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Broker-Dealer agents and Investment Adviser Representatives frequently sign a host of legal documents when they join up with a B/D or RIA. Such documents may include:

  1. Independent Contractor Agreements
  2. Promissory Notes
  3. Stock Participation Plans
  4. Compliance Procedures Manuals

Unfortunately, Agents and Representatives, in my experience, sign these documents without much thought and almost always without the benefit of legal counsel.

When an Agent and a B/D or a Representative and an RIA decide to part ways, something akin to a divorce proceeding is often on the horizon.  Both sides often feel justified in taking impulsive actions that may have various legal consequences.  It is on this battlefield, either during or after the war, that our attorneys spend many of their days.  The file cabinets are flush with U-5 and promissory note matters.  Every now and then, however, an individual will call us on the eve of, rather than in the midst of or the aftermath of the fray.  This person’s foresight almost always pays in cost effective dividends.

Admittedly, legal counsel’s ability to satisfy the goals of the client are frequently limited by legally binding documents signed during the courtship or in the heat of the honeymoon.  Regardless, legal counsel may assist in navigating the choppy waters of a transition.  Impulsive actions in the areas of recruiting or even sabotage can be counseled against from a cool and objective perspective.  U-5 language, payment plans, and stock payouts can be negotiated.

If the transition is of the kind that will generate a regulatory inquiry, legal counsel will be able to familiarize themselves with the facts of the matter before the letter of inquiry arrives.

In sum, if you anticipate transition conflicts, or are even contemplating changing horses; seek out legal counsel.  If you are already midstream, seek faster.

Missouri has adopted Section 551 of the Restatement (Second) Torts, which makes clear that under some circumstances a person’s failure to disclose information constitutes a positive misrepresentation.  Kesselring v. St. Louis Group, Inc., 74 S.W.3d 809, 814 (Mo.App. E.D.,2002).  But the Missouri Court of Appeals has made clear that non-disclosure amounts to a misrepresentation only when the person is under a duty to disclose.  Id.  The Restatement identifies five circumstances under which persons in a business transaction have a duty to disclose:

One party to a business transaction is under a duty to exercise reasonable care to disclose to the other before the transaction is consummated:

(a) matters known to him that the other is entitled to know because of a fiduciary or other similar relation of trust and confidence between them; and

(b) matters known to him that he knows to be necessary to prevent his partial or ambiguous statement of the facts from being misleading; and

(c) subsequently acquired information that he knows will make untrue or misleading a previous representation that when made was true or believed to be so; and

(d) the falsity of a representation not made with the expectation that it would be acted upon, if he subsequently learns that the other is about to act in reliance upon it in a transaction with him; and

(e) facts basic to the transaction, if he knows that the other is about to enter into it under a mistake as to them, and that the other, because of the relationship between them, the customs of the trade or other objective circumstances, would reasonably expect a disclosure of those facts.


In Kesselring, the buyers of a business argued that the brokers for the business provided all relevant financial documents prior to the purchase of the business except for the “December 1999 Balance Sheet” and the “1999 Moneys Owed.”  Id.  These documents would have disclosed $93,861.32 in outstanding expenses from 1999.  Id.  The buyers claimed this partial disclosure of information created a duty to make a complete disclosure.  The brokers claimed they were under no duty to disclose the documents.

The court of appeals agreed with buyers. Specifically, the court found that “if the brokers gave the buyers the impression that their files contained all relevant business documents, they had a duty to disclose all relevant documents.”  Id.  Although not expressly stated by the court of appeals, they presumably relied upon Section 551(b) or (e), because the duty disclose was premised on the fact that only partial financial information had been provided by the brokers while assuring the buyers, at least implicitly, that all relevant financial information had been disclosed.

This holding from Kesselring could be applied as the basis for a cause of action in any number of situations where partial or non-disclosure is misleading, whether it be a broker or seller of a business, or a broker or seller of investments.  The attorneys at Cosgrove Law Group, LLC, have experience with claims based on non-disclosure of material information in commercial transactions.  Contact us for more information.

