The Securities Litigation Expert Blog

Dear "Prudent": The DOL Proposal

Posted by Jack Duval

Sep 24, 2020 8:56:32 AM

NOTE: Since the DOL Fiduciary Rule has been dead for two years, I have provided a review of events since then, primarily focused on Regulation Best Interests and the new DOL proposed class exemption.

If you are familiar with those, skip to the “Prudence - and the Prudent Expert” section for the good stuff.


SEC Regulation Best Interest ("RBI") went into effect on June 29, 2020. I've written extensively about RBI and the implications for broker-dealer obligations to clients and won’t cover that here.

Instead, I want to focus on the Department of Labor (“DOL”) proposed class exemption (“DOL Proposal”) that was also released on June 29, 2020.

While much ink has been spilled on RBI and its implementation, on the same day it went into effect the Department of Labor released a proposed update to the Employee Retirement Income Security Act of 1974 ("ERISA").[1]

The DOL Proposal has received much less focus. It shouldn't have. This potential change to ERISA could make almost anyone advising on IRA rollovers, and their investments, a fiduciary.

Indeed, the release appears to be a Trojan horse for the broker-dealer community. It allows for a host of prohibited transactions (welcomed), but will hold those making the recommendations to the prudent expert standard, the highest fiduciary standard in the land (most unwelcomed).

As will be discussed below, many of those criticizing the DOL release, including the Public Investors Advocate Bar Association (“PIABA”)[2] and the State of California Attorney General,[3] (who is leading a coalition to oppose the DOL proposal), appear to have not understood the entirety of the DOL's proposal, or at least not fully understood its terms.


Before reviewing the DOL Proposal, it is helpful to review a quick timeline of how we got here. Additionally, you can access all my writings on the original DOL Fiduciary Rule here.

In 2010, the DOL began work to clarify that anyone advising on IRA rollovers and their assets was subject to ERISA and thus a fiduciary. Six years later, in 2016, the DOL published its final Fiduciary Rule.

The Fiduciary Rule was vigorously opposed by the broker-dealer community, which sued and won a Fifth Circuit Court of Appeals ruling in 2018. This vacated the Fiduciary Rule.

In the mean time, the SEC undertook to create a heightened standard of care for investment professionals dealing with retail clients, Regulation Best Interest (“RBI”). In 2019 it finalized RBI, which requires a neither-fish-nor-fowl "best interest" standard that lies between the FINRA suitability standard and the Investment Advisor fiduciary standard. (Notably, the SEC could not find the spine to define what "best interest" actually means.)

In June, the DOL quietly proposed changes to ERISA that would provide exemptions from prohibited transactions, and also significantly clarified the "five-part test" for fiduciary status. There was a short one-month comment period that has now come and gone.

The DOL Proposal

The DOL Proposal provides prohibited transaction exemptions for IRA rollover accounts:[4] 

This exemption permits Financial Institutions and Investment Professionals who provide fiduciary investment advice to Retirement Investors to receive otherwise prohibited compensation and engage in riskless principal transactions and certain other principal transactions (Covered Principal Transactions) as described below.


This exemption permits Financial Institutions and Investment Professionals, and their affiliates and related entities, to engage in the following transactions, including as part of a rollover for a Plan to an IRA as defined in Code section 4975(e)(1)(B)... (Emphasis added)

IRA accounts are significant because roughly 40 percent of U.S. household assets are held in them. According to IRS data, at year-end 2017, there were $9.4 trillion in IRA assets for 60.3 million taxpayers.[5] Furthermore, rollovers are a significant source of new funds for brokers and investment advisors. In 2017, there were 4.7 million rollovers totaling $478 billion in assets.[6]

These trends will almost certainly accelerate as increasing numbers of Baby Boomers retire and roll over their pensions, which were the dominant saving vehicle at the beginning and middle of their careers, and 401(k) accounts, which became popular in the later part of their careers.

Importantly, the DOL proposal also reverses a key 2005 ruling, and now requires the advising broker to satisfy the Impartial Conduct Standards and other conditions.

