Robinhood: Massachusetts fiduciary rule could quash broker-dealer industry

By seeking to ban the conflicts of interest that are inherent to broker-dealers' business models, Massachusetts securities officials could end up making their state inhospitable to the industry.

So argued a lawyer representing Robinhood Markets in a case brought before the state's high court on Wednesday. Amy Mason Saharia, a partner at Washington, D.C.-based Williams & Connolly representing Robinhood, portrayed Massachusetts' adoption of a fiduciary rule for broker-dealers in February 2020 as a frontal assault on the brokerage industry.

The rule, Saharia argued, will make it "difficult to retain the traditional broker-dealer model because it could be construed to require complete elimination of conflicts of interest."

The case before Massachusetts Supreme Judicial Court arose from Secretary of the Commonwealth William Galvin's decision in December 2020 to sue Robinhood over allegations that the brokerage's online trading system was in violation of his state's new fiduciary rule. 

In an amended complaint submitted on April 15, 2021, Galvin accused Robinhood of not taking care to make sure the investment options it was presenting to customers could be reasonably deemed in their best interest. It was no excuse, he said, that no one at Robinhood had explicitly told an investor to buy a given stock.

"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 then argued. 

Massachusetts' fiduciary standard was adopted largely in response to concerns that federal regulators weren't doing enough to help the investing public sort the differences between brokers and investment advisors. Robinhood responded to Galvin's initial legal action with a countersuit arguing he had exceeded his statutory authority with the state-level fiduciary rule.

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A Superior Court judge in Boston agreed in March 2022, striking down the standard. Galvin's office presented oral arguments in its appeal of that decision on Wednesday.

Saharia told Massachusetts justices that federal regulators have specifically rejected proposals to place wealth managers of all stripes under a single fiduciary standard because they want to preserve investors' current ability to choose to work with either investment advisors or brokers. Having one rule for the entire industry, as Massachusetts regulators want, would eliminate that choice, she said.

The Robinhood case goes to the heart of a longstanding debate over whether investors would fare better if brokers and advisors were both treated as fiduciaries. Proponents of fiduciary rules consider them the gold standard of conduct governance, requiring wealth managers to always put clients' interests first and avoid conflicts of interest.

But the Securities and Exchange Commission has rejected calls to make everyone in the industry a fiduciary. The federal Wall Street regulator instead decided in June 2019 to adopt a different rule, known as Regulation Best Interest, for broker-dealers. Regulation Best Interest, or Reg BI for short, places an emphasis on disclosing conflicts of interest rather than eliminating them.

Saharia said some conflicts are inherent to the way broker-dealers do business. Brokers, for instance, will often receive a commission in return for carrying out a stock transaction on behalf of a client, giving them an incentive to trade as frequently as possible.

Reg BI seeks to mitigate those conflicts by insisting that broker-dealers only make trades that can be reasonably deemed to be in clients' best interest. It also calls on brokers to present alternatives to any investment they might recommend.

Broker-dealer advocates argue investors who want to make a solitary stock trade or similar transaction benefit from being able to get that done by paying a broker a one-time commission. Otherwise, they'd find themselves working with fiduciary advisors who charge set fees regardless of how much work they do on behalf of clients.

If Massachusetts' fiduciary rule were adopted, Saharia argued, the result would be "fewer broker-dealers offering a broker-dealer model."

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Phoebe Fischer-Groban, a lawyer representing Galvin's office, countered that nothing in the SEC's adoption of Reg BI precludes states from going further with their regulations for the brokerage industry.

"Many states … already hold broker-dealers to a higher standard," she said.

A brief on the case from the Public Investors Advocate Bar Association, which represents investor interests, notes at least 20 states that subject brokers to some sort of fiduciary rule. They include some of the most populous U.S. states, such as California, Texas and Florida.

Meanwhile, "The states that have expressly stated that there are no fiduciary duties between securities broker-dealers and their customers are outliers," according to the brief. "Only a few such states, such as Arkansas, Hawaii, Montana, and Washington, have made any such finding."

The North American Securities Administrators Association, which represents state and provincial regulators in the U.S., Canada and Mexico, contended in its own brief: "State and federal securities regulators share responsibility and authority to regulate the conduct of broker-dealers."

Many of the arguments presented Wednesday centered on the separate question of how far Galvin is allowed to go under the Massachusetts Uniform Securities Act in adopting new rules for the industry. Robinhood argued in its own brief that the state act limits Galvin to promulgating regulations that are in line with existing industry standards. Galvin's office countered in its own brief that it was explicitly entrusted through the act to do what is necessary to protect investors.