The Securities Litigation Expert Blog

Coronavirus Cases

Posted by Jack Duval

Mar 24, 2020 9:23:37 AM

This is the first post in a series on the securities litigation likely to arise from the recent market declines.

Since the Global Financial Crisis ("GFC") in 2008-9, the Federal Reserve has keep interest rates at extremely low levels.

Indeed, at the end of 2007, the yield on the 10-year U.S. Treasury note was 4.0232 percent and at the end of 2011 it was 1.8762 percent.[1]  As I write this, it is at 0.69 percent.[2]

This has lead brokers and advisors to “reach for yield" for their investors.  Of course, they were able to grasp it, primarily by reducing high quality equity and fixed income investments and increasing:

  • Equity allocations;
  • Equity “bond proxy” allocations, and;
  • Low-quality fixed income allocations.

Over time, these combined shifts have led to an increasing amount of risk in investor's portfolios, even if the equity allocation did not increase (or even decreased).  Indeed, many investors have seen their portfolios become predominately equity exposed, greatly increasing their risk.  Table 1, below offers a comparison.

Table 1:  Typical Pre- and Post-GFC Portfolio Composition


Typical Pre- and Post-GFC Portfolio Composition

Table 1, above, compares typical investor portfolios from the pre- and post-GFC periods.  The yellow banded rows highlight investments with equity or equity-like exposure (even if they are bonds).

The pre-GFC portfolio has a 55/35/10 (stocks/bonds/cash) asset allocation, and is heavily skewed to quality on both the equity and fixed income sides.  The post-GFC portfolio has a 65/30/5 asset allocation, but has added 15 percent of equity “bond proxies” and lower quality fixed income.  (Equity bond proxies include equity investments such as traditional infrastructure, utilities, REITs, MLPs, and other higher yielding equities.)

Importantly, the direct equity exposure only increased from 55 to 65 percent, however, the total equity and equity-like investments increased from 60 to 85 percent.  From a risk perspective, the post-GFC portfolio is 85 percent in equities.

This is a significant increase.  And a bad trade.

In the 10-year rolling periods from January 2001 through June 2018, a traditional 60/40 portfolio returned an average annual 6.56 percent, whereas an 85/15 portfolio returned an average annual 7.13 percent, or 57 basis points higher.[3]

However, the increase in risk is dramatic.  Over the same period, the 60/40 portfolio had a standard deviation of 9.19 percent compared to 12.84 for an 85/15 portfolio.[4]

In percentage change terms, by shifting the equity (and equity-like) allocation from 60 to 85 percent, an investor gets an approximate nine percent increase in expected return, but a 40 percent increase in expected risk.  This is what made it a bad trade.

Worse still is the max drawdown risk of the two portfolios.  The 85/15 portfolio has significantly more drawdown risk.  Those risks are now being felt as the typical post-GFC portfolio proves to be much more highly correlated (i.e. where almost all the assets decline simultaneously) than most investors thought.

Hidden Fixed Income Risks

The litigations arising from the recent declines will likely have a common theme that was not present in those arising in post-GFC litigations:  hidden risks in investor’s fixed income investments.  All the risky fixed income investments that investors have been put into as part of the reach for yield are declining similar to equities, and in some cases more than equities.

These risky fixed income investments include those investing in the following underlying investments and/or strategies:[5]

  • Corporate bonds (which were typically around 50 percent in BBB rated bonds);
  • High yield “junk” bonds;
  • High yield municipal bonds;
  • Leveraged closed-end funds;
  • Convertible bonds;
  • Preferred stocks (almost all preferred stocks are issued through trusts which buy a note from the issuer and then sell interests in the trust);
  • Commercial mortgages;
  • Asset-backed securities;
  • Leveraged loans;
  • Collateralized loan obligations, and;
  • Emerging market bonds;

Table 2:  Bottom Decile One-Month Fixed-Income Mutual Fund Returns through March 20, 2020[6]

Bottom Decile one-month fixed-income mutual fund returns

The full list can be downloaded here.

Table 2, above, shows that the fixed income funds with the worst one-month performance through March 20, 2020, also generally had high, double-digit total returns in 2019.  These funds have fallen in-line with the S&P 500, which was down about 29 percent over the same period.

When reaching for yield, the handhold is risk.  The 2019 returns were the yield part, the previous months performance is the risk part.

In my experience, when bonds decline like equities, litigation ensues.

In subsequent posts, I will examine other aspects of increased risk-taking over the past 11 years.




[1]      Source: Bloomberg.

[2]      Id.

[3]      Goldman Sachs; Diversified Investment Allocation Tool.  Available at:;  Accessed March 20, 2020.  Dataset is the 91 10-year rolling periods from January 01, 2001 to June 30, 2018.

[4]      Id.

[5]      This list is by no means exhaustive.  All kinds of risky fixed income products have been invented over the past 11 years.

[6]      Source: Bloomberg.  Performance data for U.S. domiciled fixed income mutual funds with $500 million or more in assets, through March 20, 2020.


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Topics: collateralized loan obligations, securities litigation, fixed income, Investment Suitability, commercial mortgages, CLO

Lost Gains Cases: The Broker Appropriation Fact Pattern

Posted by Jack Duval

Mar 6, 2020 6:59:31 AM

This post is the second in a series exploring Lost Gains securities arbitration cases.

In my previous post, I defined “Lost Gains” cases as those where the claimant has no investment loss and possibly even a small gain, but has not participated in the upside that was available in the market.

