The Securities Litigation Expert Blog

Robinhood Recommendations - Rise of the Machines

Posted by Jack Duval

Feb 9, 2021 7:42:31 AM

accelerant jack duval robinhood litigation - hal 9000 image

Your broker will see you now.

In my first two posts in this series, here and here, I focused on Robinhood's trading restrictions and the potential litigation from those actions.

In this post, I want to shift focus to examine potential liability that could arise from Robinhood's business model and use of algorithms.

This potential liability revolves around Robinhood’s communications to its clients and if those communications constitute recommendations.


Does Robinhood make recommendations to its clients?

At first blush, the obvious answer is “no”. Robinhood is an online broker-dealer that facilitates its clients making self-directed trades through an app. There is no traditional human broker making recommendations to the client, so how could a recommendation have been made?

Upon deeper inspection, the obvious answer is very likely incorrect.


First, it is important to review how FINRA defines a "recommendation".

FINRA Notice to Members (“NTM”) 01-23 - Online Suitability, gives clear guidance about what constitutes a recommendation. FINRA writes: 

The determination of whether a "recommendation” has been made, moreover, is an objective rather than a subjective inquiry. An important factor in this regard is whether - given its content, context, and manner of presentation - a particular communication from a broker/dealer to a customer reasonably would be viewed as a "call to action", or suggestion that the customer engage in a securities transaction...


Another principle that members should keep in mind is that, in general, the more individually tailored the communication to a specific customer or a targeted group of customers about a security or group of securities, the greater likelihood that the communication may be viewed as a "recommendation".[1]

To simplify, there are two criteria that must be met to satisfy FINRA's definition of a recommendation:

  1. A suggestion to transact, (the “call to action”); and,
  2. Specificity to the customer.

For context, NTM 01-23 arose from the proliferation of online brokerage firms during the technology bubble in the late 1990's. These firms would frequently publish "Top 10" stock lists and other types of equities hyping on their websites.

The “Top 10” lists and similar communications clearly meet the call to action prong of the FINRA criteria - the firm was suggesting its clients invest in the listed securities. However, those lists clearly failed the specificity prong - the lists were posted on the firm’s website and were not specific to any individual client.

In a sense, these communications were like billboards on a highway.   Anyone driving down the highway could see them, not just one person or one group of person that had been targeted because of their specific traits.

Importantly, NTM 01-23 specifically addresses “electronic” recommendations, meaning those made by a computer and not by a human speaking to the customer. FINRA writes: 

… NASD Regulation believes that the suitability rule applies to all “recommendations” made by members to customers – including those made via electronic means – to purchase, sell, or exchange a security. Electronic communications from broker/dealers to their customers clearly can constitute “recommendations.” The suitability rule, therefore, remains fully applicable to online activities in those cases where the member “recommends” securities to its customers.[2] (Emphasis added)

Electronic communications to clients is an integral part of Robinhood’s business model and strategy. As will be discussed below, Robinhood did not use the “billboard” approach to its electronic communications. It targeted specific customers (based on their unique traits) with specific suggestions

Robinhood's Business Model

First and foremost, Robinhood is a technology company. It has applied a number of social media business techniques to a broker-dealer business and the results have been spectacular.

The Massachusetts’ Securities Division, filed a complaint against Robinhood (“MA Complaint”) in December 2020. The MA Complaint describes the firm’s business model and growth: 

Robinhood is a broker-dealer that offers commission-free trading for stocks and options. In lieu of commissions and fees, Robinhood earns revenue through a process known as payment for order flow. Payment for order flow is a process in which market makers or exchanges pay broker-dealers to route trades to the market maker or the exchange for execution. Therefore, the more trades Robinhood customers execute, the more revenue Robinhood receives from market makers or exchanges.[3]


Robinhood's stated mission is to 'democratize finance for all'. In its attempt to 'democratize' investing, Robinhood has targeted younger individuals with its advertising, many of whom have limited or no investment experience. According to Robinhood, the median customer age is 31 years old.[4]


