SEC Argues that Broker-Dealers Make Implied Representations

The SEC has filed an amicas curiae brief in the U.S. Court of Appeals for the Second Circuit arguing that broker-dealers make implied representations to their customers simply by operating as broker-dealers (aka the “shingle theory”). In the case, a failing broker-dealer repo’d and otherwise hypothecated customer margin securities held in nondiscretionary accounts without customer consent. The District Court ruled that the broker-dealer did not violate Section 10(b) because it made no express representations and was not a fiduciary. According to the brief, the SEC “has long held that by hanging out its professional shingle a broker-dealer makes the implied representation that it will treat customers ‘fairly, and in accordance with the standards of the profession.’” The SEC argues that all broker-dealers make an implied representation not to hypothecate margin securities without customer consent and to return such securities upon demand.

OUR TAKE: The “shingle theory” is a backdoor legal argument to essentially put a fiduciary duty on broker-dealers. Over the last several years, both FINRA and the SEC have broadly interpreted a BD’s standard of care to approach that of a fiduciary. It remains to be seen whether Congress will change the standard by legislation.

http://www.sec.gov/litigation/briefs/2009/cmsf0609.pdf