Reversing Advisory Opinion 2005-32A the "Deseret Letter”

The DOL has specifically put rollovers into fiduciary play by reversing a 2005 ruling known as the “Deseret Letter”, writing:[7] 

In light of potential conflicts of interest related to rollovers from Plans to IRAs, ERISA and the Code prohibit an investment advice fiduciary from receiving fees resulting from investment advice to Plan participants to roll over assets from a Plan to an IRA, unless an exemption applies. The proposed exemption would provide relief, as needed, for this prohibited transaction, if the Financial Institution and Investment Professional provide investment advice that satisfies the Impartial Conduct Standards and they comply with the other applicable conditions discussed below. (Emphasis added)


In particular, the Financial Institution would be required to document the reasons that the advice to roll over was in the Retirement Investor's best interest. In addition, investment advice fiduciaries under Title I of ERISA would remain subject to the fiduciary duties imposed by section 404 of that statute.


In determining the fiduciary status of an investment advice provider in this context, the Department does not intend to apply the analysis in Advisory Opinion 2005-23A (the Deseret Letter), which suggested that advice to roll assets out of a Plan did not generally constitute investment advice. The Department believes that the analysis in the Deseret Letter was incorrect and that advice to take a distribution of assets from an ERISA-covered Plan is actually advice to sell, withdraw, or transfer investment assets currently held in the Plan. A recommendation to roll assets out of a Plan is necessarily a recommendation to liquidate or transfer the Plan's property interest in the affected assets, the participant's associated property interest in the Plan investments, and the fiduciary oversight structure that applies to the assets. (Emphasis added)


Typically the assets, fees, asset management structure, investment options, and investment service options all change with the decision to roll money out of the Plan. Accordingly, the better view is that a recommendation to roll assets out of a Plan is advice with respect to moneys or other property of the Plan. Moreover, a distribution recommendation commonly involves either advice to change specific investments in the Plan or to change fees and services directly affecting the return on those investments. (Emphasis added)

The last part of this is in agreement with SEC and FINRA guidance, which note that a rollover almost always involves a securities transaction. Under RBI the SEC has written:[8] 

… it is our view that Regulation Best Interest should apply broadly to recommendations of securities transactions and investment strategies involving securities. Accordingly, the Commission is including in the rule text account recommendations as recommendations that will be covered by Regulation Best (sic). “Account recommendations” include recommendations of securities account types generally (e.g., to open an IRA or other brokerage account), as well as recommendation to roll over or transfer assets from one type of account to another (e.g., a workplace retirement plan account to an IRA). (Emphasis added)

Similarly, FINRA has put its members on notice that:[9] 

a broker-dealer’s recommendation that an investor roll over retirement plan assets to an IRA typically involves securities recommendations subject to FINRA rules.

Critically, the IRA rollover recommendations and subsequent investment recommendations would enjoy the exemptions from prohibited transactions only if the broker (and broker-dealer) met the Impartial Conduct Standards.

The importance of this language cannot be overstated.

The Impartial Conduct Standards

The DOL proposal would require broker compliance with the Impartial Conduct Standards, which have three components:[10] 

  • Providing advice that is in Retirement Investors’ best interest;
  • Charging only reasonable compensation, and;
  • Making no materially misleading statements about the investment transaction and other relevant matters.

Furthermore, the DOL proposal would require:[11] 

Financial Institutions, prior to engaging in a transaction pursuant to the exemption, to provide a written disclosure to the Retirement Investor acknowledging that the Financial Institution and its Investment Professionals are fiduciaries under ERISA and the CODE, as applicable.


The disclosure also would be required to provide a written description, accurate in all material respects regarding the services to be provided and the Financial Institution’s and Investment Professional’s material conflicts of interest. (Emphasis added)

Critics of the DOL proposal have taken aim at the best interest element of the Impartial Conduct Standards. For instance, PIABA, in its comment letter, wrote:[12] 

The first prong of the Impartial Conduct Standards, the best interest obligation, is to be interpreted and applied consistent with the best interest standard as defined by the Commission’s recently enacted Reg. BI.

