BOSTON (Legal Newsline) - Massachusetts can impose tougher securities regulations on Internet broker Robinhood, the state’s highest court ruled, reversing a lower-court decision that held the “fiduciary rule” equating brokers with investment advisors exceeded regulators’ authority.
Robinhood challenged the rule after the Secretary of the Commonwealth accused it of encouraging small investors to engage in "frequent, risky, and unsuitable trading" by recommending the "100 Most Popular" stocks or "Top Movers," without considering if they were in the customers’ best interest. A lower court agreed, ruling the Massachusetts Uniform Securities Act held broker-dealers to the lower standard of ensuring only that investments were suitable for their customers.
The Massachusetts Supreme Judicial Court disagreed, upholding the fiduciary duty rule in an Aug. 25 decision by Justice Dalila Argaez Wendlandt. “MUSA sets forth the Legislature's fundamental policy decision to protect investors, and more specifically to protect them from `unethical or dishonest conduct or practices,’” the court said.
Broker-dealers historically were held to a lower standard of fiduciary duty than investment advisors, who monitor client portfolios and make trading recommendations. But “over time, the once-clear dichotomy” became blurred, the Supreme Court said. Some brokers recommended stocks and many engaged in the practice known as payment for order flow, where they charged low or no commissions and made money by routing customer orders to specialists who may not provide the best execution price.
The Securities and Exchange Commission studied whether there was a problem of consumer confusion and enacted the “best interest rule” for brokers instead of a uniform fiduciary duty for brokers and investment advisors. Massachusetts securities regulators disagreed with that decision and in March 2020 issued the fiduciary duty rule, interpreting MUSA to mean broker-dealers provide the “utmost care and loyalty to the customer” when recommending stocks or investment strategies.
The rule was subjected to extensive public notice and comment before being enacted, the court observed and was supported by a study that found consumers “mistakenly believed broker-dealers had a fiduciary obligation equal to investment advisors to act in their customers’ best interests.”
Critics of the rule said it would raise costs and force brokers to reduce the investment choices available to consumers. But the court agreed with the Secretary that "when preserving 'choice' means preserving the option to choose opaque, poorly understood products that are sold via heavily conflicted advice, the benefits of such 'choice' are illusory."
Robinhood argued the phrase “unethical or dishonest conduct or practices” referred to traditional industry norms, where brokers only had to make sure they recommended suitable investments. But with the rise of internet brokers the business changed and the SEC altered “industry norms” by increasing broker duties under the best interest rule, the court said.
“The Secretary permissibly adapted the standard of care required of these new-age broker-dealers, who have themselves adopted new business models inconsistent with their traditional roles and prior industry norms, to carry out his charge under MUSA to protect investors,” the court concluded.
Finally, the court said the rule isn’t preempted by federal law because Congress had observed other states imposing heightened fiduciary duties on brokers without taking action. The SEC’s best interest rule is a floor, not a ceiling, the court said.