The Clients’ Waiver of Their Rights Under Regulation BI of the Securities and Exchange Commission

Posted in: Business Law

The Securities and Exchange Commission (SEC) recently passed Regulation Best Interest (Regulation BI), which imposes on broker-dealers a commitment to act in the best interests of their clients. This rule was negotiated and is quite detailed. After the rule was passed, the SEC was asked: “Can a retail customer waive the protections of Regulation Best Interest? For example, could a non-professional legal representative certify or otherwise represent that it is not relying solely on the advice of the broker-dealer in advising a natural person, in order to be excluded from the definition of ‘retail customer’ of the broker-dealer?”

The answer to this inquiry, posted February 11, 2020, was:

No. A broker-dealer must comply with Regulation Best Interest. A failure to comply with all four component obligations is a violation of Regulation Best Interest, and a retail customer, which includes a natural person or her non-professional legal representative, cannot waive or agree to waive the protections afforded under Regulation Best Interest.

Thus, the client-investors cannot effectively promise not to enforce their rights under Regulation BI. This waiver, unlike another free consensual agreement, is unenforceable. Could the broker-dealer induce or accept the client’s waiver of these duties under this Regulation? The SEC answered the query clearly: Such a waiver is unenforceable. That is because the details of the service to the retail client are not known. There is a difference between a general waiver and a waiver of a particular arrangement that might pose conflicts of interest.

A general waiver of the kind that was rejected by the SEC is not unique to brokers. It has been exercised and discussed by other fiduciaries, such as lawyers. For example, a case in California posed the following question: May an attorney, who is also licensed as a real estate broker, act in both capacities on behalf of a client in connection with the purchase of real property? If an attorney may act in both such capacities, is it ethically proper for the attorney to enter into a fee agreement with the client whereby the attorney is compensated by either sharing in the real estate broker’s commission if the transaction is consummated or at the attorney’s usual hourly rate if the transaction, is not consummated?

The answer:

An attorney may ethically act as an attorney and licensed real estate broker in the same transaction. However, the attorney must at all times conform to the standards of both professions and, to the extent that those standards are in conflict, the attorney must at all times conform to the standards of the State Bar of California. As a result, there are substantial risks for the attorney/broker.

Thus, the answer in this case makes it clear that the fiduciary duties of the attorney both as a legal adviser and as a broker must be preserved.

The answer of the SEC may be viewed to some extent stricter than the law governing fiduciary relationships. Under the current general fiduciary law, a fiduciary may not act for a client when the fiduciary has conflicting interests with those of the client. If he or she does have such a conflicting interest the fiduciary must disclose it to the client. The client may then either consent to the conflict or refuse to consent. If the client does not consent to the conflicts, the fiduciary may not act under these conflicting interests.

There are important factual differences between the cases mentioned above. These differences are that: (i) Under the proposed waiver, the client has a very general idea about the conflicting possibilities because they do not arise currently with his signature; and (ii) the client may not understand the practical nature of the conflicts and the resulting harm that the client might suffer. The main difference between these waivers and the law is that the waivers are general—not about specific situations. The waiver changes the entire law in advance.

The law allows conflicting interests when the client receives the details of the current conflicts and can then presumably seek the advice of a third party or evaluate the current results of such conflict. In the case of general waiver that is impossible to do unless the client says: NO automatically to any waiver. That may not reflect the reality, however. Let the adviser tell the client (i) when the conflict arises (ii) the details of the conflict and its impact on the client. Then, and only then, could the client provide an informed waiver or say: YES or NO.

On the other hand, the SEC goes further than the general fiduciary law has gone. It prohibits any waiver of the broker-dealer’s conflicting interests. The result is to expose brokers who serve their clients in conflicts of interest to the clients’ claims, according to the law. The SEC is apparently wary of brokers’ attempts to change fiduciary law and introduce an innovative release from conflicts of interest before they actually occur, and it has foiled this latest attempt of brokers to prospectively evade clients’ claim of conflict of interest. That brokers attempted it at all may be problematic for some people. We may hope that such attempts in various forms will never be made in the future.

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