I identified two common fact patterns in those cases:[1]

  • Broker appropriation of investment gains, and;
  • Failure to follow instructions.

Here I will examine the broker appropriation fact pattern.

Broker Appropriation of Investment Gains

Broker appropriation of investment gains is the most common type of Lost Gains case, and I have been involved in a number of these.

In my experience, broker appropriation cases have a typical fact pattern involving a client who has, or should have, a long-term buy-and-hold approach to investing.  This is the vast majority of clients, since most clients don’t have the time or inclination to follow the markets closely, and (as will be discussed below) want to avoid short-term capital gains and the accompanying taxes.

The second part of the typical broker appropriation fact pattern is the purchase of high commission investment products such as: new issue closed-end funds, preferred stocks, UIT's, and other products with high up-front commissions, and their subsequent sale after a short period.  This purchase-and-sale pattern is repeated with the client’s cash (from securities sales) serving as an evergreen source of funds.

This behavior is a form of churning, but is not as obvious as the rapid fire buying and selling of stocks to generate commissions.

The difference is that the commissions are hidden inside the purchase price of the newly issued securities, so the client does not see them.  In theory, the client could discover these hidden commissions if she read the prospectus for each product that was sold to her.  In my experience, almost no client reads prospectuses, or if they do, they give up after reading one and never venture back, especially when they receive multiple prospectuses every month.

I’ve written about this as it relates to Complexity Risk, and how clients are highly unlikely to understand the language in a prospectus, even if they do read it.  Indeed, often the brokers selling complex investments don’t understand them.

Importantly, FINRA has been crystal clear that delivery of a prospectus does not cure an otherwise unsuitable recommendation and that there can be no disclaiming of any responsibilities under the suitability rule (by prospectus delivery or any other method).[2]

Multiple Fee Layers

In broker appropriation cases it is also not uncommon to see multiple fee layers.  That is, there will often be three discrete charges assessed against the client, including:

  • Commissions charged on the investment product(s) upon sale to the client (1 to 7 percent);
  • Annual internal management fees inside the product(s) sold (1 to 3 percent), and;
  • Annual account asset-based fees on the same assets (1 to 2 percent).

This “triple dipping” is especially pernicious.  Furthermore, it is, in my experience, never explicitly disclosed to the client.

In aggregate, these commissions, internal fees, and account asset-based fees can easily add up to three to seven percent (or more) of an account’s assets each year.

When this is the case, the abusive nature of the investment strategy becomes clear.[3]

Dividing (Potential) Gains

An example is instructive.  Assume a long-term oriented client has a 60/30/10 (stocks/bonds/cash) asset allocation and the expected returns are 10 percent for the stocks, three percent for the bonds, and one percent for the cash.  The blended expected return for the portfolio is thus seven percent.

If the aggregate annual commissions and fees are even three percent, they will consume 43 percent of the expected return, over time.

One way to think about this is that the client takes 100 percent of the risk, but will only get 57 percent of the return.  Of course, no one would knowingly accept such a strategy, and it cannot be said to be suitable.


Another issue in broker appropriation cases is the tax implications of short investment holding periods.  Short-term capital gains are taxed at the investor’s ordinary income rate.  For most investors, this rate is at or close to 40 percent (combining federal, state, and local taxes).[4]

Thus, the various government entities take 40 percent of these gains, despite (like the broker) taking none of the risk.  In the business, this is known as a bad trade.  While there can be instances where taking a short-term gain is the appropriate action, it should not be the norm for a long-term investor.

Going back to our seven percent blended return example, if the broker is taking three percent off the top through fees and commissions, and short-term capital gains taxes are consuming 40 percent of the remaining four percent gain, that leaves only 2.4 percent for the investor on a net, after-tax basis.

This 2.4 percent net, after-tax, return is roughly 34 percent of the original seven percent gross return.  A long-term investment strategy which can be reasonably expected to leave only 34 percent of potential returns for the client is abusive and cannot be said to be suitable.

In my next post, I will examine the failure to follow instructions fact pattern in Lost Gains cases.



[1]      Lost Gains Securities Arbitration Cases; Jack Duval; February 26, 2020.  Available at:; Accessed March 4, 2020.

[2]      See “Understanding FINRA Suitability Rule 2111 – Prospectus Delivery and Suitability”; Jack Duval; December 19, 2013.  Available at:;  Accessed February 18, 2020.

[3]      It is important to remember that under FINRA Rule 2111, an investment strategy recommended to a client must be suitable.  If the costs of a strategy will consume the lion’s share of the expected returns, then that strategy cannot be said to be suitable.

[4]      For instance, the 2020 federal short-term capital gains tax rate is 37 percent for a married couple, filing jointly, with over $622,051 in income.  Of course, state and local taxes would be added to this.  See “Capital Gains Tax Brackets 2019 and 2020:  What They are and Rates; Robert Farrington; The College Investor; March 1, 2020.  Available at:; Accessed March 4, 2020.

To learn more about suitability and fiduciary expert Jack Duval, click here.


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Topics: Investment Suitability, Lost Gains Cases

Lost Gains Securities Arbitration Cases

Posted by Jack Duval

Feb 26, 2020 9:15:30 AM

This post begins a series exploring Lost Gains securities arbitration cases.

A record eleven-year (and nearly uninterrupted) bull market has caused a decline in the number of FINRA securities arbitration claims.  In short, very few investors have lost money during this period.  Indeed, on a calendar year-end basis, the worst annual decline in the S&P 500 price index has been 6.25 percent, in 2018, and this would be even less if dividends were included.