While PIABA quote the DOL Proposal accurately, the spirit of the DOL Proposal reflects stronger medicine:[13] 

This proposed best interest standard is based on longstanding concepts derived from ERISA and the high fiduciary standards developed under the common law of trusts, and is intended to comprise objective standards of care and undivided loyalty, consistent with the requirements of ERISA section 404. (Emphasis added)

This DOL Proposal language echoes the language propounded in the Impartial Conduct Standard in the proposed Best Interest Contract Exemption on April 8, 2016. At the time, the DOL wrote: 

(the Impartial Conduct Standards) are fundamental obligations of fair dealing and fiduciary conduct, and include obligations to act in the customer’s best interests, avoid misleading statements, and receive no more than reasonable compensation.[14]


The Impartial Conduct Standards represent fundamental obligations of fair dealing and fiduciary conduct. The concepts of prudence, undivided loyalty and reasonable compensation are all deeply rooted in ERISA and the common law of agency and trusts.[15] (Emphasis added) 

Prudence - and the Prudent Expert


“Prudence” is a word that appears throughout ERISA and the DOL Proposal. However, it was assiduously removed from the originally proposed RBI and did not make the final rule.[16] It’s appearance in the DOL Proposal provides an important distinction between RBI and ERISA.

Critically, the DOL’s version of fiduciary conduct contained within the Impartial Conduct Standards is the prudent expert standard, the absolute highest fiduciary standard in the land.

ERISA Section 404(a)-1 Investment duties, lays out the prudent expert standard:[17] 

… a fiduciary shall discharge his duties with respect to a plan with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. (Emphasis added)

The DOL Proposal reiterates the prudent expert standard language, essentially verbatim from ERISA Section 404(a)-1:[18] 

Investment advice is, at the time it is provided, in the Best Interest of the Retirement Investor. As defined in Section V(a), such advice reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person, acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, and does not place the financial or other interests of the Investment Professional, Financial Institution or any affiliate, related entity, or other party ahead of the interest of the Retirement Investor, or subordinate the Retirement Investor’s interest to their own. (Emphasis added)

After the 2016 DOL Fiduciary Rule was vacated by the Fifth Circuit, the DOL issued Field Assistance Bulletin (“Bulletin”) No. 2018-02 that kept the Impartial Conduct Standards in effect. The current DOL Proposal describes the Bulletin guidance:[19] 

In the FAB, the Department stated it would not pursue prohibited transactions claims against investment advice fiduciaries who worked diligently and in good faith to comply with “Impartial Conduct Standards” for transactions that would have been exempted in the new exemptions, or treat the fiduciaries as violating the applicable prohibited transaction rules. (Emphasis added)

The Impartial Conduct Standards discussed in the Bulletin were originally articulated in the Best Interest Contract Exemption proposal, the language of which will by now be familiar:[20] 

As defined in the (Best Interest Contract) exemption, a Financial Institution and Adviser act in the Best Interest of a Retirement Investor when they provide investment advice that reflects the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims, based on the investment objectives, risk tolerance, financial circumstances, and needs of the Retirement Investor, without regard to the financial or other interests of the Adviser, Financial Institution or any Affiliate, Related Entity, or other party.” (Emphasis added)

Thus, the Impartial Conduct Standards from the now-vacated Fiduciary Rule/Best Interest Contract Exemption have been in effect under the May 7, 2018 DOL temporary enforcement policy, and would remain in effect under the DOL Proposal.

The point of tracing this language back to the original ERISA text is to show the continuity of the prudent expert standard. It has not changed. From ERISA Section 404(a)-1, to the Fiduciary Rule/Best Interest Contract Exemption, to the Bulletin, to the new DOL Proposal, the prudent expert standard has remained intact.

Shifting the Burden of Proof

PIABA and others were correct to flag the adoption of the RBI version of “best interest” in the DOL Proposal. PIABA summarized it well:[21] 

None of the foregoing obligations actually requires the firm to place the customer’s interests ahead of the adviser’s. Instead, Reg BI states that the advisor cannot “place its own interests ahead of the customers’ interests. Consequently, Reg BI allows the adviser to put its own interests on equal footing with the customers’ interests. In baseball terms, a tie goes to the adviser. This is contrary to the fundamental premise of a fiduciary duty: that the investors’ interests must always come first. Similarly, the Department has said that the Impartial Conduct Standard will only require that the Investment Advice Fiduciary may not place their interests ahead of the retirement investors’ interests. (Emphasis added)

There is no doubt that the RBI “best interest” language is less rigorous than the fundamental fiduciary duty that the client’s interests must always come first, which has always existed under ERISA and the Investment Advisors Act. There are no “ties” of interest with the traditional fiduciary duty, the client’s interests win every time.