Have you pondered why your employer chose the particular 401k platform with which you are saving for retirement? Your employer has a fiduciary duty to ensure that you are provided with a 401k product that offers you a reasonable opportunity to achieve retirement income security – you just need to fund it adequately!

We all have various duties, but it’s important to understand that your employer’s fiduciary duties are mandated by the Employee Retirement Income Security Act (ERISA). Fiduciary duties have been described as “the highest known to the law” and the individuals responsible for choosing your 401k platform can be held personally liable for any fees that are deemed to be unreasonable.  See Donovan v. Bierwirth, 680 F.2d 263 (2nd Cir. 1982) In fact the individual employees who served on the ABB, Inc. pension and benefits committee were recently found jointly liable, along with ABB, Inc., for $35.2 million because they failed to properly document and monitor 401k fees!

Despite the complexity of fiduciary duties, there is no mandatory training for fiduciaries. However, ERISA requires that if an employer doesn’t have the expertise to fulfill the highest duties known to the law, they must engage a qualified, independent expert – and here is where fiduciariness comes into play.

Truthiness, Fiduciariness and Lemoniness

Stephen Colbert coined the term truthiness which is defined by Miriam-Webster as “the quality of preferring concepts or facts one wishes to be true, rather than concepts or facts known to be true.”  In an excellent blog post Chuck Humphrey, Employee Benefits & ERISA Counsel for Fiduciary Plan Governance, LLC. applies truthiness to the 401k industry.

Humphrey is more direct than Colbert writing that “truthiness is a clever way of characterizing what is in fact lying…” and coins the word fiduciariness which more accurately describes the practices of some 401k plan vendors. He defines fiduciariness as “the selling by the financial service industry the concept or fact of assumption of fiduciary status to 401(k) plan sponsors who want it to be true, rather than it actually being true.” There are many employers who are, unknowingly, the victims of fiduciariness. They might have thought they engaged a qualified, independent expert when in fact they only hired a well-trained salesperson whose company rejects any fiduciary responsibility whatsoever.  To learn more about fiduciariness see The Wizard of Oz, Retirement Plans & You.

If your employer is the victim of fiduciariness, then unfortunately so are you. This is because those 401k vendors who practice fiduciariness, often sell what might be considered fiduciary lemons. Scott Wooley aptly describes these products in Retirement Plans from Hell . Simply, these are 401k products fraught with hidden, hard-to-find fees that pilfer away your 401k assets as well as your prospects of retiring with dignity. Just as truthiness is a euphemism for lying, pilfer is a euphemism for stealing – how else might one describe continuously taking small amounts of your 401k assets without your knowledge and consent?

If the Food & Drug Administration was responsible for regulating the 401k industry, these products might come with a warning label which read: This 401k product may be harmful to your retirement income security! However, there is no government agency responsible for regulating the marketing materials and representations of 401k vendors. Ironically, the regulator responsible for punishingfiduciariness is a private corporation, bought and paid for by Wall Street, and accurately described by Madoff whistleblower Harry Markopolos as a “very corrupt self-regulatory organization.”

Regrettably, lemoniness comes in too many varieties to discuss here; however, there is something that you can do. As of 2012, your employer must provide you with what is known as a Rule 404(a)(5) fee disclosure. Ensure you read it and if it isn’t clear to you exactly how much your 401k plan is costing you, demand an explanation from your employer who in turn should demand an explanation from your 401k vendor.  To learn more about how some 401k vendors intentionally hide how they pilfer your money See Rule 408(b)(2): The New Fiduciary Paradox .  If you don’t motivate your employer, no one else will and it’s your retirement income security that is at risk!