Chart 1:  S&P 500 v. FINRA Annual Arbitration Claims[1]

jack duval accelerant finra suitability fiduciary expert - S&P 500 v. Arbitration Claims chart

In Chart 1, above, it can be seen that since the end of 2008, the S&P 500 price index (green line) has increased by 258 percent and the number of FINRA arbitration claims (red line) has decreased by 47 percent.  These trends are certainly well known to securities litigators.

After this record-setting bull market, one would suspect there would be some FINRA arbitration cases arising from customer accounts that did not appreciate, i.e. that the client lost out on the gains that were to be had.  However, these claims have not been prevalent.[2]

In this post, I will explore some reasons why Lost Gains cases are not more common, as well as the common types of Lost Gains cases that I have seen brought.

First, I need to make a distinction, most claimant’s attorneys make lost gains claims, but tend not to bring lost gains cases.

Lost Gains Claims

In a typical FINRA customer arbitration, the brokerage client has lost money in her account.  The claimant will usually plead damages from the principal (out-of-pocket) loss and what the account would have made if it had been invested suitably, this is known as the market-adjusted damage (“M-AD”).

The M-AD damage is a lost gain claim.  In essence, the claimant is saying, but for the unsuitable recommendations of the broker, her principal would, first, not have declined, and second, it would have appreciated.

Lost Gains Cases

Lost gains cases are different from lost gains claims because, in them, the claimant did not lose money on her investmentd.  That is, the account was profitable (or flat) over the period at issue.

Thus when a lost gains case if brought, it only contains the lost gain damage claim, there is no out-of-pocket loss claim.

Reticence to Bring Lost Gains Cases

I believe attorneys are reluctant to bring Lost Gains cases for a number of reasons, including the following:

First, the claimants are perceived to be unsympathetic.  They either didn't lose money or actually made money, just not as much as they could have but for the allegedly unsuitable investment recommendations or other violative behavior by the broker.

Second, because there are no out-of-pocket losses, the damage claim rests entirely upon the market-adjusted damages theory.  While panels frequently award market-adjusted damages, they are less common than awards of out-of-pocket losses.

Third, since Lost Gains cases are perceived to have the headwinds described above, they are typically only brought for large clients who can make seven- or eight-digit damage claims.  Since fewer investors have accounts large enough to support such claims (likely $10 million or more), this necessarily reduces the number of potential claims.

Despite these issues, lost gains cases are brought, and can be won.

Two Common Fact Patterns in Lost Gains Cases

Although there are many fact patterns that could give rise to a Lost Gains case, I want to discuss two types that I have had experience with.  Importantly, they both involve abusive behavior and are not of the sour grapes variety, i.e. where the market was up 20 percent and the client was only up 17.

Those types are:

  • Where the broker appropriates the investment gains for herself through abusive commissions and/or fee structures, (“broker appropriation”), and;
  • The failure of the broker to follow client instructions (“failure to follow”).

In my next post, I will explore these fact patterns in more detail.



[1]      Data obtained from Bloomberg and FINRA.

[2]      This is anecdotal as FINRA arbitration statistics do not track Lost Gains claims.  To get a sense of these case filings, I have surveyed a number of securities litigators across the country.


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Topics: Investment Suitability, Lost Gains Cases

The Decline of FINRA Membership and the Litigation Implications

Posted by Jack Duval

Feb 7, 2020 8:52:25 AM

In the six years ending in 2018, the number of broker-dealers ("BDs") shrank by 13.5 percent.  Over the same period, the number of SEC Registered Investment Advisor ("RIA") firms increased by 19.7 percent.[1]

Chart 1: FINRA Broker-Dealer and SEC Registered Investment Advisor Firms[2]

FINRA Broker-Dealer and SEC Registered Investment Advisory Firms - Fiduciary Duties

I expect these trends to continue, if not accelerate.

Firms and/or brokers shifting from BDs to RIAs reflect the trends in the market and what business models are sustainable.  The business model based on generating commissions from transactions in customer accounts is losing to the business model of asset management fees based on the amount of assets in the client's account.  This trend has been in place for well over a decade.

At the same time, both of these business models are under attack by the index investing trend.  However, the RIA model is less subject to declines from indexing because an RIA firm can charge the same fees whether it invests in index funds or actively management funds.

Indeed, many RIA firms are disintermediating asset managers by using index ETFs that the RIA selects.

Something that is hidden in the data in Chart 1, above, is that most BDs are dually registered (meaning they are also RIA firms) so they are acting as fiduciaries for a significant percentage of clients.  This, as will be examined below, is showing up in FINRA arbitration statistics, and has important implications for securities litigations, in-house counsel, and compliance and supervisory implementation.

Changing Trends in Securities Litigation

The decline in the number of broker dealers and the increase in the number of RIA firms would suggest that securities arbitrations will shift from being primarily suitability driven to being primarily fiduciary duty driven.

The shift from BDs to RIAs will also entail a shift in securities arbitrations from being overwhelmingly heard in FINRA forums to those of AAA, JAMS, and other forums.

This will have a number of impacts on attorneys and their clients.

Obviously, the fiduciary standard is much higher than the suitability standard.  (I have written about fiduciary duties extensively here.)  This will benefit claimants and make respondent's cases harder to defend.

For respondents, one offsetting factor could be the fact that BD cases with breach of fiduciary duty claims will be heard in FINRA forums.  FINRA arbitrators who have years of experience hearing suitability claims may not fully appreciate the difference between the suitability and fiduciary standards, even when it is explained to them.

