Measure to Impose Fiduciary Duty on Brokers and Dealers Backed by Professor John Coffee


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Washington, D.C., May 4, 2010—Proposed legislation that would impose a fiduciary duty on brokers, dealers, and investment banks to act in their clients’ best interests is backed by Professor John Coffee, who told a Senate panel Tuesday it fills a “fundamental hole” in financial reform bills now before Congress.
Coffee, the Adolf A. Berle Professor of Law at Columbia Law School, said such a measure could deter the conflicts of interest he said helped spark the financial meltdown in 2008.
“Except in a very few states, like California, broker-dealers owe no general fiduciary duty to clients,” Coffee told the Senate Judiciary Subcommittee on Crime and Drugs. “That defines the problem and that makes possible the continuation of serious conflicts of interest.” Click here to watch a webcast of the hearing.
Currently, investment banks and broker-dealers owe a much-lesser obligation to customers, Coffee noted. Known as “suitability rules,” they basically require only that recommendations given to an investor about a security are suitable given the investor’s financial position. In contrast to a fiduciary duty, however, they do not require a broker to act in the investor’s best interests. Coffee said that stricter standard is needed now.
“This is an idea that has been discussed for years, but whose time has come because of recent developments,” Coffee said in prepared remarks for the hearing. “My basic message is that a fundamental hole exists in the financial reform proposals now before Congress that this bill fills.”
Coffee said the need for this measure was heightened by the Securities and Exchange Commission’s suit against Goldman Sachs, which he said “raises serious issues about the level of integrity in our capital markets.” The SEC has charged Goldman with fraud by intentionally creating derivatives it knew would fail if the housing market went bust and not telling customers they were designed to fail.
Coffee told the committee that criticisms of the legislation as “vague” and “liability-laden” were a “laundry list of Chicken Little reasons.” In fact, he said, the statute is fairly narrow, in that it is limited to investment advice and the solicitation of purchases or sales. He also downplayed objections to a provision in the bill that would allow for criminal penalties for “willful violation” of a fiduciary duty.
“Willful violation, in the federal criminal law, means a conscious intent to defraud an investor and receive a gain at the investor’s expense,” Coffee said, and would not include negligence or bad advice.
Coffee, who believes that criminal penalties effectively deter white-collar crime, said tougher measures were needed to restrict practices that could injure capital markets and reduce investor confidence.
“Both to protect investors and to maintain market transparency and economic efficiency, the traditional norm that brokers should serve their clients and not seek to profit from their losses should be legislatively mandated,” Coffee said in his remarks.
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