Since its founding in 2013, Robinhood has experienced a rapid growth in its customer base. Between 2016 and October 2018, Robinhood grew its customer accounts from approximately one million to approximately six million, a 500% increase. Between the end of 2019 and May 2020, Robinhood grew its customer accounts from approximately ten million to approximately thirteen million, an increase of 30% in only a few short months. [5]


During this period of exponential growth, Robinhood used advertising and marketing techniques that targeted younger individuals, including Massachusetts residents, which little, if any, investment experience. The median age of a Robinhood customer has been reported as 31 years old and approximately 68% of Massachusetts customers approved for options trading on the Robinhood platform identified as having no or limited investment experience.[6]

Perhaps the social media technique most heavily used by Robinhood is that of gamification.


“Gamification” is the use of elements typical in game playing to encourage engagement with a product or service.[7] The MA Complaint states that Robinhood: 

(Used gamification) to encourage and entice continuous and repetitive use of its trading application.[8]


Once individuals become customers, Robinhood relentlessly bombards them with a number of strategies designed to encourage and incentivize continuous and repeated engagement with its application. The use of these strategies is often referred to as gamification: the application of typical elements of game playing to other activities, typically as a marketing technique to boost engagement with a product or service.[9] (Emphasis added)

Robinhood’s “strategies designed to encourage and incentivize continuous and repeated engagement with its application” includes the following: 

Robinhood sends push notifications to customers to encourage interaction with the application and trading.[10]


A customer that has not yet traded in their account may receive a push notification that states: 'Top Movers: Choosing stocks is hard. [flexing bicep emoji] Get started by checking which stock prices are changing the most'. Upon clicking on the push notification, the customer redirects to the aforementioned Top Movers list.[11] (Emphasis added)


Customers may also receive a push notification that states, 'Popular Stocks: Can't decide which stocks to buy [thinking emoji] Check out the most popular stocks on Robinhood.' Upon clicking on the push notification, the customer redirects to the aforementioned 100 Most Popular list.[12]

Robinhood’s Recommendation Engine

I believe the push notifications were recommendations and the algorithms Robinhood used to communicate with the firm’s clients constitute a recommendation engine.

It is almost certain that all the push notifications sent by Robinhood to its clients are tailored to groups that meet specific criteria, such as having not made a trade after opening an account. This is not “billboard” advertising. This was specific communication sent to specific clients based on specific traits they shared.

By suggesting trades to specific clients based on their specific account traits, the communication meets both prongs of the FINRA definition of a recommendation.

Most troublesome is that a push notification based on the number of times the client has traded is not based on information that would enable one to determine client suitability, such as the client’s risk tolerance and investment objective.

The Best Interest Standard

I have written extensively on SEC Regulation Best Interest (“RBI”) and will only review the basics here. In short, RBI requires a broker-dealer to know both the client and the investment in order to make a best interest recommendation. In the final RBI release, the SEC wrote: 

… when making a recommendation to a particular retail customer, broker-dealers must weigh the potential risks, rewards, and costs of a particular security or investment strategy, in light of the particular retail customer’s investment profile. As discussed above, a broker-dealer ‘s diligence, care, and skill to understand the potential risks, rewards, and costs of a security or investment strategy should generally involve a consideration of factors, depending on the facts and circumstances of the particular recommendation and the particular retail customer’s investment profile…[13]

As discussed in the MA Complaint, Robinhood’s recommendation engine appears to have failed to know the investor or the investment in any meaningful way.

First, if an algorithm bases its trade recommendation to a client off of the client's previous number of trades, the recommendation is based off of factors that have nothing to do with the client's investment objective, risk tolerance, and other relevant facts and circumstances, and thus did not consider the investment profile of the clients it made recommendations to.

Second, if the algo is suggesting trades in stocks that have the biggest daily percent change or are the most heavily traded on the platform, the algo only knows those stocks in the most trivial manner (ultra short-term performance and popularity), and in ways that cannot be used to evaluate their appropriateness for each client.