If the cases are in AAA or JAMS forums, the costs will almost certainly be higher than at FINRA.  This comparatively higher cost may be well worth it for claimants (not that they have a choice in most instances) because many AAA and JAMS arbitrators are former judges (and if not, almost always attorneys) who are well versed in the weight and import of fiduciary duties.

Trends in FINRA Arbitration Claim Types

FINRA publishes statistics on arbitration case filings and has broken out customer case filings (that is, excluding cases between member firms) since 2013.

The trends in types of controversy are indicative of the falling number of BDs and rising number of RIA firms and RIA services provided by dually registered BDs.

Table 1:  FINRA Arbitration Claims by Type of Controversy[3]

FINRA Breach of Fiduciary Duty Table

Table 1, above, shows that Breach of Fiduciary Duty claims now comprise 86.9 percent of all customer cases filed, up from 75.9 percent in 2013.  Suitability claims have risen even more, to 66.9 percent in 2019 up from 52 percent in 2013.[4] 

Importantly, these types of claims are not exclusive of one another, and in my experience, almost all Breach of Fiduciary Duty claims will also have a Suitability claim attached.

Trends in FINRA Arbitration Resolutions

It would appear that the increasing number of Breach of Fiduciary Duty claims (and the higher hurdle to defending them) is showing up in FINRA arbitration settlements.

Table 2:  FINRA Arbitration Case Settlements[5]

FINRA Arbitration Settlements Table - Fiduciary Duties

Indeed, in 2019 69.4 percent of arbitrations settled, up from 58.9 percent in 2013.[6]

The correlation between the 17.8 percent rise in settlements and the 14.5 percent rise in Breach of Fiduciary Duty Claims over the same period can be seen clearly in Chart 2, below.

Chart 2:  FINRA Breach of Fiduciary Duty Claims and Case Settlements[7]

FINRA Breach of Fiduciary Duty claims and Case Settlements chart

The Long-Term Effects of a Shift from BDs to RIAs

While the number of FINRA Arbitration claims has fallen to the 3,400 to 4,000 per year range during the post-GFC bull market,[8] the types of claims have shifted, with a notable rise in Breach of Fiduciary Duty claims.

Breach of Fiduciary Duty claims must be prosecuted and defended differently than suitability cases.  As I have written about here and here, the difference is profound.  In short, the defenses to suitability claims will generally fail if a fiduciary standard is operative.


The increase of Breach of Fiduciary Duty claims and the shift from BDs to RIAs, are trends that are almost certain to continue, if not accelerate.  They require changes in all aspects of BD compliance, supervision, education and training, and business structure.  BDs doing fiduciary business must be built to do that type of business.  That structure is fundamentally different from the old BD brokerage/suitability structure.


For BDs doing an increasing amount of RIA business, being a FINRA member firm will become less and less attractive as their brokerage revenue declines and FINRA membership becomes a source of expensive regulatory oversight.


Needless to say, with Breach of Fiduciary Duty claims comprising nearly 87 percent of Customer claims, securities litigators should be honing their chops on fiduciary duty case construction and prosecution.



[1]      Investment Advisor Association; “2018 Evolution Revolution: A Profile of the Investment Adviser Profession”; 38.  Available at:;  Accessed January 30, 2020.

[2]      Id.

[3]      FINRA Dispute Resolution Statistics;  Available at:;  Accessed December 31, 2019.

[4]      Id.  I have excluded the other types of controversy for this analysis.

[5]      Id.  “Settled via Mediation” means cases settled with a FINRA mediator.  In the vast majority of instances, “Direct Settlement by Parties” involves a mediation with a third-party, non-FINRA mediator.

[6]      Id.

[7]      Id.

[8]      Id.


To learn more about fiduciary expert Jack Duval, click here.


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Topics: supervision, Investment Suitability, Securities Exchange Commission, fiduciary duties, Breach of Fiduciary Duty Claims

SEC Regulation Best Interest - FINRA RN 19-26

Posted by Jack Duval

Aug 8, 2019 8:16:52 AM


This blog post continues my series on SEC Regulation Best Interest ("RBI") and the DOL Rule.


FINRA RN 19-26 Image

Yesterday, FINRA published its first Regulatory Notice related to RBI, RN 19-26.  This Notice was relatively unremarkable and essentially set the table for further FINRA guidance on RBI.

FINRA has created a webpage of RBI content for member firms.  Of note was FINRA's hinting at future rule changes:

As with other SEC rules, FINRA will examine for and enforce compliance with Reg BI and, in doing so, FINRA will adhere to SEC guidance and interpretations. FINRA staff expects to work with SEC staff to ensure consistency in examining broker-dealers and their associated persons for compliance with Reg BI. In addition, FINRA will review FINRA rules to see whether changes are needed to align FINRA rules with the SEC’s rulemaking. Any proposed changes to FINRA rules will be filed with the SEC for public comment and available on FINRA’s website.1  (Emphasis added)

I suspect changes will be coming to FINRA Suitability Rule 2111, which I wrote about here.



1.          FINRA SEC Regulation Best Interest website.  Available at:  Accessed August 8, 2019.

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Topics: supervision, Investment Suitability, Suitability Expert, Securities Exchange Commission, Regulation Best Interest, FINRA RN 19-26

IPO Churning - It Ain't What it Used to Be (And it Never Was)

Posted by Jack Duval

Jul 18, 2019 7:38:28 AM

I'm pleased to announce a new white paper entitled IPO Churning - It Ain't What it Used to Be (And it Never Was).

