Is the Shingle Theory Dead

I. IntroductionBroker-dealer liability to customers frequently is analyzed under the "shingle theory," whereby it is presumed that a broker-dealer that hangs out a shingle and solicits customers makes an implied representation of fair dealing.(1) Although breach of this representation has resulted in liability under the antifraud provisions of the federal securities laws, the shingle theory also can be justified by the obligation to adhere to just and equitable principles of trade under the rules of the securities industry's self-regulatory organizations. Part II of this article will discuss the development of the shingle theory and its variations.(2)After years of expanding the parameters of the antifraud provisions, the United States Supreme Court in 1975 began cutting back on liability under the antifraud provisions. This retrenchment has accelerated in recent terms, under both the implied and express liability provisions. Nevertheless, in cases involving regulated entities such as securities firms, the Court has not shown the same enthusiasm for eliminating liability for broker-dealers as for other types of defendants. Part III of this article will analyze the Supreme Court cases interpreting the antifraud provisions, emphasizing the requirements for scienter and a duty to speak under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and explaining the limits the Court has put on the use of other statutory sections for implying private rights of action.(3) Part IV of this article then will speculate concerning the continuing viability of the shingle theory under Sections 17(a) and 12(2) of the Securities Act of 1933 (Securities Act) and Section 15(c) of the Exchange Act, as well as under the controlling person provisions of both statutes.(4)Recent Supreme Court case law has cast considerable doubt on customers' ability to use the antifraud provisions to impose liability on broker-dealers. Ironically, however, most suits instituted by customers against broker-dealers now are prosecuted in securities industry self-regulatory arbitrations in which breach of just and equitable principles of trade can be the basis for recovery. Accordingly, the question has rarely arisen as to whether or to what extent Supreme Court cases have undermined the theoretical underpinnings for the shingle theory. Furthermore, while this article is being written, securities reform legislation is pending and may create an express right of action under Section 10(b) of the Exchange Act that may change the law in this area. Part V of this article will trace the developments pushing most customer-broker litigation into arbitration and will discuss the implications of proposed securities legislation.(5)The author's conclusion, explicated in Part VI of this article and based upon the logical conclusion of Supreme Court antifraud doctrine, is that the shingle theory is no longer a sound basis for civil liability to private parties under the antifraud provisions. Nevertheless, the Court may retreat from this conclusion because of its general policy view that the purpose of the federal securities laws is to police the securities industry.(6)II. The Shingle TheoryA. GenerallyA broker-dealer does not have the same relationship to all of its customers. If a firm exercises actual or de facto control over a customer's account because of a customer's trust and confidence, the broker may owe a fiduciary obligation to the customer.(7) In many situations, a broker-dealer deals with its customers at arm's length, and a fiduciary relationship may not exist. Some older cases stated, however, that broker-dealers impliedly represent that they will deal fairly with their customers, and, therefore, unfair dealing is a breach of this implied representation and a violation of the antifraud provisions.(8) This implied representation arises from the mere act of hanging up a shingle and going into business as a broker-deal, and, therefore, it is known as the "shingle theory. …