Regardless of whether a financial advisor is an “investment advisor” or a “broker” or neither under federal securities laws, the advisor might be an agent of the client under the common law of agency. If so, then as a matter of state law the advisor is a fiduciary who will be subject to liability for breach of any of several fiduciary duties to the client. In a recent paper sponsored by Federated Investors that is available for download here, I examine the fiduciary obligations of financial advisors who are agents under the common law of agency. The paper draws on earlier work on the economic structure of fiduciary law.
The debate about whether to impose a harmonized federal fiduciary standard of conduct on investment advisors and brokers notwithstanding, a financial advisor who is an agent under state agency law is subject to fiduciary duties of loyalty, care, and a host of subsidiary rules that reinforce and give meaning to the broad standards of loyalty and care as applied to specific circumstances. In the event of the advisor’s breach of duty, the client will be entitled to an election among remedies that include compensatory damages to offset losses incurred or to make up gains forgone owing to the breach; disgorgement by the advisor of any profit accruing from the breach or compensation paid by the client; or punitive damages. A financial advisor who ignores the possibility of fiduciary status under state agency law acts at his peril.
The possibility of fiduciary liability for a financial advisor under state agency law is nicely illustrated by the Delaware Supreme Court’s decision in O’Malley v. Boris, 742 A.2d 845, 849 (Del. 1999):
The relationship between a customer and stock broker is that of principal and agent. The broker, as agent, has a duty to carry out the customer’s instructions promptly and accurately. In addition, the broker must act in the customer’s best interests and must refrain from self-dealing unless the customer consents, after full disclosure. These obligations at times are described as fiduciary duties of good faith, fair dealing, and loyalty. They are comparable to the fiduciary duties of corporate directors, and are limited only by the scope of the agency.
My paper considers how agency fiduciary law might be applied to a financial advisor with discretionary trading authority over a client’s account. The paper (1) surveys the agency problem to which the fiduciary obligation is directed; (2) examines the legal context by considering how the fiduciary obligation undertakes to mitigate this problem; and (3) examines several potential applications of agency fiduciary law to financial advisors. These applications include: (a) principal trades, (b) informed consent, (c) the common practice in the mutual fund industry in which a fund pays a shareholder’s broker or other intermediary for providing nondistribution related services to the shareholder, and (d) the potential applicability of the prudent investor rule to a financial advisor who gives individualized investment advice to a retail customer. The discussion is organized under the great fiduciary rubrics of loyalty and care.
The paper is available for download here.