Any recommendation made in ignorance of the investor and investment completely fails the RBI standard of care.

Conflicts of Interest

Another relevant part of RBI that is violated in this scenario is the conflict of interest obligation, which states, in part: 

The broker or dealer establishes, maintains, and enforces written policies and procedures reasonably designed to:


(B) Identify and mitigate any conflicts of interest associated with such recommendations that create an incentive… to place the interest of the broker, dealer, or such natural person ahead of the interest of the retail customer.[14]

If Robinhood’s algorithms were making recommendations based on the number of trades (or lack thereof) a client had made, then the recommendations were made purely to generate revenue for the firm. This is a blatant conflict of interest.

Indeed, it’s just a form of high-tech churning with bots making the recommendation instead of brokers.


If Robinhood has been making blatantly conflicted and demonstrably unsuitable recommendations to its clients via push notifications, and those clients have lost money on the recommended trades, it would appear the firm has significant liability under RBI.

Furthermore, unlike traditional cases where the broker and client typically give conflicting testimony about what was said as part of the recommendation, or if there was a recommendation at all, there will be none of that here.

The algorithms are likely very simple: 

  1. Call the number of trades for all accounts;
  2. Filter for accounts that have not traded since opening; and,
  3. Send push notification to the filtered list account holders.

The algorithm will establish the basis of the recommendation to each client. The push notifications will establish what was “said”. The statement records will show if the client traded those securities after the push notification was received and the profit and loss on those recommended transactions.

The algorithms, push notifications, and statements should all be discoverable and would establish a causal chain from Robinhood’s selection of the clients for the push notification to the profit and loss of those recommended transactions.



[1]      FINRA Notice to Members 01-23; Online Suitability; 2. Available at:; Accessed February 4, 2020.

[2]      Id. FINRA use to be known as “NASD”.

[3]      In the Matter of: Robinhood Financial, LLC; Administrative Complaint; Docket No. E-2020-0047; 8. Available at:; Accessed February 4, 2020; In Massachusetts, a broker-dealer is a fiduciary. The MA Complaint was filed on December 16, 2020, before the short squeeze mania.

[4]      Id. at 9.

[5]      Id. at 3.

[6]      Id.

[7]      See Merriam-Webster; s.v. “gamification”. Available at:; Accessed February 5, 2021. I am paraphrasing above.

[8]      Id. at 2.

[9]      Id. at 4.

[10]    Id. at 13.

[11]    Id. at 14.

[12]    Id.

[13]    17 CFR Part 240; Regulation Best Interest: The Broker-Dealer Standard of Conduct; 270. Available at:; Accessed February 8, 2021.

[14]    17 CFR Part 240; Regulation Best Interest: The Broker-Dealer Standard of Conduct a(iii)(B); 765-8. Available at:; Accessed February 8, 2021.


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


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Topics: FINRA, Conflicts of Interest, suitability, securities litigation, investment recommendation, SEC Regulation Best Interest, Robinhood

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

SEC Regulation Best Interest - The Five-Part Test

Posted by Jack Duval

Aug 1, 2018 8:51:34 AM

This post continues my blog post series on SEC Regulation Best Interest.

A note to long-time readers of this blog:  You may have noticed that I haven’t been posting for a while.  This is due to the launching of my RIA firm Bantam Inc.  I have posted over 20 blog posts on that site in the past three months.  They cover investments and should be of interest to anyone involved with securities litigations.  There are also many posts with attorney-related content.  You can find those here.


Accelerant SEC Regulation Best Interest - five-part test


The SEC Regulation Best Interest Standard

One of the most significant changes from the FINRA suitability regime to SEC Regulation Best Interest (“RBI”) is a move from subjectivity to objectivity. 

While there are some objective elements to suitability, such as what needs to be included in a client profile, the actual suitability determination is subjective.  This will change under RBI.

What the SEC has proposed is not only a new standard of best interest, but a five-part test to satisfy that standard.