About the Author

Mark Mensack

 Mark Mensack, AIFA®, GFS® is the Principal of Mark D. Mensack, LLC., an independent fiduciary consulting practice affiliated with Fiduciary Plan Governance, LLC.. His expertise is in the area of fiduciary best practices, 401k hidden fees and ethical issues in the retirement plan marketplace. He has eighteen years of financial services experience; fourteen as a financial advisor with broker-dealers, and four as an RIA. Mark has a Masters in Philosophy from the University of Pennsylvania and is a former US Army Officer. His final active duty assignment was on the faculty of the United States Military Academy at West Point, NY where he taught Philosophy, Ethics & Critical Reasoning. Mark also writes the 401k Ethicist column for the Journal of Compensation & Benefits and some of his work can be found at Mark welcomes examples of ethical issues in the retirement plan space, and especially misleading 401k marketing materials at

To learn more about Mark Mensack, visit his sites and

In 1378, the Statute of Scandalum Magnatum granted judges and church officials in England a legal right to compensation if they had been insulted or defamed. The first Common Law defamation action on record was filed in England in 1507. Back then, however, the cause of action only applied to false utterances regarding criminality, incompetence, and disease. The law evolved dramatically in the United States. Indeed, Supreme Court Justice Stewart once wrote that the tort of defamation “reflects no more than our basic concept of the essential dignity and worth of every human being.1

Defamation law has been somewhat static since the seminal Supreme Court case of New York Times Co. v. Sullivan in 1964. But consider what has changed in the 50 years since that ruling. Let me cite just a few examples of developments that have completely transformed the impactof damages caused by defamatory conduct:

  1. An erosion of society’s perception of what is a private matter;
  2. 24-hour news cycles;
  3. The relative decline of more thorough print media; and
  4. The internet (and the explosion of linked high-speed outlets for the dissemination of falsehoods.)

As the old saying goes, “A lie makes its way around the world before the truth has time to get its pants on.”

I will blog again shortly about the intersection of defamation and U-5 FINRA defamation claims. The lesson for now is as follows: brokers that have suffered from U-5 defamation need to do much more than simply file an arbitration claim. Reputation management is critical.


1  If you want to dig deeper in to the legal history of defamation law, start with David Hudson’s excellent piece by clicking here.

Thinking about making a career change and switching firms?  Your thoughts about wanting to switch firms or even opening your own shop are not uncommon.  There may be various reasons why making a change may be in your best interest.  Before doing so, however, there are some legal and professional considerations with regard to your clients that deserve your attention.

When determining whether to change firms, the question of whether it is in your clients’ best interest should be part of the equation.  Building your client base and meeting their needs is crucial to your overall success as an adviser.  Thus, you should have an understanding of the culture and environment of the new firm and analyze how these may or may not be beneficial for your clients before deciding to jump ship.  For instance, if you have a business that is heavily concentrated in certain products or if you are considering expanding the products you offer, make sure the firm can offer the support you need.  You should also consider if there is a change in the fee or commission structure at your new firm and whether it will cost your clients more to move their accounts.  Will some of your clients have to sell any portion of their portfolio in order to move?  These are questions you will need to answer before making a decision.

If you do decide to seek employment with another firm, you’re probably wondering how to inform your clients.  This area can get murky.  You should thoroughly review the contracts you signed with your current employer.  It is likely that these agreements govern your rights upon terminating your employment.  For instance, many employment and independent contractor agreements and contain clauses that prohibit an adviser from soliciting clients, or even other co-workers from moving their accounts or joining you at your new firm.  You may also be prohibited from informing your clients that you are joining a new firm or taking any information about your clients to your new firm.

If you are a registered representative, find out if both your current firm and the firm you are seeking employment with participate in the Protocol for Broker Recruiting.  This program is administered by SIFMA and seeks to “further the clients’ interests of privacy and freedom of choice in connection with the movement of their Registered Representative between firms.”

