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Law Expert Examines Proposed Regulations to Protect Institutional Investors

University of Cincinnati research suggests that extending certain investment advisers regulations to broker-dealers would be “much ado about nothing” in protecting institutional investors.

Date: 2/4/2014 8:00:00 AM
By: Dawn Fuller
Phone: (513) 556-1823
Photos By: Dottie Stover

The global financial crisis of 2008 launched a litany of lawsuits in the U.S. as institutional investors claimed they were duped by the misrepresentations of Wall Street securities firms and their broker-dealers. However an examination of proposed new protections finds that extending certain regulations on broker-dealers would not be an effective solution to the problem. The article by Lynn Bai, a University of Cincinnati law professor, is published this month in the William & Mary Business Law Review.

The article is a response to the U.S. Securities and Exchange Commission’s examination of whether broker-dealers should fall under fiduciary duty when advising retail and institutional investors.

Fiduciary duty requires a person or organization to act in the best interest of the client. Although federal regulations hold investment advisers under fiduciary duty to their clients, those obligations generally don’t apply to broker-dealers, explains Bai.

Nevertheless, Bai says the article takes an angle that has been overlooked by proponents and opponents in the debate. “Since investment advisers are recognized as ‘fiduciaries’ but broker-dealers are generally not, people perceive that their standard of conduct is different when providing advice to investors,” writes Bai. “However, both investment advisers and broker-dealers are subject to elaborate, albeit different, sets of regulations that have, at least on the surface, some overlap in the scope of obligations their regulated financial service providers owe to their clients.”


Bai cites refraining from fraudulent advising as one of those obligations, which would apply to a client’s tolerance of financial risk.

The article delves into the standard of conduct of both investment advisers and broker-dealers, as well as the federal regulations that apply to both parties. It finds that standards of conduct in advising clients, whether retail or institutional, are comparable to investment advisers. Among those regulations is the required disclosure of conflicts of interest as well as acting in the best interest of clients.

Furthermore, Bai writes that both investment advisers and broker-dealers can be held liable for negligence or willfully violating their obligations. “There is no palpable difference in the enforcement of the obligations of investment advisers and broker-dealers, even though the former are labeled fiduciary while the latter are not,” writes Bai.

Bai says that imposing fiduciary duty on broker-dealers would result in only a limited effect on institutional investor protection, applying to a subset of institutional investors that are well capitalized, capable of assessing risks independently and acknowledging in writing their non-reliance on broker-dealers’ advice.

She adds that in private litigation, institutional investors face “substantial obstacles” in recovering damages from broker-dealers who violate conduct, and the issue would not be solved by applying fiduciary duty.

“Even though broker-dealers are not deemed fiduciary – they’re not given that label – if you compare their substantive obligations in dealing with institutional investors with the investment advisers under fiduciary duty, there is no substantive difference,” says Bai. “On the surface, it appears to be a good idea, but even for people who are receptive to fiduciary duty in dealing with clients, they can ask a client to sign disclaimers stating that the client is not going to rely on the firm’s recommendation only, that they’re going to do their individual homework. The court is very much in favor of disclaimers. People should do their research if they’re signing a disclaimer stating that they’re not relying entirely on this advice.”

The article suggests that if the SEC truly wants to add to institutional investor protection, it should not take the fiduciary duty route, rather it should examine whether a different approach be adopted by the courts in enforcing disclaimers that were insisted by broker-dealers upon their clients – an approach that is less preoccupied with the contractual provisions per se, but more receptive to the totality of circumstances surrounding the signing of the disclaimer contract.

Bai has a decade of experience working in corporate finance in securities law in New York and Hong Kong. Her research interests cover corporate law, empirical legal methods, property and securities regulation.