Robinhood decision eases way for state-level fiduciary rules for brokers

A Massachusetts court's decision against the popular online brokerage Robinhood has kicked the door open to other states imposing strict fiduciary responsibilities across all aspects of the wealth management industry.

The Massachusetts Supreme Judicial Court issued an opinion Friday striking down a lower court's decision finding the state's top securities officer had overstepped his authority by attempting to hold Robinhood Markets and other companies to the fiduciary obligation to always put clients' interests first. In most of the U.S., broker-dealers are expected instead to abide by what's known as Regulation Best Interest, often considered a weaker standard of investor protection.

Massachusetts' top court of appeals found in its decision Friday that Regulation Best Interest, also known as Reg BI, constitutes a "floor" that states are free to build on with stricter requirements rather than a "ceiling" limiting what they can do.

"State and Federal (regulatory) schemes have existed side by side since the Great Depression; and Congress repeatedly has expressed its intent to preserve the States' role in regulating securities," according to the court's ruling.

In imposing a fiduciary duty on brokers in March 2020, Secretary of the Commonwealth William Galvin argued that the federal Regulation Best Interest wasn't doing enough to protect residents of his state. He later accused Robinhood of using its popular online app to prod people into specific investments without regard for their individual circumstances and best interests.

"This landmark decision affirms the fiduciary duty of brokers to their customers and vindicates the role of my Securities Division to principally, but aggressively protect investors and police broker-dealer misconduct," Galvin said in a statement on Friday.

Lucas Moskowitz, the deputy general counsel and head of government affairs at Robinhood, said his firm is reviewing the court's opinion and considering its next steps.

"We are disappointed in today's decision and remain committed to providing access to the markets for our Massachusetts customers," Moskowitz said in a statement.

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Much of the Massachusetts Supreme Judicial Court's decision in the Robinhood case was rooted in the specific powers granted Galvin and his office by the Massachusetts Uniform Securities Act. Knut Rostad, the president of the Institute for the Fiduciary Standard, acknowledged other states' ability to follow Massachusetts' lead will depend on their individual statutes.

Still, Rostad said, many regulators outside Massachusetts have been eagerly awaiting the outcome in Galvin's case.

"This will give them an incentive to drill down and take a look at their own situations," he said.

Ben Edwards, a law professor specializing in securities regulation at the University of Nevada, Las Vegas, said in a conference call that he doesn't expect Friday's decision to prevent Robinhood from doing business in Massachusetts.

"It might change the way it behaves," Edwards said. "But I don't see it not being able to offer services in Massachusetts because of this."

Rich Kerr, a partner in the law firm K&L Gates' Boston office, predicted the consequences will reach farther. The court's decision that Reg BI is merely a regulatory floor "will cause broker-dealers to have to monitor the standard of care in each jurisdiction where they operate as opposed to adhering to a single standard, and may minimize investor options as broker-dealers choose to exit states with higher standards."

Robinhood's dispute in Massachusetts goes to the heart of a long-standing debate over whether investors would be better off if both sides of the wealth management industry — investment advisors and broker-dealers — were brought under a uniform code of conduct. In rejecting such calls for a single standard, the Securities and Exchange Commission instead adopted Regulation Best Interest in June 2019.

Regulators then argued the separate Reg BI would let broker-dealers continue offering investors access to a wider range of investment products and services than they could obtain strictly through the advisory model. Those who wanted long-term assistance with everything from stock picking to retirement savings and inheritance planning could go to a fiduciary advisor who would provide conflict-free advice for an easily understandable fee. 

Meanwhile, those who wanted help investing only in a single product — an annuity, say — could approach a broker and pay a one-time commission. As long as brokers disclosed what they were charging as required by Reg BI, they would not run afoul of any prohibition on conflicts of interest.

SEC regulators argued the system preserved the best of both worlds. Investors who wanted long-term advice could obtain it for a relatively low charge. And people who only wanted a single investing product through a broker wouldn't be stuck paying annual advisory fees.

But Galvin's office argued such distinctions are usually lost on the public. In adopting his state's fiduciary standard for broker-dealers, Galvin contended, "Since the SEC has failed to enact a meaningful conduct rule to protect working families from abusive practices in the brokerage industry, it has been left to my office to apply a real fiduciary standard on broker-dealers and agents in Massachusetts."

Groups supporting Galvin in court agreed that wealth managers operating under the broker-dealer model will always have conflicts with investor interests. Stephen Hall, the legal director and securities specialist at the market reform group Better Markets, said brokers who charge commissions have a fundamental incentive to make as much money as possible.

"At least in Massachusetts, important safeguards have been restored and other states should do the same," he said in a statement in response to Friday's decision.

In siding with Galvin over his state-level fiduciary standard, the Massachusetts Supreme Judicial Court lent credence to the idea that Robinhood and its imitators have been partially responsible for some of the confusion in the public mind between investment advisors and broker-dealers. Robinhood's industry-changing introduction of commission-free trading in 2013 led to an unprecedented upswell in the number of regular investors using brokerage services for stock trading and other activities.

This "Robinhood effect," as the court deemed it, also involved changes in marketing, service offerings and compensation methods. Increasingly, according to Galvin's arguments, investors have come mistakenly to believe "that the broker-dealers had a fiduciary obligation equal to investment advisers to act in their customers' best interests."

Galvin's office sued Robinhood in December 2020 over allegations that the brokerage's online trading system had not been providing adequate protection of its customers' interests. In an amended complaint submitted on April 15, 2021, Galvin accused Robinhood of violating Massachusetts' new fiduciary standard by its tendency to "gamify" stock transactions — giving its popular app video-game-like features meant to encourage frequent trading.

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He also accused Robinhood of not taking care to make sure investment options it was presenting to customers could reasonably be considered in their best interests. Galvin said he couldn't accept the argument that Robinhood was only presenting options rather than making actual recommendations.

"This is no different from a broker-dealer agent handing a list of securities to a customer, pretending to be surprised when the customer purchases securities from that list, and then proclaiming that he made no recommendations to that customer," Galvin argued in the brief. 

"Robinhood gave hundreds of customers with little or no investment experience the ability to make thousands of trades in a matter of months."

Robinhood filed a countersuit on April 15, 2021, arguing that Galvin had both superseded his state-granted authority in adopting a fiduciary standard for the brokerage industry and was undermining the federal-level Reg BI. Suffolk County Superior Court Judge Michael Ricciuti in Boston agreed with those arguments in a decision handed down in March 2022.

In overturning Ricciuti's decision, the Massachusetts Supreme Judicial Court rejected arguments that Galvin had overstepped the authority granted him by the state legislature. The Massachusetts Uniform Securities Act provides him with broad powers to protect investors from "unethical or dishonest conduct or practices."

The court also noted that Nevada put in place its own fiduciary rule for the broker industry in 2017, when the SEC was still debating Reg BI. Regulators could have decided when adopting Reg BI that the new federal standard would trump any existing state rules, according to the court. But they didn't take that step.

Friday's decision does not mark the end of Robinhood's dispute with the state of Massachusetts. It merely sends the case back to the Suffolk County Superior Court, where Robinhood will now have to prove that its business practices pass muster under the state's newly affirmed fiduciary standard.

"The rule that has been upheld by the Supreme Judicial Court today will give the highest protections to Massachusetts investors when brokers provide investment advice," Galvin said in his statement. "Now that the case has been remanded to the Superior Court, I look forward to moving on with our administrative case."