If both firms participate in the Protocol, reps may take only the following account information to his or her new firm: client name, address, phone number, email address, and account title of the clients that they serviced while at the firm (“the Client Information”) and are prohibited from taking any other documents or information.  Reps must also submit written resignations to local branch management and must include a copy of the Client Information that the rep is taking with him or her and include the account numbers for the clients serviced by the rep.  If you’ve complied your own information or notes about your clients during your career, taking this information with you is a common Protocol violation which could potentially lead to legal proceedings.  Remember that these rules only apply if both your current firm and the firm you are moving to belong to the Protocol.

If both firms do not participate in the Protocol, then look to your employment contract to see what restrictions may be placed on informing and soliciting customers.  These prohibitions could create a dilemma for advisors.  Even if there are no restrictions in your contract you should still consider the possible implications of alerting your clients about a new position.  From a legal standpoint, the most protective measure is likely not informing your clients that you are jumping ship, but is that the best decision professionally?  Clients may be confused upon learning about your departure and unsure of the circumstances surrounding the departure which may cause them to speculate and possibly resist moving their accounts to your new firm.  Some clients that you maintain close relationships with may feel offended that they were uninformed of your career choice.  Thus, if there is not some sort of contractual bar to letting your clients know you are switching firms, it’s probably best to inform them.

If you do decide to tell you clients that you are accepting a position with a new firm, you should almost never tell them of your plans until your current employer is informed.  You do not want to risk your employer finding out about your departure before you are ready to tell them.  When you do let your clients know about your opportunity, be sure to explain why the move is in their best interest and never say anything disparaging about your current employer even if your departure was the result of a tumultuous situation.  Be ready to inform your clients about any changes in the fee or commission structure, or any change in their portfolio that would result from moving their accounts.  Make a point to emphasize the benefits but always give your clients the material information they need to make an informed decision.

If at any point during your decision making process you are unsure of what restrictions are contained in your employment agreement, or the requirements of the Protocol, contact an attorney to assist you in understanding your rights and protect yourself during your transition.

Most of us know by now to have a plan for our eventual exit from this life. The centerpieces of the plan typically are insurance, a will and a trust, and beneficiary designations properly completed on all applicable accounts. On the other end of the scale, most of us have an emergency fund for a sudden precipitous financial hit caused by an unexpected decline in revenue or a spike in expenses. Some of us even plan ahead for the unfortunate possibility of the demise of our marriage with a “pre-nup” or other financial arrangements.

But how many of you have made contingency plans for your current position in the industry? If you are a decent producer associated with a large wire-house, are you blinded to the fact that your relative contentment might not be the only determining factor for your continued tenure? That is a fancy way of asking if you have a plan if you get shit-canned.

Many investment advisers and dually registered folks conjugate about what it would be like to have their own RIA. The American dream of being one’s own boss and the shining promise of independence and profits can almost make one giddy. But, I am trying to impress upon you the importance of realizing that one day circumstances beyond your control might push you from dreaming to scrambling.

Whether you would prefer to experience practicing your honed fiduciary skills with an independent broker/dealer, a large SEC registered RIA, or a small state-registered RIA, the amount of preparation for the transition will depend upon your current model. The more detailed your plan, the more likely you will survive the transition, particularly if sudden, with less (rather than no) financial or cardiovascular hardship. The amount of regulations pertaining to everything from the type of files you must keep, regulatory filing deadlines, and certain policy packets that must be in place can be overwhelming without the assistance of a valued and knowledgeable advocate.

The market is filled with attorneys and consultants that can assist you with your transition. You will need one of each and this is not the time for you to employ penny wise and pound foolish measures. Once you have a specific confidential plan in place, you can decide whether or not to use it, or simply put it in the drawer with your insurance policy and estate planning documents.

My law firm has assisted individuals that have needed to migrate at the drop of a hat for employment or regulatory reasons. While it is doable, it certainly isn’t optimal. And the more independent you want to be, the more details there are to identify, evaluate, and address. Where you want your office to be located will suddenly be as important as why you want to rely upon us for back-office support.

