Major Changes Governing Brokers

There are major changes that have been made by the Dodd-Frank Wall Street Reform and Consumer Protections Act that was passed on July 21, 2010. This law changes the relationship between the broker and the investors that work with the broker, increasing the standard of care that is required by the broker. In addition, the law provides that investors will have access to better protection where the standard of care is breached by the broker.

Prior to the change in the law, brokers owed investors a relatively lower standard of care, as they were regulated by a different law. Brokers were required to recommend investments that were suitable for the investor, which required that a broker had to have a reasonable basis to recommend the security in light of the investor’s investment objectives and whatever the financial circumstances were for that investor. This duty is contrasted with that required of an investment advisor who has a duty of loyalty to the investor and has to act in the investor’s best interest. The distinction between these two standards of care are not readily apparent to an investor, but are very clear when a dispute arises between the broker and the investor. When there is a dispute between broker and investor, the investor must normally arbitrate that dispute. The standard of care used by the arbitrator was always the lower standard of care, which meant that the broker, more often than not, met that standard and the investor probably lost the arbitration in all but the most blatant situations.

The new law was designed to increase the standard of care, equating the broker-investor relationship to the Investment advisor-investor relationship. The new law requires the Securities Exchange Commission (SEC) to conduct a study and report to Congress by January 21, 2011, on the existing standard of care for brokers versus investment advisors. The law allows the SEC to make rules for any deficiencies that it determines. Although the SEC has not yet concluded its research, the indications are that the SEC will raise the standard of care that brokers must use for investors to the higher standard of care, which involves a duty of loyalty to the investor and to recommend to the investor what the broker determines is in the best interests of the investor.

The SEC also has the power to either prohibit, or provide limitations on the use of agreements that require an investor to use arbitration to resolve disputes. This is not to say that arbitration will not be used to resolve disputes, but the SEC may provide a more level playing field by eliminating the requirement that there be an industry arbitrator on the three member arbitration panel.

While time will tell, this legislation raises the standard of care that brokers will have to provide and may assist investors who believe that their losses were the result of broker misconduct to receive relief and resolution to their dispute.