In its August 25, 2023 decision in Robinhood Financial LLC vs. Galvin, the Massachusetts Supreme Judicial Court (the "SJC") reversed a trial court's decision and validated a 2020 Massachusetts state regulation requiring broker-dealers (including those located outside Massachusetts) that provide investment recommendations or advice to retail customers in Massachusetts to comply with a defined fiduciary duty, bringing the fiduciary obligations of broker-dealers in line with those of investment advisers (the "Massachusetts Fiduciary Rule").
- Broker-dealers providing investment recommendations or advice to Massachusetts retail customers already have to comply with the SEC's Regulation Best Interest ("Regulation BI," described in a prior Ropes & Gray Alert) and will also need to comply with the Massachusetts Fiduciary Rule. These requirements apply even if the recommendation or investment advice is provided from outside Massachusetts, such as via the internet.
- The SJC's decision adds Massachusetts to the group of states that require broker-dealers to satisfy both Regulation BI and state-specified fiduciary obligations. For national broker-dealers having operations in Massachusetts, including those operating internet platforms, the decision further complicates compliance and increases associated costs.
Significantly, the litigation has focused to date on the legality of the Massachusetts Fiduciary Rule itself, and it has not yet addressed the crucial question of whether Robinhood's business practices as a "self-directed" brokerage firm involve providing investment recommendations or advice that could trigger application of the Massachusetts Fiduciary Rule.
Background to the Massachusetts Fiduciary Rule and the SJC's Decision
In 2019, the SEC promulgated Regulation BI to impose a standard of conduct requiring broker-dealers, when recommending any securities transaction or investment strategy involving securities to a retail customer, to act in the best interest of the retail customer at the time the recommendation is made. Regulation BI does not define the term "best interest."1 In determining what standard of conduct should apply to broker-dealers, the SEC opted not to apply the Advisers Act fiduciary standard to broker-dealers or to adopt a new uniform fiduciary standard that would apply to both broker-dealers and investment advisers.
The Secretary of the Commonwealth of Massachusetts, William F. Galvin (the "Secretary"), criticized Regulation BI when it was proposed by the SEC in 2018. In a comment letter to the SEC, the Secretary (who heads the Massachusetts Securities Division) urged the SEC to adopt a "strong uniform fiduciary standard" that would impose on broker-dealers a fiduciary duty to customers equal to that applicable to investment advisers. The Secretary's letter also stated that, if the SEC "does not adopt a strong and uniform fiduciary standard, Massachusetts will be forced to adopt its own fiduciary standard to protect our citizens from conflicted advice by broker-dealers."
In response to the SEC's decision not to impose a uniform fiduciary standard, the Secretary employed the notice-and-comment process required by Massachusetts law and promulgated the Massachusetts Fiduciary Rule in 2020.2 In general, as the SJC noted, the Massachusetts Fiduciary Rule brings broker-dealers' "fiduciary obligations when providing investment advice more in line with the standards applicable to investment advisors."3
Robinhood Financial LLC ("Robinhood") is a broker-dealer registered with the SEC and various states, including Massachusetts. Robinhood offers commission-free trading for stocks and options, does not require account minimums, and interacts with its customers through its website and mobile application. Instead of charging customers commissions for its services, Robinhood derives its revenues from other sources, including payments for order flow. At year-end 2020, Robinhood had more than 500,000 accounts owned by Massachusetts customers.
In December 2020, the Secretary filed an administrative complaint against Robinhood, alleging that several aspects of Robinhood's business model are "dishonest and unethical." In particular, the Secretary alleged that Robinhood provided investment recommendations to its internet customers without considering whether those recommendations were in the best interest of each customer who received the recommendation, and this conduct, the Secretary asserted, violated Robinhood's fiduciary duties of care and loyalty under the Massachusetts Fiduciary Rule. Robinhood denied the allegations, maintaining that, because it is a "self-directed" brokerage firm, it does not make investment recommendations or provide investment advice.
After the Secretary initiated the administrative proceeding, Robinhood brought an action in a Massachusetts trial court challenging the validity of the Massachusetts Fiduciary Rule. The trial court permitted the parties to file cross-motions for judgment on the pleadings on various questions, including whether the Secretary had exceeded his delegated authority because the Massachusetts Fiduciary Rule changed the scope under common law of a broker-dealer's fiduciary responsibilities to its customers. The scope of these duties had been defined by the SJC in a 2001 decision.4
The Massachusetts trial court issued its decision in March 2022,5 holding that the Secretary had exceeded his delegated authority and, on that basis, invalidated the Massachusetts Fiduciary Rule. The Secretary appealed the trial court's decision, and the SJC allowed Robinhood's unopposed application for direct appellate review.
The SJC conducted a de novo review of Robinhood's contentions in the trial court action, focused on the legality of the Massachusetts Fiduciary Rule.
Abrogation of the Common Law. The SJC highlighted that its 2001 decision establishing the common law duties of broker-dealers stated that the determination of the "scope of a [broker-dealer's] fiduciary duties in a particular case is a factual issue that turns on the manner in which investment decisions have been reached and transactions executed for the account." The relationship between a broker-dealer and a customer may be either a fiduciary or an ordinary business relationship and may require a fact-intensive inquiry. Accordingly, the SJC rejected Robinhood's assertion (and the trial court's holding) that the Massachusetts Fiduciary Rule changed the common law.