In addition to reviewing this blog and joining The SyndicateI would recommend to you a recent article by Jill Cornfield entitled “Independent Advisers: Is striking out on your own all it’s cracked up to be?Start planning for your dreams in case they arrive sooner than you planned!


Troy Kennedy (Kennedy”) left his position as director and executive officer of a trust and investment company when that company was bought by Central Trust & Investment Company (“CTI”). Kennedy left to found a competing firm. Both companies provided financial advice and investment management services. Within six months, Kennedy had successfully solicited 85 former clients. 

Before the sale and departure in question, Kennedy had placed a detailed list of 200 clients in a safe deposit box upon the advice of legal counsel. Kennedy did not register his new company, ITI, with the SEC as an investment adviser. Instead, Kennedy affiliated himself as an investment adviser representative of an RIA called SignalPoint Asset Management, LLC (“SignalPoint”), the defendant in this case. The agreement between Kennedy and SignalPoint allowed Kennedy to offer investment services through SignalPoint in exchange for various fees on an independent contractor basis.

CTI filed suit against Kennedy and his new company, ITI. At the time it filed suit, it didn’t even know about the client list in the safe deposit box. The suit included causes of action for conspiracy, misappropriation of trade secrets (MUTSA) and tortious interference with business relations. CTI then added SignalPoint as a third defendant. All three defendants filed motions for summary judgment. The trial court granted SignalPoint’s only. The Supreme Court ordered the matter transferred to it from the Court of Appeals. The Supreme Court’s analysis of the three different claims begins on page 7 of the 2014 Opinion [Click HERE]. The Opinion is a must read for attorneys representing agents or representatives that are about to “change ships” or broker-dealers or RIAs that are taking on a competitor’s producer.

The Supreme Court sustained the dismissal of the statutory trade secret claim because CTI could not establish that SignalPoint had access to the client list. In doing so, it side-stepped the issue of whether the client list qualified as a trade secret. Ironically, the most valuable portion of the opinion for practitioners might be the two extensive footnotes (8 and 9) about client lists that prove that lawyers and judges can render obscure what should be obvious. Regardless, the Supreme Court concluded that because there was no access, there was no misappropriation, so there was no MUTSA violation.

The first 10 pages of the opinion fail to pin the law to the reality of the situation—that Kennedy had access to the list and was using it to benefit himself and SignalPoint. Ironically, the plaintiff’s attorney couldn’t pin that tail on the donkey either—he or she somehow failed to plead any theory of vicarious liability. The theory of respondent superior was not available either—Kennedy’s IAR Agreement clearly established him as a non-employee. CTI needed but failed to plead that Kennedy was an agent over whom SignalPoint had a sufficient degree of control.

The Court proceeded to set forth the elements of a claim for tortious interference:

  “To prove a claim for tortious interference with a contract or a business expectancy, the plaintiff must prove the following five elements: “(1) a contract or a valid business expectancy; (2) defendant’s knowledge of the contract or relationship; (3) intentional interference by the defendant inducing or causing a breach of the contract or relationship; (4) absence of justification; and (5) damages resulting from defendant’s conduct.”

The Court concluded that the fourth element requires a showing of “improper means” and the plaintiff could not establish any because there was no misappropriation of a trade secret. The civil conspiracy claim died from the same wound. Food for thought.

The Cosgrove Law Group represents individual agents and reps both before and after they make a move to a new B/D or RIA. Retaining counsel before the litigation starts just might help you prevail and prosper.

A broker-dealer agent, whether dually registered or a straight-up 7, is obviously subject to FINRA’s enforcement apparatus. Sometimes agents/reps make serious mistakes that prompt a FINRA enforcement investigation. Many such investigations or actions are resolved through an agreed upon resolution commonly referred to as an “AWC.” An AWC is a FINRA Rule 9216 letter of Acceptance, Waiver, and Consent.

