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On December 17, 2020, Robinhood, a popular financial technology company favored by younger investors, agreed to pay $65 million to settle charges filed by the Securities and Exchange Commission (“SEC”). These charges were a result of their failure to disclose that they sold their clients' orders for securities to high-speed trading firms and to fulfill their duty to seek the best available terms for customer orders. Just one day prior, Massachusetts regulators filed a separate complaint against Robinhood, alleging customer manipulation.
The complaint accused Robinhood of violating the Massachusetts Uniform Securities Act (“MUSA”) by engaging in unethical practices in the securities business. Specifically, the Secretary of the Commonwealth of Massachusetts (“Secretary”) alleged that Robinhood provided investment recommendations to customers without considering their best interests, thereby breaching its fiduciary duties of care and loyalty. Robinhood, however, denied these allegations, asserting that, as a "self-directed" brokerage firm, it does not make investment recommendations or provide advice. The lower court ruled in Robinhood's favor, asserting that the Secretary had exceeded their authority in enforcing the law. The Secretary then appealed the decision, and the Supreme Judicial Court of Massachusetts reviewed the case.
In its opinion, the Massachusetts Supreme Judicial Court (“SJC”) acknowledged that the line between services offered by broker-dealers and investment advisers had become “blurred” over time. Some broker-dealers, including Robinhood, rather than charging commissions, generated revenue through "payments for order flow," a method that transferred trading profits to brokers routing customer orders to specialists for execution. This compensation model tied broker-dealers' revenues to the number of customer trades, potentially incentivizing them to prioritize third parties with better rebates over those offering the best execution price for clients.
On appeal, the issue before SJC was “whether, by promulgating the fiduciary duty rule, the Secretary overstepped the bounds of the authority granted to him” under MUSA. This issue turned on a resolution of the long-established differences in the standards of care customarily applied to investment advisers and broker-dealers.
The Secretary’s Power Under the Massachusetts Uniform Securities Act
In particular, the Massachusetts Uniform Securities Act sets out to protect investors and advisory clients by granting the Secretary the authority to discipline “unethical or dishonest conduct or practices in the securities, commodities or insurance business.” Further, it provides the Secretary with various powers, including the power to administer MUSA through discretionary investigations as deemed necessary and the power to make, amend, and rescind rules when necessary.
Promulgated in section 12.207 of the Code of Massachusetts Regulations, the fiduciary duty rule deems it “unethical or dishonest conduct or practices” by broker-dealers when they “fail to act in accordance with a fiduciary duty to a customer when providing investment advice or recommending an investment strategy, the opening of or transferring of assets to any type of account, or the purchase, sale, or exchange of any security.” Notably, to comply with this fiduciary duty, broker-dealers are required to “adhere to duties of utmost care and loyalty to the customer.”
The Secretary’s Arguments in Support of Promulgating the Fiduciary Duty Rule
After a thorough consideration of various sources, including public comments concerning investor harm resulting from false confidence in broker-dealers who did not owe a fiduciary duty to act in the customers’ best interests unlike investment advisers, the Secretary decided to adopt the aforementioned fiduciary duty rule.
In support of his decision to promulgate such a statute, the Secretary provided that the fiduciary duty rule was imperative to protect the public interest and provide investor protection due to their lack of “education and background” necessary to differentiate the various disclosure requirements of broker-dealers versus investment advisers. This conclusion aligns with MUSA’s purpose of protecting investors and advisory clients and consistent with the Secretary’s duty to regulate “unethical or dishonest conduct or practices.”
Credit: Robinhood
Robinhood’s Arguments Against the Fiduciary Duty Rule
Robinhood questions the Secretary’s authority under MUSA, particularly when it comes to the fiduciary duty rule.
1. Secretary’s Authority Under MUSA
Robinhood contends that the Secretary’s fiduciary duty rule exceeds their MUSA authority. However, regulations by administrative agencies are typically presumed valid and treated with the same deference as statutory law. Therefore, the burden of proving the regulations’ invalidity falls on the challenging party. MUSA was designed to protect investors in Massachusetts by regulating securities offerings. Under MUSA, the Secretary has significant investigative and enforcement powers to fulfill MUSA’s objectives.