The SEC defines the best interest standard as follows:[1]

The proposed standard of conduct is to act in the best interest of the retail customer at the time a recommendation is made without placing the financial or other interest of the broker-dealer or natural person who is an associated person making the recommendation ahead of the interest of the retail customer.

The Five Elements to Satisfy the Best Interest Standard

The SEC then lays out the five elements that must be met in order to satisfy RBI:[2]

This obligation shall be satisfied if:

  1. The broker-dealer or a natural person who is an associated person of a broker-dealer, before or at the time of such recommendation reasonably discloses to the retail customer, in writing, the material facts relating to the scope and terms of the relationship, and;
  2. (Disclosure of) all the material conflicts of interest associated with the recommendation;
  3. The broker-dealer or a natural person who is an associated person of a broker-dealer, in making the recommendation, exercises reasonable diligence, care, skill, and prudence;
  4. The broker-dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and at a minimum disclose, or eliminate, all conflicts of interest that are associated with such recommendations, and;
  5. The broker-dealer establishes, maintains, and enforces written policies and procedures reasonably designed to identify and disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives associated with such recommendations. (Emphasis added)

A few quick points on the Best Interest standard.

First, one similarity between RBI and FINRA suitability is that both are recommendation-based rules.  This means the best interest obligation is episodic and only arises at the time of the recommendation.  (As with FINRA suitability, the exception to this arises from an explicit recommendation to hold.[3])

This is a critical distinction between RBI and the fiduciary standard to which registered investment advisors are held.  A fiduciary is held to the best interest standard in all their dealings with the client, not just for recommendations.  Also, the fiduciary standard is continuous and operates throughout the relationship, not just when recommendations are made.

Retail Customers

Second, RBI applies to “retail customers” which only includes individuals (and their trusts and IRA accounts) and not to any business entities they may own.  The SEC defines a retail customer as:[4]

“… a person, or the legal representative of such person, who: (1) receives a recommendation of any securities transaction or investment strategy involving securities from a broker, dealer or a natural person who is an associated person of a broker or dealer, and (2) uses the recommendation primarily for personal, family, or household purposes.”

The Commissions preliminarily believes this proposed definition is appropriate, and in particular, the limitation to recommendations that are “primarily for personal, family or household purposes,” as we believe it excludes recommendations that are related to business or commercial purposes, but remains sufficiently broad and flexible to capture recommendations related to the various reasons retail customers may invest (including, for example, for retirement, education, and other savings purposes).

There is no such distinction under the fiduciary standard.  Under RBI, business accounts would come under the FINRA suitability rules.

In my next post, I will unpack the five elements that must be satisfied.

Note to securities litigators:  I am working on a white paper on RBI and as part of that have been conducting a survey of attorneys involved with customer disputes.  If you would like to participate in the survey (it’s only six questions), please send me an email at: to schedule a call.



[1]           SEC Regulation Best Interest; Release # 34-83062; April 18, 2018; 1.

[2]           Id. at 1-2.

[3]           Id. at 82.  “The Commission proposes to apply Regulation Best Interest to recommendations of any securities transaction (sale, purchase, and exchange) and investment strategy (including explicit recommendations to hold a security or regarding the manner in which it is to be purchased or sold) to retail customers.”  Emphasis added.  Notes omitted.  FINRA has identical language under Regulatory Notice 12-25 at Q7.

[4]           Id. at 83-4.  Notes omitted.

For information about SEC Regulation Best Interest expert Jack Duval, click here.


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Topics: FINRA, Investment Suitability, fiduciary duties, SEC Regulation Best Interest, Best Interest five elements

The Historical Origins of Fiduciary Duties

Posted by Jack Duval

Jun 21, 2018 8:36:41 AM

This post continues my blog post series on fiduciary duties and the changing regulatory landscape around a unified fiduciary standard of care for investors.

Accelerant - Jack Duval - Fiduciary Duties Expert Witness

Statue of Cicero

Given the tremendous amount of ink that has been spilled regarding the DOL Fiduciary Rule and now SEC Regulation Best Interest, I thought it would be useful to review the existence of fiduciary rules throughout history.