The pursuit of an AWC may be a reflexive response for many industry members and their attorneys. A couple of critical issues should, however, be considered. For example, if FINRA has not yet, but wishes to take an on-the-record (“OTR”) exam of you, will an AWC still be available at the end of the exam? Or will you be forced to choose between a lack of candor or making matters worse for yourself in the OTR? Some agents—perhaps retired—are in the envious position of just not really needing to be bothered with the cost and stress of an OTR.

A second issue you should consider before hitting the AWC button is publicity. The AWC will include a substantial statement of facts and FINRA will issue a rather thorough non-negotiated public summary of the AWC terms, factual basis, and sanction. If you are dually registered as an IAR, consider whether the AWC route will destroy the fee-based side of your book. Is it worth retaining your association with a FINRA member in light of the nature and composition of your book? Has your attorney communicated with the states and/or SEC regarding their position on your ticket on the 65 side?

If you firmly believe that an OTR would put you in greater jeopardy than you are already in, or would simply be a waste of your time and money, or that an AWC would throw out the baby with the bathwater—consider a fairly quiet FINRA Rule 9552 exit.

Rule 9552 addresses a regulated person’s failure to provide information to FINRA. The Rule provides for expedited automatic procedures that will allow for a gradual letter-notice transition from warning to suspension to revocation. Unless one decides to challenge one of the automatic stages, there are no pleadings or hearings or press releases. Refusing to sit for an OTR is a violation of Rule 9552.

It is possible your current counsel has only laid out two options for you: an expensive prolonged legal battle with FINRA or an AWC suicide pact. At least consider your third option, Rule 9552. But remember—the 9552 disposition is probably not an option once you sit for an OTR.

Being a fiduciary to clients means acting in the client’s best interest and putting their interest before yours and others. Sometimes knowing what is in the client’s best interest can get foggy so establishing certain guidelines can help protect you, your client, and your representatives.
In accordance with Rule 204A-1 of the Investment Advisers Act of 1940, RIA’s registered with the SEC are required to maintain a written code of ethics that outline the fiduciary duties and standards of conduct of the RIA and its representatives. State registered RIA’s may also be required to develop a code of ethics consistent with state regulations.
It’s important to keep in mind that in creating a code of ethics, the SEC and various state regulations set minimum requirements.  The following items are required in an RIA’s code of ethics under Rule 204A-1:
  • A standard of business conduct which reflects the fiduciary obligations to clients;
  • Provisions requiring all advisers’ and supervised persons’ compliance with applicable federal securities laws;
  • Protection of material non-public information of both the adviser’s securities recommendations, and client securities holdings and transactions;
  • Periodic reporting and reviewing of access persons’ personal securities transactions and holdings;
  • Adviser’s approval before an access person can invest in an IPO or private placement;
  • Duty to report violations of the code of ethics;
  •  A written acknowledgment that all supervised persons received the code of ethics; and
  • Recordkeeping provisions.
RIAs often set higher standards that work to reinforce the values or business practices of the company.  Rule 204A-1 does not require detailed measures to be included into every code because of the vast differences among advisory firms.  However, the SEC has offered guidance and recommendations on additional best practices that advisors should consider incorporating into its code of ethics.  The following list contains additional safeguards that are commonly implemented by other advisers:
  • Prior written approval before access persons can place a personal securities transaction (“pre-clearance”);
  • Maintenance of lists of issuers of securities that the advisory firm is analyzing or recommending for client transactions, and prohibitions on personal trading in securities of those issuers;
  • Maintenance of “restricted lists” of issuers about which the advisory firm has inside information, and prohibitions on any trading (personal or for clients) in securities of those issuers;
  • “Blackout periods” when client securities trades are being placed or recommendations are being made and access persons are not permitted to place personal securities transactions.
  • Reminders that investment opportunities must be offered first to clients before the adviser or its employees may act on them, and procedures to implement this principle.
  • Prohibitions or restrictions on “short-swing” trading and market timing.
  • Requirements to trade only through certain brokers, or limitations on the number of brokerage accounts permitted;
  • Requirements to provide the adviser with duplicate trade confirmations and account statements; and
  • Procedures for assigning new securities analyses to employees whose personal holdings do not present apparent conflicts of interest.
Another issue that may be important to include in your code of ethics is provisions concerning gifts and entertainment since giving or receiving gifts between a client and adviser may create the appearance of impropriety.  Gift and entertainment provisions usually contain reporting requirements and a prohibition of accepting gifts over de minimus values, such as $100.
While the above requirements and recommendations generally encompass an adviser’s fiduciary duty as it relates to conflicts of interests, advisers have additional fiduciary duties to clients that should be memorialized in a code of ethics as well.  For example, and what might appear obvious to some, advisers cannot defraud or engage in manipulative practices with a client in any way.  Advisers also have a duty to have a reasonable, independent basis for the investment advice provided to a client and to ensure that investment advice meets the client’s individual objectives, needs, and circumstances.  Advisers are also expected to stay abreast of market conditions.  Clients should be provided with all material information related to their investments or investment strategy and should be adequately informed of the risks associated with those investments.  The depth of the explanation of those risks or strategy depends on the client’s level education and experience.
The buck doesn’t stop with establishing a written code of ethics, however.  Implementation and enforcement of your code of ethics are just as crucial.  This also includes educating your representatives.  Rule 204A-1 does not mandate specific training procedures but ensuring that your representatives understand their obligations and their fiduciary duties is imperative.  Thus, periodic training with new and existing employees is not only in your best interest, but also the interest of your employees and clients.  Finally, you should annually review your code of ethics to determine if there are any areas of deficiency or whether changes need to be made.