Over the years, I have participated in many IPO churning cases and have heard defense counsel argue that the client doesn't pay the commission and therefore there can be no churning.

This argument is just plain wrong.

Confusion about this issue arises from counsel not understanding the different types of IPOs commonly used today.  This white paper unpacks the different types of IPOs and shows how in almost all cases, the client pays the markup (commission) to the underwriters, not the issuing firms.

The paper also discusses:

  • How IPO churning has changed since the technology bubble and why clients are unlikely to make money in such a "strategy";
  • How prospectuses are used to solicit investors into IPOs;
  • The different types of prospectuses used;
  • Suitability, and;
  • Supervision.

To learn more about fiduciary expert Jack Duval, click here.


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Topics: supervision, IPO, Investment Suitability, FINRA Suitability Rule 2111, Suitability Expert, Churning, Section 2(a)(10), Section 15(c)(2)

SEC Regulation Best Interest - The Final Rule

Posted by Jack Duval

Jun 13, 2019 8:03:07 AM

Accelerant SEC Regulation Best Interest - Logo 

This blog post continues my series on SEC Regulation Best Interest ("RBI") and the DOL Rule.

After having disappeared for about a year, SEC Regulation Best Interest (“RBI”) is back, in finalized form.  The new rule will have an effective date 60 days after it appears in the Federal Register and a compliance date of June 30, 2020.[1]  The compliance date is when RBI goes live for all customers at all broker-dealers (“BDs”).

Like the '33 Act, the '34 Act, and both of the '40 Acts, as well as FINRA itself, the raison d'etre of RBI is to protect investors.  The SEC writes: [2]

We are adopting a new rule 15l-1 under the Exchange Act ("Regulation Best Interest") that will improve investor protection by: (1) enhancing the obligations that apply when a broker-dealer makes a recommendation to a retail customer and natural persons who are associated persons of a broker-dealer… and (2) reducing the potential harm to retail customers from conflicts of interest that may affect the recommendation.  (Emphasis added)

As a quick refresher, most of the language in the Proposed Release has been accepted, including that:

  • The RBI “standard of conduct draws from key principles underlying fiduciary obligations”;[3]
  • RBI is designed to “enhance the BD standard of conduct beyond existing suitability obligations”;[4]
  • RBI is still recommendation-based (like FINRA's Suitability Rule 2111). In particular, “regardless of whether a retail investor chooses a broker-dealer (“BD”) or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a BD) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interest of the firm or the financial professional ahead of the interest of the retail investor”;[5]
  • The obligations of RBI exist at the time of the recommendation. (This is a key distinction from the continuous fiduciary obligations owed by investment advisors to their clients);[6]
  • The RBI standards cannot be satisfied through disclosure alone;[7]
  • To the chagrin of many, the final version of RBI still does not define “best interest” but does give significant discussion to the four elements that must be satisfied to meet the best interest standard.

There have been a number of significant modifications to the Proposed Rule.  I have summarized them below.[8]

Modifications of the Proposed Regulation Best Interest

Definition of a “Retail Customer”

A “retail customer” is now defined as:

any natural person who receives a recommendation from the BD for the natural person's own account (but not an account for a business that he or she works for), including individual plan participants… The plan representative will be a retail customer to the extent that the sole proprietor or self-employed individual receives recommendations directly from a BD primarily for personal, family or household purposes. [9]

Implicit Hold Recommendations

While BDs will not be required to monitor accounts, in instances where a BD agrees to provide the retail customer with specified account monitoring services, it is our view that such an agreement will result in buy, sell or hold recommendations subject to RBI, even when the recommendation to hold is implicit.[10]

Recommendations as to Account Types and Rollovers

RBI expressly applies to account recommendations including, among others, recommendations to roll over or transfer assets in a workplace retirement plan account to an IRA, recommendations to open a particular securities account (such as brokerage or advisory), and recommendations to take a plan distribution for the purpose of opening a securities account.[11]

Dually Registered Firms

RBI does not apply to advice provided by a BD that is dually registered as an investment adviser (dual-registrant") when acting in the capacity of an investment advisor.[12]

“Best Interest” Determination is Fact Specific

Whether a BD has acted in the retail customer's best interest in compliance with RBI will turn on an objective assessment of the facts and circumstances of how the specific components of RBI - including its Disclosure, Care, Conflict of Interest, and Compliance Obligations - are satisfied at the time that the recommendation is made (and not in hindsight).[13]

Definition of “Conflict of Interest”

RBI now defines a conflict of interest as, "an interest that might incline a BD - consciously or unconsciously - to make a recommendation that is not disinterested”.[14]

Disclosure of Material Facts

The final version of RBI revised the Disclosure Obligation to require disclosure of "material facts" regarding conflicts of interest associated with the recommendation.  This explicitly requires BDs to provide "full and fair" disclosure of material facts, rather than requiring BDs to "reasonably disclose" such information.

We are also clarifying that at a minimum, a BD needs to disclose whether or not account monitoring services will be provided (and if so, the scope and frequency of those services), account minimums, and any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer.

Also, we conclude that the basis for a BDs recommendations as a general matter (i.e., what might commonly be described as the firm's investment approach, philosophy, or strategy) and the risks associated with a BDs recommendations in standardized (as opposed to individualized) terms are material facts relating to the scope and terms of the relationship that should be disclosed.[15]  (Emphasis added)

The Care Obligation

The final version of RBI added explicit focus on the costs of a recommendation and reiterated that meeting the standard will be judged by how the BD established a reasonable basis to believe the recommendation was in the client’s best interest.

