As the costs of basic needs such as education, healthcare, and retirement have increased, many financial responsibilities have shifted from government and employers to individuals. Consequently, individual investors must now manage a dizzying array of complex investment and insurance options. Yet brokers and advisers who appear to offer similar investment services to retail customers may have vastly different fee and compensation structures, and may be held to vastly different standards of care. These distinctions are neither obvious nor meaningful to the average retail investor seeking to insure his or her family against disaster, invest for retirement, or prepare for the costs of a child’s higher education.
Much of the regulation of financial services arose in the 1930s and 1940s, when investment services were more bifurcated: brokers executed securities transactions for customers in return for a commission, while investment advisers dispensed advice and managed customer accounts in return for a fee that was typically a percentage of assets under management. As a result, brokers are regulated by the Securities Exchange Act of 1934 (“Exchange Act”), while investment advisers are regulated by the Investment Advisers Act of 1940 (“IAA”). A significant difference between the two acts is that the Exchange Act does not impose a fiduciary duty on brokers, while the IAA does impose such a duty upon those brokers who are not exempted from its regulations.
Today, brokers often provide both transactional and advisory services for clients. Thus, some broker activities are regulated by both acts, while others are exempted from the IAA and its higher standards. In Thomas v. Metropolitan Life Insurance Co., the Tenth Circuit held that the broker exemption of the IAA applied to the activities of a Metropolitan Life (“MetLife”) representative whose compensation was tied to the sale of certain proprietary financial products. Although the court’s analysis was couched as an exercise in statutory interpretation, its plain language analysis of the statute was flawed, and created an overly-broad exemption that will result in the improper exclusion of broker activities from the requirements of the IAA.
The case turned on the interpretation of the language in the IAA that explicitly exempts from fiduciary duty brokers or dealers whose performance of advisory services is “solely incidental to” the conduct of their business and who do not receive “special compensation” for those services. Using plain language, administrative guidance, and legislative history, the court interpreted “solely incidental to” broadly as indicating any relationship between two things. Employing a similar analysis, the court narrowly interpreted “special compensation” as compensation that is not a commission and is specifically received for investment advice.
The primary implication of the Thomas holding is that brokers are broadly exempted from regulation under the IAA, resulting in less protection for investors (specifically from conflicts of interest). The court appeared to balance deference to the statutory language with a desire for a predictable rule that doesn’t require a subjective weighing of the relative importance of advisory and selling activities. Alternatively, the court could have adopted a “substantial factor” test to determine whether advice was “solely incidental to” the sale of a security, with factors including the specificity of the advice in relation to the security sold, the presence of information on competing options, and the reasonable reliance of the customer on the selection of the security. Any theoretical increase in the broker’s burden would be offset by the social good of increased investor protection.
The precedential impact of the Tenth Circuit’s Thomas decision may be short-lived. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 mandated that the SEC conduct a study of broker and adviser regulations; the ensuing report recommended that brokers be held to “a fiduciary standard no less stringent than currently applied to investment advisers” under the IAA. The legislation also gave the SEC authority to make rules establishing a uniform fiduciary standard for brokers and advisers, but the Commission has yet to engage in such rulemaking.
For further explication of the case and its ramifications, see Jeremy Liles, Thomas v. Metropolitan Life Insurance Co.: Semantics, Fiduciary Duty, and an Outdated Distinction, 89 Denv. U. L. Rev. ____ (forthcoming 2012).
 J.D. Candidate, 2014, University of Denver Sturm College of Law.