The Syndicate can assist with your firm in the following ways: (1) drafting or establishing a code of ethics; (2) reviewing your current code to assure it complies with applicable state or federal laws; (3) implementing training programs; and (4) analyzing your firm’s implementation procedures to ensure compliance with the codes provisions.

The Securities and Exchange Commission regulates larger investment advisers under the Investment Advisers Act of 1940 (the “Act”). In a previous posting, we noted that perhaps the most significant provision of the Act is Section 206, which prohibits advisers from defrauding their clients and which has been interpreted by the Supreme Court as imposing on advisers a fiduciary duty to their clients. See Transamerica Mortgage Advisors, Inc. (TAMA) v. Lewis, 444 U.S. 11, 17 (1979) (“[T]he Act’s legislative history leaves no doubt that Congress intended to impose enforceable fiduciary obligations.”).

A number of obligations to clients flow from the fiduciary duty imposed by the Act, including the duty to act in the clients’ best interests, to fully disclose any material conflicts the adviser has with its clients, to seek best execution for client transactions, to provide only suitable investment advice, and to have a reasonable basis for client recommendations. SeeRegistration Under the Advisers Act of Certain Hedge Fund Advisers, SEC Release No. IA-2333Status of Investment Advisory Programs under the Investment Company Act of 1940, SEC Release No. IA-1623.

From these fiduciary obligations arises the duty to properly explain investments or an investment strategy to clients. Where a financial adviser provides advice about investments, “a fiduciary duty is breached when the client is encouraged to purchase an investment with a level of risk that is not appropriate for the client, or is not properly informed of the speculative nature of an investment.” Sakai v. Merrill Lynch Life Ins. Co., C-06-2581 MMC, 2008 WL 4193058 (N.D. Cal. Sept. 10, 2008) (citing Vucinich v. Paine, Webber, Jackson & Curtis, Inc., 803 F.2d 454, 460-61 (9th Cir.1986) (holding that broker had fiduciary duty to fully inform client of nature and risks of selling short, “in terms capable of being understood by someone of [client’s] education and experience.”)).