We are expressly requiring that a BD understand and consider the potential costs associated with its recommendation, and have a reasonable basis to believe that the recommendation does not place the financial or other interest of the broker-dealer ahead of the interest of the retail customer.  Nevertheless, we emphasize that while cost must be considered, it should never be the only consideration.  Cost is only one of many important factors to be considered regarding the recommendation and that the standard does not necessarily require the "lowest cost option".

... determining whether a BDs recommendation satisfied the Care Obligation will be an objective evaluation turning on the facts and circumstances of the particular recommendation and the particular retail customer.  We recognize that a facts and circumstances evaluation of a recommendation makes it difficult to draw bright lines around whether a particular recommendation will meet the Care Obligation.  Accordingly, we focus on how a BD could establish a reasonable basis to believe that a recommendation is in the best interest of its retail customer and does not place the BDs interest ahead of the retail customer's interest, and the circumstances under which a BD could not establish such a reasonable belief.[16]

We are clarifying that an evaluation of reasonably available alternatives does not require an evaluation of every possible alternative (including those offered outside the firm) nor require BDs to recommend one "best" product, and what this evaluation will require in certain contexts (such as a firm with open architecture).[17]

We further clarify that, when a BD materially limits its product offering ... it must still comply with the Care Obligation... and thus could not use its limited menu to justify recommending a product that does not satisfy the obligation to act in a retail customer's best interest.[18]  (Emphasis added)

Conflicts of Interest

Eliminate the distinction between financial incentives and all other conflicts of interest; and focus on mitigating conflicts of interest associated with recommendations that create an incentive for the associated person of the BD to place the interest of the firm or the associated person ahead of the interest of the retail customer.[19]

Elimination of Sales Contests

We are requiring BDs to establish written policies and procedures reasonably designed to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or the sale of specific types of securities within a limited period of time.[20]

General Compliance Obligation

Establishing a new general "Compliance Obligation" to require BDs to establish policies and procedures to achieve compliance with RBI in its entirety.[21]

Federal Securities Laws, Scienter, and State Laws

Compliance with RBI will not alter a BDs obligations under the general antifraud provisions of the federal securities laws.  RBI applies in addition to any obligations under the Exchange Act, along with any rules the Commission may adopt thereunder, and any other applicable provisions of the federal securities laws and related rules and regulations.[22]

Scienter will not be required to establish a violation of RBI.

We note that the preemptive effect of RBI on any state law governing the relationship between regulated entities and their customers would be determined in future judicial proceedings based on the specific language and effect of that state law.[23]

No Waiver of Compliance or Protections

In addition, under Section 29(a) of the Exchange Act, a BD will not be able to waive compliance with RBI, nor can a retail customer agree to waive her protections under RBI. Furthermore, we do not believe RBI creates any new private right of action or right of rescission, nor do we intend such a result.[24]

“Federalizing” the Suitability Rule

FINRA CEO Jay Cook recently commented that FINRA is:

… thinking more generally about are there aspects of our rules that might need to be adjusted/aligned with where the SEC lands.  It’s not surprising because most of the sales practice requirements historically have come from the FINRA rulebook.  Reg BI is sort of federalizing sales practice issues… There’s a suitability element to Reg BI, and that’s when we’re talking about looking at alignment with our rulebook; if they (the SEC) have covered 100 percent of our suitability rule, then we might look at whether we need our suitability rule or do we need it in all circumstances?[25]

My guess is that FINRA Suitability Rule 2111 will be modified, possibly to focus on institutional investors.

In subsequent posts I will unpack the implications of the finalized RBI in more detail.



[1]      Regulation Best Interest: The Broker-Dealer Standard of Conduct; 17 CFR Part 240; Release No. 34-86031; File No. S7-07-18; 2 and 371. Available at; Accessed June 9, 2019.

[2]      Id. at 5.

[3]      Id. at 1.

[4]      Id.

[5]      Id. at 2.

[6]      Id. at 1.  As discussed below, this is true unless there is an explicit representation by a Registered Representative that positions will be monitored, which must be disclosed by the BD.

[7]      Id.

[8]      There were also a number of less significant modifications which I have left out of this summary.

[9]      Id. at 33 and Footnote 62.  A “retail customer” also includes a nonprofessional trustee who represents the assets of a natural person.

[10]    Id. at 34.

[11]    Id.

[12]    Id. at 35.

[13]    Id.

[14]    Id.

[15]    Id. at 37.

[16]    Id. at 38.

[17]    Id. at 39.

[18]    Id.

[19]    Id. at 40.

[20]    Id. at 41.

[21]    Id. at 42.

[22]    Id. at 43.

[23]    Id.

[24]    Id. at 44.

[25]    Melanie Waddell; ThinkAdvisor; “FINRA’s Cook: SEC Reg BI Compliance to Be a Heavy Lift”; May 8, 2019.  Available at:; Accessed July 12, 2019.

To learn more about fiduciary expert Jack Duval, click here.


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Topics: supervision, Investment Suitability, FINRA Suitability Rule 2111, Suitability Expert, Securities Exchange Commission, Regulation Best Interest

Jack Duval Quoted in AdvisorHub Article on Protecting Senior Investors

Posted by Jack Duval

Jan 10, 2019 7:22:42 AM


Accelerant Managing Partner Jack Duval was quoted yesterday in an AdvisorHub article on abuses of senior investors.

The article discusses the hiring of Jacqueline Rahn, the wife of Trevor Rahn, a J.P. Morgan broker who was fired for abusing elderly investors.