Federal Preemption. The trial court never reached Robinhood's contention that the Massachusetts Fiduciary Rule was preempted by Regulation BI. The SJC addressed the federal preemption issue and noted that, in the release adopting Regulation BI, the SEC "recognize[d] that there is substantial variation in the sources, scope, and application of state fiduciary law." Moreover, while the adopting release stated that "several commenters opined that the Commission should preempt (or avoid preempting) state law," the SEC declined the opportunity to indicate whether it believed or intended Regulation BI to preempt state laws. Instead, the SEC stated:
We note that the preemptive effect of Regulation Best Interest on any state law governing the relationship between regulated entities and their customers would be determined in future judicial proceedings based on the specific language and effect of that state law.
Robinhood asserted that the SEC intended Regulation BI to set a ceiling on broker-dealers' fiduciary obligations in order to preserve access by retail investors to investment options that may no longer be economically feasible for broker-dealers to offer if they are required to comply with different fiduciary standards in all 50 states.6
The SJC noted that, in the absence of an express intent by the federal government to preempt state law, Robinhood's preemption argument was particularly weak because Congress and the SEC "were aware of State laws imposing fiduciary obligations on broker-dealers and declined to express an intent to preempt those laws."
The SJC observed that Robinhood's preemption argument rested upon the doctrine of "conflict preemption," which may occur where a state regulation would frustrate the objectives of a federal rule.
The SJC stated that Robinhood's theory of conflict preemption relied upon the SEC's decision not to impose a uniform fiduciary duty standard and the SEC's statement in the adopting release that Regulation BI:
balances the concerns of the various commenters in a way that will best achieve the Commission's important goals of enhancing retail investor protection and decision making, while preserving, to the extent possible, retail investor access (in terms of choice and cost) to differing types of investment services and products. (Emphasis added by the SJC).
The SJC rejected Robinhood's conflict-preemption theory (i.e., retail investor access), stating that "[a]s both Congress and the SEC have made clear, the central 'purposes and objectives'. . . of Federal law as it pertains to broker-dealer standards are to improve investor protection." Therefore, the Court stated, "we conclude that the Regulation Best Interest constitutes a regulatory floor that does not foreclose State regulation to more clearly protect investors."
The SJC rejected Robinhood's other arguments and reversed the judgment of the trial court, upholding the validity of the Massachusetts Fiduciary Rule.
Broker-dealers providing investment recommendations or advice to retail customers in Massachusetts will have to comply with Regulation BI and with the Massachusetts Fiduciary Rule. These requirements apply even if the investment recommendation or advice is provided from outside Massachusetts via the internet.
The SJC's decision validates Massachusetts as one of the handful of states that require broker-dealers to satisfy both Regulation BI and state-specified fiduciary obligations, which are not uniform.7 For national broker-dealers, including those operating internet platforms, the decision further complicates compliance and increases associated costs in states that impose obligations, like the Massachusetts Fiduciary Rule, that extend beyond Regulation BI's obligations. Particular attention will be required to assess what sorts of communications by broker-dealers regarding investment opportunities to retail investors can be construed as investment recommendations or advice subject to heightened state-level standards. For example, in Robinhood's case, the Secretary claimed Robinhood had encouraged frequent, risky, and unsuitable trading by retail investors, published investment categories like "100 Most Popular" or "Top Movers," implemented strategies to incentivize customer engagement with its trading platform, and that each of these practices was tantamount to making investment recommendations to customers. Robinhood's defenses to these arguments have yet to be addressed by the trial court or in the Secretary's administrative proceedings – as the litigation to date has focused on the legality of the Massachusetts Fiduciary Rule itself, not its application to Robinhood's business.
More generally, the SJC's reasoning regarding the legality of the Massachusetts Fiduciary Rule – that Regulation BI sets a floor rather than a ceiling, and leaves the door open for other state regulators to set more demanding standards applicable to broker-dealers operating in their states – raises a substantial threat of the very "patchwork of inconsistent state-level standards" of which Former Chair Clayton warned. Further litigation in other state or federal jurisdictions may seek to challenge this reasoning.
1. Instead, whether a broker-dealer acted in the best interest of its customer is determined by an objective consideration of the facts and circumstances of how the specific components of Regulation BI were satisfied.
2. 950 Code Mass. Regs. § 12.207 (2020).
3. The Massachusetts Fiduciary Rule deems it “unethical or dishonest conduct or practices” under the Massachusetts Uniform Securities Act for a broker-dealer to “fail to act in accordance with a fiduciary duty to a [retail] 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.” 950 Code Mass. Regs. § 12.207(1)(a).
4. See Patsos v. First Albany Corp., 433 Mass. 323 (2001).
5. Robinhood Financial LLC v. Galvin, 2022 Mass. Super. LEXIS 19, 2022 WL 1720131 (Mar. 30, 2022).
6. At the June 5, 2019 SEC meeting at which Regulation BI was adopted, then SEC Chair Jay Clayton noted the “potential patchwork of inconsistent state-level standards” and stated that he was “hopeful that our regulatory colleagues will continue to work with us to minimize inconsistencies and maximize the effectiveness of our collective efforts.” Chair Clayton's statement is available here.
7. Not only is the standard of care required by the Massachusetts Fiduciary Rule different from that of Regulation BI, the definition of “customer” for purposes of the Massachusetts Fiduciary Rule does not fully align with the definition of “retail customer” in Regulation BI.
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