“A fiduciary must provide a proper disclosure and explanation of the investment activity, and should warn a client to exercise caution if an investment presents a greater risk than tolerable, given the client’s goals and circumstances.” Id.see also Gochnauer v. A.G. Edwards & Sons, Inc., 810 F.2d 1042, 1049-50 (11th Cir. 1987) (finding that where adviser assisted clients in establishing speculative option trading account, “[a] more studied opinion of the risks of option trading in light of the [clients’] then-existing investment objective was owed by [the adviser] to [his clients]. This he failed to do, in breach of his fiduciary duty.”); In re Old Naples Sec., Inc., 343 B.R. 310, 324 (Bankr. M.D. Fla. 2006) (stating that “failing to disclose and fully explain the risk of an investment to an investor can be a breach of the broker’s fiduciary duty.”); Rupert v. Clayton Brokerage Co. of St. Louis, Inc., 737 P.2d 1106, 1109 (Colo. 1987) (“A broker who becomes a fiduciary of his client must act with utmost good faith, reasonable care, and loyalty concerning the customer’s account, and owes a duty . . . to keep the customer informed as to each completed transaction, and to explain forthrightly the practical impact and potential risks of the course of dealing in which the broker is engaged.”).

A good example of the application of the fiduciary duty to explain comes from Faron v. Waddell & Reed, Inc., 930 S.W.2d 508 (Mo. App. E.D. 1996).  Although this case involves a broker-dealer as opposed to an investment adviser, Missouri imposes an unambiguous fiduciary standard on broker-dealers.  In Faron, the client approached a registered representative of the broker-dealer inquiring whether he could obtain money from a trust to purchase a new home. He asked whether it would “cost any money.” Id. at 510. After he consulted with the registered representative he felt assured he could get the money and the transaction would result in no cost to him. He did not specifically consider tax ramifications nor did he directly ask about tax consequences. He assumed Waddell & Reed was lending the money to him to use, at no cost. However, instead of a loan the transaction actually consisted of a redemption of mutual funds. Id. He obtained the $250,000 from Waddell & Reed, returning the same amount within the required 21 days. The client’s accountant discovered the tax liability in the amount of approximately $32,000 while preparing an income tax return. The accountant brought it to the attention of the client, who brought suit against Waddell & Reed.

The trial court granted summary judgment for Waddell & Reed, finding that Waddell & Reed had no duty to provide tax information because none was requested.  On appeal, the court noted:

In Missouri, stockbrokers owe customers a fiduciary duty. This fiduciary duty includes at least these obligations: to manage the account as dictated by the customer’s needs and objectives, to inform of risks in particular investments, to refrain from self-dealing, to follow order instructions, to disclose any self-interest, to stay abreast of market changes, and to explain strategies. Implicit in these obligations is a duty to disclose to the customer material facts.

Id. at 511 (emphasis added).

The court of appeals found that Waddell & Reed was privy to information and had expertise not yet proven on summary judgment to be equally or reasonably available to the client. In particular, the registered representative was aware of details of the transaction which consisted of a redemption of mutual funds, while the clients understood the transaction to amount to a short-term loan. Id. Waddell & Reed had a duty to manage the account according to the client’s expressed needs and objectives, to bridge finance by use of trust assets with “no loss whatsoever,” if possible, or to inform the client of the costs. Id. The client communicated his concerns about possible costs associated with the proposed transaction to the registered representative. The client was not told how the transaction would occur but was told it would not cost any money. The court of appeals concluded that what was meant by “costs” in the discussions between the parties remained uncertain. This implicated an unresolved question of fact, making summary judgment for Waddell & Reed inappropriate. Id.

In sum, the fiduciary duty standard requires that the client be properly informed of the nature of an investment or investment strategy. What is necessary in order to meet this standard will depend on the facts and circumstances of each case. A more in depth explanation of the risks of an investment or investment strategy will be necessary where the client’s related education and experience is minimal. Similarly, a more detailed explanation of strategy will become necessary where the strategy being implemented is more speculative in nature. Whether the fiduciary duty to explain has been met will usually be a question of fact to be decided by the judge, jury, or arbitrator after hearing all of the evidence.