THAT DEPENDS - TO SOME THEY DO AND TO SOME THEY DON’T
Full service securities brokerage firms owe their clients certain fiduciary duties. They have an obligation to clients to whom they offer investment advice or recommendations, to make reasonable efforts to assure that their investments are “suitable.” They also have a duty to monitor the client’s investments on an ongoing basis and warn the clients of any undue risks.
Discount brokers, on the other hand, make no recommendations and therefore, take the position that they owe their clients no duties other than to execute trades in accordance with the clients’ instructions. Thus, when a discount broker permits a client to commit “economic suicide” by making wholly unsuitable or extremely risky investments or over-trading the account, the broker can avoid liability by claiming it had no duty to monitor the client’s investments or warn him of their unsuitability or riskiness.
In support of this position, discount brokers usually cite two leading cases, de Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 1302 (2d Cir.2002) and Stewart v. J.P. Morgan, 2004 U.S. Dist. LEXIS 16114, (S.D.N.Y. 2004).
However, a careful reading of those cases shows that they contain important exceptions to the rule granting discount brokers immunity from fiduciary obligations to their clients. In de Kwiatkowski, the Second Circuit Court of Appeals noted that “[i]t is uncontested that a broker ordinarily has no duty to monitor a nondiscretionary account or to give advice to such a customer on an ongoing basis” (emphasis supplied). However, as the Court explains, when the client has “impaired faculties” or is “lacking in sophistication” the ordinary rule does not apply and “[t]he law thus imposes additional extra-contractual duties on brokers who can take unfair advantage of their customers' incapacity or simplicity.”
In Stewart v. J.P. Morgan, the Court citing de Kwiatkowski noted that ordinarily a discount broker has no fiduciary duties between trades; however, where “special circumstances” are present, the broker has enhanced fiduciary duties. Stewart explains that “special circumstances” include when “the client is prevented by ‘impaired faculties’ or extreme lack of sophistication from understanding the basics of trading and thus simply lacks the capacity to handle such an account.”
Implicit in de Kwiatkowski is that when “special circumstances” are found, the broker has as part of his heightened duties, a duty of care that encompasses the duties to render market advice and issue risk warnings, and the duty to determine the suitability of the client’s investments on an ongoing basis.
Beckstrom v. Parnell, 730 So.2d 942 (La. App. 1 Cir., 1998) illustrates when heightened fiduciary duties comes into play and how they are applied. In Beckstrom, the court held that even with a self-directed account, a securities broker had a continuing duty to investigate a client’s competence and ability to direct the account and that where such competence was called into question, he had a duty to advise the client regarding the suitability of his investments.
Backstrom involved a suit by the children of Ewald Beckstrom, who was deceased, against Steven Parnell and Morgan Keegan & Co. relating to Mr. Backstrom’s investments in several bond funds. Mr. Beckstrom had been an accountant and a retired vice president at a Fortune 500 company when he opened his account with Mr. Parnell in 1983. Mr. Beckstrom had been a sophisticated investor with extensive experience in the stock market. He maintained a non-discretionary account with Mr. Parnell at Morgan Keegan and directed all of the trading in it. However, over several years, his health began to deteriorate and he developed a drinking problem. In 1986, after he was in a car accident, he opened a joint account with his daughter and gave his daughter a power of attorney. In 1988, after Mr. Beckstrom suffered a stroke, he ceased directing the account and his daughter took over this function.
One of the issues which the Court focused on was whether the defendants owed Mr. Beckstrom a heightened fiduciary duty before he suffered the stroke. Here is how the court described the positions of the parties:
The plaintiffs alleged that Mr. Beckstrom was impaired because of his drinking and advanced age. They assert that Mr. Parnell either knew, or should have known, of this impairment and that Parnell entered into trades for Mr. Beckstrom which he knew, or should have known, would be unsuitable … They further contend that Mr. Parnell breached his fiduciary duty by failing to disclose material facts to Mr. Beckstrom [and his daughter]. . . . The crux of plaintiffs' argument is that Mr. Beckstrom was not capable of understanding the full financial impact of the trades based on the extent of information provided by Mr. Parnell . . .
On the other hand, the defendants contend that Mr. Beckstrom was fully aware of the financial consequences of the trades and chose to pursue them for other valid reasons. Defendants argue that Mr. Beckstrom was a very sophisticated investor and was informed of the status of his non-discretionary account through confirmation slips mailed within one day of each transaction and through his monthly account statements.”
In support of defendants’ position, Mr. Parnell testified that he was not aware that Mr. Beckstrom was impaired, that he did not believe that Mr. Beckstrom was incompetent before the stroke, and that he had never seen Mr. Beckstrom drink.
The Court held for the plaintiffs, reasoning as follows:
It is not disputed that Mr. Beckstrom had been a sophisticated and knowledgeable investor at one time and that he had directed all the trades in his Morgan Keegan account. The pivotal issue before us involves Mr. Beckstrom's capabilities as an investor as of the time that the investment decisions [before the stroke] and Mr. Parnell's professional responsibility in dealing with a man whose physical and mental capacity had deteriorated. In this regard, we note that no matter how skilled an investor Mr. Beckstrom demonstrated himself to be by past actions, age of the investor and alterations in behavior must force a broker to constantly challenge his/her reliance on the investor's history. (emphasis added).
The court concluded that a broker, in dealing with an impaired customer, had a fiduciary duty to explain to him in detail the risks associated with the customer’s investment strategy, to make sure that the client was fully informed before each trade and to obtain an acknowledgement in writing that he had done so.
The trial court then concluded that the burden shifted to the defendants to establish that Mr. Beckstrom was fully informed. The lack of written confirmation of Mr. Parnell's disclosures to Mr. Beckstrom led the court to conclude that the defendants had not sustained their burden of proof.
The court also noted that the inappropriate trades that the client was engaged in by themselves should have put the broker on notice of the client’s diminished capacity:
The shocking terms of this deleterious trade should have reasonably put a broker on notice that the client's capability, and the financial relationship had changed. The fact that the trade comprised the entirety of Mr. Beckstrom's stock portfolio renders the broker's passive response particularly egregious.
Notably, the Court placed no significance on the fact that during the period in question while Mr. Beckstrom was directing the account, he had a joint account with his daughter or that she had a power of attorney.