However, I believe PIABA (and the other critics) have missed the significance of the prudent expert standard, which imposes an even more rigorous standard by:

  1. Holding the advice to the standard of what a third-party expert fiduciary would do in the same circumstances, and;
  2. Without regard to their own financial interests.

These elements of the prudent expert standard raise the bar exceedingly high, much higher than the suitability standard, higher than RBI (which has a version of the prudent expert standard) and arguably higher than even the fiduciary standard of an investment advisor.

Chart 1: The Shrinking Universe of Investment Options

 accelerant jack duval - dol proposal - prudent expert - investment strategy chart

Chart 1, above, shows how the available investment options shrink under successively more exacting standards, with the prudent expert standard being the most rigorous.

Where PIABA is worried that the DOL Proposal allows for the interests of the advisor and client to be pari passu, that potential fails under the prudent expert standard.

No prudent expert, giving advice without regard to their own financial interests, would recommend an investment or investment strategy that put their own interests equal with their clients. This is simply due to the simple math of compensation: all broker compensation comes at the expense of the client.

The Defense Will Have to Make Its Case

In the typical lawsuit, the plaintiff is required to prove their case against a standard. That will change under the DOL Proposal.

At a hearing, a defendant fiduciary will have to prove they met the prudent expert standard, including:

  • Proving the contemporaneous application of care, skill, prudence, and diligence that a prudent expert would have undertaken in a similar situation for a similar client, and;
  • Proving that the recommendations made were consistent with what a prudent expert would have made without regard to their own remuneration.

This is a completely different context than what has existed for broker-dealer clients under the suitability standard, more rigorous that what exists under RBI, and possibly more rigorous that what exists under the Advisers Act.

Changing the Arbiter

Under FINRA’s Suitability Rule 2111, the standard of care is that the broker must have a reasonable basis to believe the recommendation made was suitable for the client. The rule is from the perspective of the broker. Under this rule, the broker is the arbiter of the reasonableness of the recommendation.

Under the DOL Proposal, the rule is from the perspective of an impartial prudent expert observer. That third-party prudent expert is the arbiter of whether skill, care, prudence, and diligence were applied in the making the recommendation.

This shift is enormous. The arbiter is no longer the broker but an expert fiduciary. The standard is not determined by the broker but by the expert fiduciary. The standard is no longer subjective, but objective.

Even more stark is that “reasonableness” is an opinion. It requires no evidence. In contrast, the application of skill, care, prudence, and diligence is objective and requires contemporaneous evidence. (A broker can claim to have come to an opinion about reasonableness with nothing in her files, however, she cannot credibly claim to have applied skill, care, prudence, and diligence in the manner of a prudent expert with an empty file.)

Additionally, how thorough the work was undertaken is objective and the conclusions drawn from that work can be easily weighed.

In most securities litigations I’ve been involved with, the defense has been something like this: the client wanted growth and the broker gave them growth investments, therefore they were suitable. This argument was made with a straight face no matter how expensive, illiquid, speculative, and tax-inefficient the “growth” investment was.

Under the FINRA Suitability Rule, virtually any vaguely plausible investment and/or investment strategy could be argued to be “suitable”, although those arguments frequently failed in arbitrations and in SRO disciplinary proceedings.[22]

Under the DOL Proposal they will be per se deficient.

The burden of proof will shift from the client having to prove that the investments recommended to her were unsuitable, to the broker having to prove that she undertook the required care, skill, prudence, and diligence, and after that work determined the investments recommended were in the client’s best interest. Even more daunting, the broker will have to prove that a prudent investment expert, acting without concern for her own remuneration, would have made the same recommendation, in the same situation, for the same client.

In my experience, the vast majority of “vaguely plausible” investment defenses will wither in the face of the prudent expert standard. Fiduciary defendants will not be able to demonstrate the contemporaneous “care, skill, prudence, and diligence” required to have met the standard, nor will they be able to show their recommendations would have been the same if they had been advising without regard to their own compensation.

Indeed, in the majority of cases I have participated in, brokers typically have very few notes and no evidence of any care, skill, prudence, and diligence being applied to their investment recommendations. Frequently, there is absolutely nothing in the record except the trade confirmation, sent to the client after the trade.

This fact pattern will epically fail the prudent expert standard.