The original Accelerant blog post about Trevor Rahn can be found here.



For information about securities expert Jack Duval, click here.


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Topics: fraud, Senior Investors, supervision, Protecting Senior Investors, Elder Abuse, dementia, Alzheimer's, financial exploitation

SEC Regulation Best Interest - State Fiduciary Laws

Posted by Jack Duval

Oct 26, 2018 7:52:58 AM

Accelerant SEC Regulation Best Interest - Logo 

This blog post continues my series on SEC Regulation Best Interest ("RBI") and the DOL Rule.

There has been some hand-wringing over the past year about the potential of a fractured fiduciary duty landscape for Broker-Dealers ("BDs") and their Registered Representatives.  The concern is that individual states will impose a fiduciary standard on Registered Representatives while the FINRA suitability standard, and ultimately SEC Regulation Best Interest ("RBI"), cover the rest.

Allow me to allay these concerns:  the fractured fiduciary landscape already exists, and has for decades.

Nevada's Fiduciary Statues

The event that started the concern was Nevada passing legislation that imposed a fiduciary duty on anyone giving financial advice.  In short, the Nevada law:  "imposes a statutory fiduciary duty as set for in Chapter 628A of the Nevada Revised Statutes on Broker-Dealers and Investment Advisers."[1]

However, four other states have common law fiduciary duties for registered representatives and 31 additional states have quasi-fiduciary duties required under common law.[2]  I'm defining "quasi-fiduciary" obligations as Finke and Langdon do: those that exceed the FINRA suitability rules but do not expressly classify BDs as fiduciaries.[3]

Table 1: Fiduciary Status of Registered Representatives by State[4]

 Accelerant LLC Jack Duval - table of fiduciary status of registered representatives by state

Thus, 36 states already have some form of fiduciary duty required of registered representatives.

Voluntary Fiduciary Status for Broker-Dealers?

The existing uneven fiduciary duty landscape has not hampered BDs business efforts and I wouldn't expect it to in the future.[5]  Furthermore, if BDs were to find complying with the varying standards too taxing, they could just implement a fiduciary standard nation-wide.

Given SIFMA’s[6] long-standing resistance to a fiduciary standard, voluntary adherence to one is highly unlikely.   However, this might be more economical in the long-run, especially if more states pass their own fiduciary statutes.

As I have discussed in this blog posts series, I believe the pseudo-fiduciary standard under RBI will be difficult and expensive to implement.  BDs and their clients would be better off under a fiduciary standard.  Further, from a purely business perspective, adopting a fiduciary standard would help BDs compete with registered investment advisory firms which have been winning the battle for clients and assets.

Given the disappointment in many states with the defeat of the DOL Fiduciary Rule and RBI, it would not be surprising to see more states adopt fiduciary statutes.  Fiduciary expert James Watkins opines that “So long as states enact fiduciary laws that don’t impact a pension plan like a 401(k), they have every right to act,”.[7]




[1]       Nevada Secretary of State; Website; Available at:; Accessed October 25, 2018.

[2]       Michael Finke and Thomas Langdon; The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice; March 9, 2012; Available at:; Accessed October 26, 2018; 13.

[3]       Id. at 14.

[4]       Id.

[5]       See supra Note 2.

[6]       Securities Industry and Financial Markets Association;

[7]       Mark Miller; U.S. states eye protections for investors if federal regulation falters; Reuters; April 12, 2018; Available at:; Accessed October 25, 2018.


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Topics: supervision, Investment Suitability, FINRA Suitability Rule 2111, Suitability Expert, Securities Exchange Commission, Regulation Best Interest

SEC Regulation Best Interest - Lost Gains Cases

Posted by Jack Duval

Oct 4, 2018 9:12:46 AM

Accelerant SEC Regulation Best Interest - Logo 

This blog post continues my series on SEC Regulation Best Interest ("RBI") and the DOL Rule.

A "lost gains" case is one in which the claimant is asking for gains they believe they should have earned but did not.  These cases are different from the traditional securities litigation, where the claimant is asking for actual losses that have been incurred. 

Because the damage theory involves foregone gains instead of out-of-pocket losses, lost gains cases are generally considered to have a higher degree of difficulty.

On the face of it, this is common sense.  If an investor puts $10 million into an account and it declines to $5 million.  Most arbitrators can understand how the client has been damaged.  However, if the same investor puts $10 million into an account and six years later it's still worth $10 million, this is likely to generate less sympathy.

However, in my experience, lost gains cases can represent some of the most abusive fact patterns.

In the lost gains cases I have been involved with, the client’s accounts were essentially treated as an ATM for the Registered Representative.  These fact patterns involved extremely high fees charged for products that were churned into and out of the accounts at issue (as well as account-level fees).  The results were that the Registered Representative appropriated the growth of the accounts.

What growth wasn't appropriated was lost to the short-term holding of the investments.  That is, the investments were never invested as intended and allowed the time needed to generate returns.

In these cases, the clients were invested during strong bull markets but did not participate because of the abusive nature of the trading in their accounts.  

Six years later, they had experienced no growth while their Registered Representatives had made millions (literally).  In a bear market, such a pattern would exacerbate the decline in the accounts due to market forces and be discovered much sooner.  Bull markets hide these kinds of abuses, and the current historic bull market will surely be no exception.

However, what is different this time is the SEC’s pending Regulation Best Interest (“RBI”), which could be made law before the market declines.

Lost Gains Cases Under Regulation Best Interest

Under SEC Regulation Best Interest, lost gains cases should be easy.

