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Massachusetts Superior Court Strikes Down Overreaching Fiduciary Duty Rule

On March 30, 2022, in Robinhood Financial, LLC v. William F. Galvin, et. al., the Massachusetts Superior Court (Ricciuti, J.) struck down the recently adopted Fiduciary Duty Rule (950 C.M.R § 12.207), a state regulation that held brokerage dealers to the same fiduciary obligations as investment advisers when providing investment advice or recommendations to their customers.

In December 2020, the Massachusetts Secretary of State filed an Administrative Complaint against Robinhood Financial LLC, an institutional brokerage company with approximately 500,000 Massachusetts customers, alleging that several features of the broker-dealer’s business model are dishonest, unscrupulous, and unethical. Specifically, the Secretary alleged that Robinhood failed to comply with the Fiduciary Duty Rule and engaged in behavior that put its customers at risk.

Robinhood then filed an action in the Massachusetts Superior Court and sought an injunction against the Fiduciary Duty Rule in the administrative action, but the Superior Court did not issue the injunction. However, the Court allowed the parties to file cross-motions for judgment on the pleadings regarding the Rule. In its motion, Robinhood argued the Fiduciary Duty Rule was invalid both on its face and as it applied to Robinhood. It argued that (1) the Secretary exceeded his authority by imposing a rule that created a duty not recognized at common law as outlined by the Massachusetts Supreme Judicial Court; (2) that the Secretary exercised legislative authority in violation of the Massachusetts Declaration of Rights by adopting the rule, and (3) that the rule is preempted by federal law. Needless to say, the Secretary’s motion argued the exact opposite position on each issue.

The Court concluded that the Secretary’s adoption of the Fiduciary Duty Rule was beyond his authority. Under the common law, the scope of a broker-dealer’s fiduciary obligations to its customers is determined by the degree of discretion a customer entrusts to their dealer. If the account is non-discretionary, meaning the customer makes all of the investment decisions and the broker-dealer’s only role is to execute the customer’s orders, the relationship does not create any fiduciary duties. However, if the customer trusts the broker-dealer to select and execute transactions without the customer’s prior approval or direction, a fiduciary duty is created. A Court may look to other factors to support a finding that a broker-dealer assumed fiduciary obligations to its customers, such as the investment acumen of the customers or social/personal ties between the broker and its customer.

The Secretary argued that the Fiduciary Duty Rule did not conflict with the common law because it created a very narrow regulation that only applies if a broker-dealer provides a customer with advice or recommendations. The Court disagreed and held that such an interpretation was inconsistent with the common law since encouraging trust in an unsophisticated customer through advice and recommendations would not give rise to fiduciary obligations under the common law, but it would under the Fiduciary Duty Rule. Thus, it found the Fiduciary Duty Rule expands on the common law and subjects more broker-dealers to fiduciary obligations than the common law. The Secretary could not direct the Court to any case that allows an executive agency to override common law through regulation and, thus, the Court held that the Secretary exceeded his authority by promulgating the Fiduciary Duty Rule and declared the Fiduciary Duty Rule unlawful. The Court declined to address both the constitutional issue raised by the second issue and the Federal preemption question posed by the third. However, given the significant public policy implications, the Court stayed the order for the next thirty days to permit the Secretary time to pursue an appeal.

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