Before adopting the fiduciary duty rule, the Secretary considered various sources, including the Securities Division’s enforcement experience, empirical studies, and relevant public comments. These sources revealed that many investors did not understand the difference between standards of care required of broker-dealers and investment advisers, which suggested the need for the Secretary to adopt the fiduciary duty rule. Moreover, despite Robinhood’s claim that MUSA only requires adherence to existing industry norms, the Secretary’s findings indicate a departure from traditional industry practices due to changes in business models, marketing, and compensation structures.
2. Common Law
Next, Robinhood argues that the fiduciary duty rule is unenforceable because it invalidates common law principles. However, the SJC acknowledged that common law outlines how broker-dealer relationships can either be fiduciary or ordinary business arrangements. The SJC held that the fiduciary duty rule “is of equal status to the common law” and may be used to “protect investors under MUSA.”
3. Nondelegation Doctrine
Robinhood claims that if MUSA allows the Secretary to adopt the fiduciary duty rule, it violates the nondelegation doctrine. According to the nondelegation doctrine, the Legislature cannot delegate the power to make laws. To assess this claim, three factors are considered: 1) whether the Legislature delegated fundamental policy decisions, 2) whether the law provides adequate direction for implementation, and 3) whether safeguards are in place to control abuses of discretion.
First, MUSA clearly establishes the fundamental policy decision to protect investors without delegating those decisions to the Secretary. Second, MUSA provides guidance for the Secretary to implement the law. Third, MUSA includes safeguards to prevent misuse of power by requiring the Secretary to confirm that any rule promulgated pursuant to MUSA is necessary for the public good or investor protection and in line with MUSA’s objectives. Therefore, the Secretary's adoption of the fiduciary duty rule is not a violation of the nondelegation doctrine.
4. Conflict Preemption
Lastly, Robinhood argues that the fiduciary duty rule violates the doctrine of conflict preemption because the rule conflicts with federal regulations, specifically the SEC’s Regulation Best Interest (“SRBI”), hindering the achievement of federal goals. The company suggests that the SRBI was meant to establish a ceiling on the fiduciary responsibilities of broker-dealers. However, the SJC found this to be a weak argument because “Congress and the SEC were aware of State laws imposing fiduciary obligations” and chose not to expressly preempt the laws when drafting regulations like SRBI.
SJC Holds that the Secretary Properly Promulgated the Fiduciary Duty Rule Under his Authority Granted Under MUSA
On August 25, 2023, SJC concluded the following:
The Secretary did not overstep his bounds of authority granted to him under MUSA;
The fiduciary duty rule does not overrule common-law protections for investors, as the MUSA authorizes the Legislature to enact additional safeguards that go beyond the scope of common-law protections without repealing them;
MUSA is a constitutional delegation of legislative authority and not a violation of the separation of powers, because the Secretary’s authority to “define the precise conduct or practices proscribed” does not empower him to resolve “fundamental policy decisions”;
The SEC’s application of a federal “best interest” standard of care to broker-dealers did not preempt the fiduciary duty rule, since Congress and the SEC, fully aware of such state laws imposing a fiduciary duty on broker-dealers, did not express any intent to preempt them.
Writing for the SJC, Justice Dalila Wendlandt stated that the Massachusetts Secretary properly applied MUSA’s fiduciary duty rule by extending the standard of care governing investment advisors to modern day broker-dealers such as Robinhood. In other words, MUSA granted the Secretary the authority to apply the fiduciary duty rule against Robinhood in order to protect mistaken investors from the increasingly blurred line between broker-dealers providing investment advice and investment advisers.
Conclusion
After the ruling handed down by SJC, Robinhood’s deputy general counsel and head of government affairs, Lucas Moskowitz, provided in a statement that they are “disappointed” in the court’s ruling but “remain committed” to providing their Massachusetts customers with the opportunity to continue accessing the stock-trading market. However, the Massachusetts Secretary of State has expressed that he seeks to revoke Robinhood’s state broker-dealer license.
Moving forward, Massachusetts investors who are active on day-trading apps and other similar online brokerage trading platforms can expect to be provided with the “highest protections” when receiving investment advice from broker-dealers.
*The views expressed in this article do not represent the views of Santa Clara University.