Additionally, accounts that get loaded with multiple “product of the month” type of investments, including (but not limited to): new issues such as closed-end funds, as well as structured products, high fee and high load mutual funds, and insurance products will also fail to meet the prudent expert standard.

In almost all instances the investment thesis behind any high-fee and/or illiquid products can be expressed in low (or no) fee products and/or by shifting the asset allocation of an account.

While brokers are certainly entitled to reasonable compensation, the prudent expert standard shifts the arbiter from the profit maximizing broker to an impartial prudent expert fiduciary deciding without regard to her own remuneration.

These standards are worlds apart.

Once the rigor of the prudent expert standard is established, I would expect IRA-related securities litigations to settle, and for higher percentages of claimed damages.

I would also expect this to further accelerate the shift away from charging commissions on products to fee-based accounts where no product commissions are charged. The later generally eliminate the conflicts of interest inherent to commission-based broker compensation and greatly reduce the required supervisory effort.

Supervisory Impacts

To meet the prudent expert standard, broker-dealers will need to create policies and procedures to ensure that their brokers are undertaking and documenting the necessary care, skill, prudence, and diligence for each recommendation.

While this will require more oversight, the costs should not be large. In my experience of reviewing the compliance and supervisory systems of broker-dealers of all sizes and geographies, even the smallest firms have the supervisory, CRM, and other systems in place to implement the required policies.

While the capital expenditure required will likely be small, the supervisory effort will be larger.

As always, the real issue with broker-dealer policies and procedures is not their existence (every broker-dealer has them, and all but a few are sufficient), but their implementation.

In my next post, I will examine the DOL’s clarification of the five-part test to determine fiduciary status and how it will make almost all brokers fiduciaries when recommending rollovers and the reinvestment of the proceeds.



[1]      29 CFR Part 2550 [Application No. D-12011] ZRIN 1210-ZA29; Improving Investment Advice for Workers & Retirees. Available at :; Accessed August 14, 2020.

[2]      Public Investors Advocate Bar Association; Comments Letter RE: Application No. D-12011. Available at:; Accessed August 21, 2020.

[3]      Attorney General Becerra Opposes DOL Proposal; August 6, 2020. Available at:; Accessed August 21, 2020.

[4]      29 CFR Part 2550 at 40862.

[5]      IRS; SOI Tax Stats – Accumulation and Distribution of Individual Retirement Arrangements (IRA); Available at:; Accessed August 21, 2020.

[6]       Id.

[7]      29 CRF Part 2550 at 40839.

[8]       Federal Register; 17 CFR Part 240; Release No. 34-86031; Regulation Best Interest; 33339. Available at:; Accessed August 21, 2020.

[9]       FINRA Regulatory Notice 13-45; Rollovers to Individual Retirement Accounts; December 2013; 2. Available at:; Accessed August 21, 2020.

[10]     29 CFR Part 2550 at 40842.

[11]     Id.

[12]     PIABA Letter at 6. XXX

[13]     29 CFR Part 2550 at 40842.

[14]      29 CFR Part 2550; [Application No. D-11712]; ZRIN 1210-ZA25; Best Interest Contract Exemption; 21007. Available at:; Accessed August 21, 2020.

[15]      Id. at 21026.

[16]      17 CFR Part 240; Release No. 34-86031; Regulation Best Interest: The Broker-Dealer Standard of Conduct; 247. “… in response to comments, we are revising the Care Obligation to remove the term “prudence”.

[17]      29 CFR Section 2550.404a-1 – Investment duties. Available at:,like%20capacity%20and%20familiar%20with; Accessed September 9, 2020.

[18]      29 CFR Part 2550 at 40862.

[19]      29 CRF Part 2550 at 40835.

[20]      Id.

[21]      PIABA Letter at 8.

[22]      See, for instance, FINRA RN 12-25 – Suitability; Acting in a Customer’s Best Interest. This Regulatory Notice, gives six examples of fact patterns where FINRA and SEC regulators have found investments and/or investment strategies that might have been “vaguely plausible” to have not met the suitability standard if they were not consistent with the customer’s best interests. Available at:; Accessed September 24, 2020.

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


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Topics: Investment Suitability, dol fiduciary rule, prudent expert standard, fiduciary duties, SEC Regulation Best Interest

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.


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


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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.

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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.


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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.

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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.

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

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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