robinhood related to allegedly unethical conduct—he just may now do so only under existing brokerage laws and regulations. And Robinhood is no stranger to regulatory scrutiny for its unconventional practices. The broker-dealer was the target of a record-breaking $70 million FINRA settlement less than a year ago related to failures to supervise and outages—the same types of conduct underlying Secretary Galvin’s claims. It seems likely, then, that although the Fiduciary Duty Rule claim did not survive, Robinhood is not home free with the Massachusetts regulator.

A Win For FinTech

Broker-dealers like Robinhood are held to a lower regulatory standard than are investment advisors, as long as they are actually functioning as brokerages. Specifically, a key issue is whether Robinhood and firms like it, registered as broker-dealers, actually offer investors investment advice or whether they simply make recommendations. In the absence of the Commonwealth’s Fiduciary Duty Rule, advice is the subject of greater regulatory scrutiny than recommendations, and the provision of advice falls outside of the traditional broker-dealer role.

With the FinTech industry on the rise, brokerage is becoming increasingly automated, creating more of a gray area in the advice versus recommendations—and the advisor versus salesperson—divide. How and whether these online brokerage platforms can and should be further regulated remains to be seen. At least for now, though, it appears that no fiduciary duty standard will be applied to them.