This is because the burden of proof will be on the respondents to show their strategy was in the client's best interest and, as I've discussed in my RBI blog post series, they will need to produce contemporaneous evidence of their analyses showing how they came to that conclusion.[1]

In the fact pattern discussed above, this will be impossible.  Furthermore, a key defense will be removed.

Long-Term Time Horizons and the Risks of “Time Diversification”

In many securities litigations, a client's long-term time horizon is used as a defense to justify aggressive investments.  The logic is that the longer an investment is held, the less likely it is to generate a loss.  This is known as “time diversification”.  The problem with time diversification is that it is, at best, only partially correct, at worst it is a setup for disastrous portfolio decisions.[2]

The paradox of time diversification is that in order to benefit from higher returns (in equities usually) the client must increase their risk of interim declines in order to reduce their risk of a terminal loss.[3]

If RBI becomes law, the long-term time horizon will take on a different implication. 

Time Horizon, Fees, and Taxes under Regulation Best Interest

It has always been true that the longer a client's time horizon, the more important minimizing fees and avoiding taxes become.  This is not a matter of debate.  This is not something that reasonable minds can differ upon.  This is a 100 percent mathematical certainty.

Under RBI, this will become a key focal point.

If a client with a long-term time horizon is put into high fee products, charged high account-level fees, and/or churned into and out of commission product on a short-term basis, there is no way to argue it is in their best interest.

For instance, if fees can be reduced by one full percentage point per year, in 30 years time, the difference in terminal values will be about 30 percent.[4] 

For taxable accounts, the difference can be even more stark.  Annual after-tax returns of mutual funds often fall between one and two full percentage points compared to their pre-tax returns (the ones that are advertised).[5]

When combined, high expenses and tax-inefficient investing destroy investor returns.  In such a scenario, the broker, investment manager, and government all get paid before the investor, who is taking all the risk.[6]

Furthermore, the deleterious effects of high fees and taxes are completely return agnostic.  The return-destroying math holds true through all markets, good, bad, or sideways and compounds over time, to the investors disadvantage.

Costs Under Regulation Best Interest

As I have written about here, the SEC has recognized the importance of costs under RBI.[7]

While cost is not the only factor when evaluating an investment or investment strategy, it is one of the most important, if not the most important.  The customers tax status is also critical, which is why it is part of the profiling required under FINRA Rule 2111 and under RBI.[8]

RBI requires the Registered Representative undertake a fact specific analysis before the recommendation is made.  As mentioned above, this analysis will need to show why the recommended investment or strategy is in the best interest of the client compared to other investments offered by the firm.[9]

Any firm that can effectuate stock transactions for a client can purchase index ETFs for the same client (and most will have selling agreements with index mutual fund providers).  Thus, virtually every Broker-Dealer will be required to show why their investment or strategy  recommendation is better over the long-term than an index ETF or mutual fund on a net after-fee, after-tax basis (for their long-term investors).

This will present a significant hurdle for BDs because almost all equity investors are categorized as long-term investors, which is as it should be.[10]

Thus, all client accounts with a long-term time horizon will require an analysis that justifies the fees charged and taxes generated compared to low-fee, low-tax alternatives such as index ETFs and mutual funds.  In my opinion, this analysis will have to be rigorous, mathematical in nature, and be based on conservative assumptions.

Supervision to Avoid Lost Gains Cases

Supervisors will need to insure their Registered Representatives have undertaken a fact specific analysis for all their clients.  For those clients with a long-term time horizon, supervisors will need to insure the analyses comport to industry standards, reflect the client’s best interest given their particular facts and circumstances, and that the findings are reflected in the client’s portfolio.



[1]      Regulation Best Interest; Jack Duval; Available at:; Accessed October 4, 2018.

[2]      “The Myth of Time Diversification: Analysis, Application, and Incorrect New Account Forms”; Jack Duval; PIABA Bar Journal; Spring 2006; Available at:; Accessed October 4, 2018.

[3]       Statistically, the risk of interim declines is known as “first passage time probability”.

[4]       Reducing Attorney Fees (Investment Fees, that is); Jack Duval; Available at:; Accessed October 4, 2018.

[5]       Taxes – Another Killer of Attorney Returns; Jack Duval; Available at:; Accessed October 4, 2018.

[6]        Wealth Confiscation by Your Three Investment “Partners”; Jack Duval; Available at:; Accessed October 4, 2018.

[7]         SEC Regulation Best Interest – Reasonable Care; Jack Duval; Available at:; Accessed October 4, 2018.

[8]         Under RBI, the Retail Customer Investment Profile includes “tax status”; SEC Regulation Best Interest; Release No. 34-83062; File No. S7-07-18; 406.  Available at:; Accessed October 4, 2018.

[9]          A separate issue is investments not offered by the firm.  This will likely come up for advisors who only sell one type of product such as insurance.  This is a key difference between RBI and the fiduciary duty imposed upon Registered Investment Advisors.  An Investment Advisor's duties are not limited to the products their firm sells.  This is a non-trivial difference and a significant shortfall in RBI.

[10]        Short-term investors should not be invested in equities.  The received view is that only funds which can be held for five years or more should be invested in equities, although some authors suggest avoiding equities unless having a 12-year time horizon.


To learn more about fiduciary expert Jack Duval, click here.


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Topics: supervision, FINRA Rule 2111 (Suitability), Investment Suitability, Suitability Expert, Securities Exchange Commission, Regulation Best Interest, Fact Specific Analysis, Lost Gains Cases

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