The idea of a fiduciary duty has existed from the beginning of humanity’s codification of the rules by which it would live.  Indeed, fiduciary duties have been central to the functioning of societies from ancient to modern times and from East to West.

In the most simple terms, a fiduciary duty arises when one person relies on another to perform a task or service for them.  The duty arises from the dependence of the one on the other.  In more modern language, trust and confidence is being reposed by the principal in the agent to carry out the agreed upon work.

Fiduciary Duties Throughout History

Perhaps the first known fiduciary duties exist in Hammurabi's Code from 1790 BC.[1]

Rules of agency, reflected in Hammurabi’s laws, developed along with commerce in Ancient Mesopotamia.  The laws primarily discuss situations in which a tamkarum, or principal/merchant, gives a samallum, or agent, either money to use for travel and for investments or purchases, or goods for trading or selling.

The Bible also has many fiduciary-related quotes, the most famous of which may be:[2]

No man can serve two masters: for either he will hate the one, and love the other; or else he will hold to the one, and despise the other.  Ye cannot serve God and mammon.

Jumping to the East, somewhere between 475 and 220 BC, Confucius wrote in The Analects a heuristic for fiduciaries: “In acting on behalf of others, have I always been loyal to their interest?”[3]

From Ancient Greece, Plato’s Republic could be read as a metaphor for the fiduciary duties of leaders to their constituents, and the whole education process of philosopher-kings as instilling these virtues. 

The Roman’s coined the term “fiduciary” in their laws and defined it to mean:[4]

a person holding the character of a trustee, or a character analogous of a trustee, in respect to the trust and confidence involved in it and the scrupulous good faith and candor which it requires.

Cicero also wrote of fiduciary obligations between agent and principal, known by the expressive terms: “mandatory” and “mandator”, respectively.  “An agent who shows carelessness in his execution of trust behaves very dishonorably and ‘is undermining the entire basis of our social system’.”[5]

Making a great leap across time, we come to Anglo-American law and the English Courts of Equity.  Scholars Aikin and Fausti write:[6]

Courts of Equity granted relief in numerous circumstances involving one person's abuse of confidence and, over time, concrete rules and precise terms related to fiduciary relationships began to form as Equity evolved.

The term "fiduciary" itself was adopted to apply to situations falling short of "trusts" but in which one person was nonetheless obliged to act like a trustee.

The second point makes sense because in non-trust fiduciary situations, the principle still owns the property, whereas in the trust situation, ownership of the asset(s) have been transferred to a trust which the trustee oversees.

Lastly, we get to American Law and Benjamin Cardozo, who, in Meinhard v. Salmon, wrote what are probably the most cited words on fiduciary duties:

Many forms of conduct permissible in a workaday world for those acting at arm's length, are forbidden to those bound by fiduciary ties.  A trustee is held to something stricter than the morals of the market place.  Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior.  As to this there has developed a tradition that is unbending and inveterate.  Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the "disintegrating erosion" of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher that that trodden by the crowd.  It will not consciously be lowered by any judgment of this court.

Interestingly, the undermining of “the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions” is what is now contemplated in SEC Regulation Best Interest.  The SEC seeks to dress up FINRA suitability rules in the raiment of fiduciary language without the “uncompromising rigidity” of fiduciary law.



[1]       Keith Loveland, JD, AIFA, CIDA.  Available at:  Accessed June 19, 2018.

[2]       Matthew 6:24; KJV.  Available at:  Accessed June 19. 2018.

[3]       Confucius; The Analects; Translated by Arthur Waley; Routledge; London and New York; 1938; 84.

[4]       Blain F. Aikin et al; Fiduciary: A Historically Significant Standard; B.U. Law Review; 158.  Available at:; Accessed June 21, 2018.

[5]       Id.

[6]       Id. at 159.

For information about fiduciary expert Jack Duval, click here.


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Topics: FINRA, Investment Suitability, dol fiduciary rule, fiduciary duties, SEC Regulation Best Interest

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