Fiduciary duty is the legal obligation for one person to act in the best interests of another person. A fiduciary is someone who or an entity that has the obligation to act in the best interest of another.
When people are placed in positions of trust and power, they should be held to higher ethical standards. When people are legally required to adhere to higher ethical standards, itâ€™s known as having a fiduciary duty.
Fiduciary duty is a concept that applies in certain financial, legal, corporate and real estate regulations. In this guide, weâ€™ll look at just what it means to follow a fiduciary duty and how it could apply to the people who are managing your money.
When someone accepts fiduciary duty, not only do they agree to handle certain tasks for their client, they also agree to put the clientâ€™s interests ahead of their own. Since a fiduciary is legally bound to put their clientâ€™s interests first, they can face legal consequences if they donâ€™t do so.
In a fiduciary arrangement, there are two parties: the fiduciary, who is the professional providing a service; and the beneficiary, the client who is being aided by the fiduciary.
The fiduciary could be managing the beneficiaryâ€™s money or assets, representing them in a transaction or legal case, or even agreeing to take care of them personally, like a guardian watching over minors.
When it comes to managing your money, a financial advisor who is bound by fiduciary duty must take actions and advise you honestly and in good faith.
In a recent speech clarifying new fiduciary rules and standards for the financial industry, SEC Chairman Jay Claton described fiduciary duty for advisors as being met this way: â€śThe general obligation is satisfied only if the broker-dealer complies with the four specified component obligations: disclosure, care, conflict of interest and compliance obligations.â€ť
In order to meet these fiduciary duty obligations, a financial advisor should:
When youâ€™re dealing with a trained financial professional, chances are there will be a gap in how much you know about rules versus what they know. As a result, the advisor has the potential to negotiate unfair terms or recommend overpriced products without you realizing it.
Since youâ€™re trusting the advisor with your savings and your future, itâ€™s unsettling to think they wouldnâ€™t put your interests first. Thatâ€™s why Karl Hicks, a financial advisor and CFP from California, believes that fiduciary duty is essential for all financial advisors.
â€śI feel the fiduciary duty is important to our profession because of the nature of the work. When you state that you are a professional making a clientâ€™s life better, and particularly charging them a fee to do so, I think being a fiduciary should be the minimum requirement. People are putting their trust in you and their faith.â€ť
Just because someone is a financial advisor doesnâ€™t mean they are required by law to follow fiduciary duty. While there are regulations preventing outright illegal behavior â€” like an advisor stealing a clientâ€™s money or lying about the terms of an investment â€” the high bar of fiduciary duty is not always in force.
Non-fiduciary investment advisors need to meet something called a suitability standard. Suitable product recommendations need to make sense for your situation, but they donâ€™t need to necessarily be the very best available. For example, an advisor might recommend a product thatâ€™s slightly less advantageous for their client because they earn a higher commission from it. This would be against fiduciary rules, but acceptable behavior for an advisor following the suitability standard.
Harold Pollack, financial author and professor at the University of Chicago, supports a new rule that would make a fiduciary standard apply to all advisors. Not only would it help clients, it would also make the industry fairer.
â€śThe rule helps maintain a level playing field in which professionals who charge transparent fees for valuable services and advice do not face unfair competition from others who receive hidden compensation from third parties or who charge hidden fees for unnecessary services,â€ť said Pollack.
For now, some advisors may willingly agree to work as a fiduciary in order to stand out from the competition but others do not. Thatâ€™s why when you meet with a new advisor, this should be one of the questions to ask before signing on. There are also certain types of advisors that need to follow fiduciary duty as part of their designation, which we cover below.
The CFP Board is a nonprofit that looks to set higher professional standards for the financial planning industry, beyond what is required from the state regulatory agencies. Advisors who meet these standards can use the CFP designation and this will show up when you check their qualifications.
In order to become a CFP, an advisor must complete an extensive financial course approved by the CFP Board, pass an examination showing theyâ€™ve mastered the concepts, have at least 4,000 hours of professional experience and meet the CFP Boardâ€™s ethical standards, which includes fiduciary duty. If an advisor fails to meet any of these conditions, including not meeting their fiduciary duty, then they cannot classify themselves as a CFP.
If you meet an advisor with this designation, you can feel more confident in their fiduciary responsibility since they are being monitored by an additional nonprofit on top of the government agencies.
Registered investment advisors are another type of advisors for your financial life. RIAs enroll with the SEC or a state securities agency. The employees of an RIA, referred to as investment advisor representatives (IARs), meet with clients to discuss investments. Part of this registration means agreeing to tougher ethical standards than those asked of regular brokers. This used to mean agreeing to fiduciary duty, but a recent SEC ruling may have weakened the rules.
Before, RIAs needed to actually sign a document with clients binding them as fiduciaries. But now, they just need to sign a document saying they will put their clientsâ€™ â€śbest interests first.â€ť While that language is similar, it does hold an RIA to a slightly weaker standard. If you meet with an RIA, consider asking whether they would still meet a fiduciary standard or not.
Besides certain financial advisors and RIAs, other professionals follow fiduciary duty:
These are some of the most common examples. In all of them, you can see the fiduciary is in a position of power and trust, so they need to hold themselves to a very high standard to protect the other people.
Hicks pointed out that since so many different types of professionals can call themselves an advisor for different types of financial work, the actual enforcement depends on how the financial advisor is licensed. It may be:
If you think an advisor has acted inappropriately and youâ€™d like to report an issue, you need to consider how they are licensed, what type of transaction went wrong and the state where the advisor is located to figure out who you can turn to for enforcement.
A breach of fiduciary duty is when a financial advisor fails to put their clientâ€™s interest above their own. Naturally, cases of outright fraud or other forms of misconduct would be a breach and these are considered outright violations by the government regulatory agencies like the SEC. But there can be grey areas as well based on how an advisor is compensated.
â€śOne classic breach of fiduciary duty would for a financially-conflicted professional to steer a consumer towards a suitable investment product that is obviously over-priced relative other available products known to the financial professional but not known to the consumer,â€ť said Pollack. â€śFor example, they might recommend a total stock market index fund with an annual expense ratio exceeding 1%, when the same product is readily available from major vendors with an expense ratio below 0.2%.â€ť
While this is a breach of fiduciary duty, it could end up being legal depending on the terms of the financial advisor.
If what the advisor did was against the law, like they stole money or made unnecessary trades to drive up fees, then you could file a formal complaint with the SEC or another regulatory agency. That way you could seek damages to recover fees and other money lost from improper activity.
But what about the gray area breaches of fiduciary duty, like an advisor recommending a second-best but still suitable investment? In this case, it all depends on whether the advisor agreed to meet the fiduciary standard. If so, you could then file a complaint with the SEC or other government agencies along with the CFP board for CFPs.
But if the advisor did not agree to the fiduciary standard, then you might not have any recourse. This leads to some situations where even though an advisor acted clearly inappropriately, the client still wasnâ€™t able to take action.
Considering risks like this, itâ€™s one more good reason to use a fiduciary to manage your money.
With the potential for abuse, you would think that fiduciary duty would be a requirement for any financial advisor. But thatâ€™s just not the case just yet. However, things could be changing thanks to new government regulations. For more information, check out the second part of our series where we cover the various past and present fiduciary rules launched to tackle this issue.
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