July 15, 2010

The Dodd-Frank Act: Implications for Private Litigation

After the stock market crash of 1929, Congress empowered individual investors to sue for misrepresentations and other misconduct in connection with the issuance and sale of securities. Securities fraud litigation exploded from there.

This time, Congress has largely chosen not to empower private parties to enforce the rules designed to prevent a repeat of the last three years. There are, however, three notable areas in which the Dodd-Frank Wall Street Reform and Consumer Protection Act has the potential to change the landscape of private litigation.

Private Action Against Credit Rating Agencies

The Act provides that investors who purchase rated securities can sue credit rating agencies such as Moody's, Standard & Poor's, and Fitch for knowing or reckless failure to conduct a reasonable investigation in the securities they rated or to verify information provided to the agency. Also, credit rating agencies are now subject to the same potential liability faced by accountants, appraisers, and other experts for false or misleading statements in connection with securities registration statements. The largest credit rating agencies had previously been exempt from such liability.

Potential Nullification of Arbitration Provisions in Certain Contracts

With the Act, no residential mortgage loan may include terms that require arbitration in lieu of suing in court. Arbitration provisions in employment or other agreements will no longer be enforceable with respect to a whistleblower's claim of retaliation. Both the SEC and the Bureau of Consumer Financial Protection will study arbitration provisions in investor and consumer agreements. The SEC may prohibit or limit arbitration provisions in agreements between customers and brokers and dealers. The Bureau will have the same authority with respect to arbitration provisions in agreements for a consumer financial product or service.

Potential Change in Fiduciary Duty Standard for Broker Dealers

The SEC may now promulgate rules to impose a heightened fiduciary duty on brokers and dealers who give personalized investment advice. Brokers and dealers must currently assure the transactions they perform are "suitable" for customers, while investment advisors are required to act in the best interest of the customer. The SEC now has the power to promulgate rules that establish that brokers and dealers have the same fiduciary duties as investment advisors when brokers and dealers provide investment advice. If the SEC imposes more stringent standards of care, broker-dealers could find themselves more susceptible to litigation when investments go south.

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