Roger Wohlner is a writer and financial advisor with over 20 years of financial services experience. He writes about financial planning for Wealthsimple and for a number of financial advisors. His work has been published in Investopedia, Yahoo! Finance, The Motley Fool, Money.com, US News among other publications. Roger owns his own finance blog called 'The Chicago Financial Planner'. He holds an MBA from Marquette University and a Bachelor’s degree with an emphasis on finance from the University of Wisconsin-Oshkosh.
The term fiduciary has been prominent in the financial news media in recent years, both because of the implementation of the Department of Labor’s Fiduciary rules under the Obama administration and the subsequent repeal of those rules by the Trump administration. Let’s take a look at the term fiduciary and shed some light on what it means to be a fiduciary.Finances can be complicated, we make them simple. And offer low fees and friendly financial advice along the way. Use our state of the art technology to get started investing.
What is a fiduciary?
One definition is a fiduciary is: a person or organization, who, acting in the best interests or another person or organization, is charged with managing assets on behalf of that individual or organizational client. A fiduciary is ethically, and likely legally, bound to make recommendations that are in the best interests of those to whom they have a fiduciary obligation.
There are a number of more specific definitions that align with various types of roles in which there is a fiduciary relationship between the professional providing services and their client.
The Fiduciary Rule mentioned at the top of the article was a set of rules from the DOL governing the conduct of financial advisors and financial services firms specifically pertaining to retirement accounts like IRAs. There were a number of disclosure clauses and a “best interest” rule that advisors were required to follow.
For example, when suggesting that a client roll their 401(k) into an IRA account upon leaving an employer, there were a number of disclosures that would have been required of the advisor.
Most of the discussion so far has been, and will continue to be, about the fiduciary relationship between a financial advisor and their clients. Fiduciary relationships go beyond this, however.
The meaning of fiduciary duty
A fiduciary must act in the best interests of those for whom he or she owes a fiduciary standard of care. This means that the fiduciary must put the interests of those to whom he or she has a fiduciary obligation first.
In the case of a financial advisor, this means that their advice and any recommendations must be made with the best interests of their clients in mind.
The dictionary definition of fiduciary is:
“Fiduciary relationships often concern money, but the word fiduciary does not, in and of itself, suggest financial matters. Rather, fiduciary applies to any situation in which one person justifiably places confidence and trust in someone else and seeks that person’s help or advice in some matter. The attorney-client relationship is a fiduciary one, for example, because the client trusts the attorney to act in the best interest of the client at all times. Fiduciary can also be used as a noun for the person who acts in a fiduciary capacity, and fiduciarily or fiducially can be called upon if you are in need of an adverb. The words are all faithful to their origin: Latin fidere, which means “to trust.”
There are a number of relationships where one party has a fiduciary relationship to the other in business, finance and other areas.
Who has fiduciary responsibilities?
Examples of Fiduciary Relationships
There are many examples of fiduciary relationships in business and financial settings.
A trustee of an estate will generally have a fiduciary relationship with the beneficiaries of the estate in whose benefit the trustee is supposed to act. The trustee’s actions should be governed exclusively by what is best for the trust beneficiaries.
Directors of a corporation have a fiduciary duty towards the corporation’s shareholders. Their actions should be consistent with the goal of increasing shareholder value. Any sort of dealings that might enrich the directors at the expense of the shareholders could be considered a breach of their fiduciary duty.
The sponsors of a workplace retirement plan like a 401(k) or a pension have a fiduciary obligation to the participants in the plan. This fiduciary relationship is governed by the DOL’s ERISA rules. This means that all aspects of the retirement plan must be put in place with the best interests of the plan participants in mind. There have been a number of lawsuits in recent years brought by participants against plan sponsors for a number of reasons, quite often surrounding high cost investments offered by the plan. In a number of cases it was alleged these investments were offered due to conflicts of interest or other reasons.
Someone who is appointed to be the legal adult guardian of a minor child is responsible for the child’s welfare and must act in the child’s best interests.
In some cases, a financial or investment advisor is considered a fiduciary.
In the context of being a financial advisor, the question of who is and who isn’t a fiduciary can be complex.
Some financial advisors do have a fiduciary responsibility to act in the best interests of their clients, and some don’t. This is complicated and not always clear to clients.
Many fee-only financial advisors who are members of certain professional groups or networks do pledge to act in their client’s best interests. The National Association of Personal Financial Advisors (NAPFA), The Garret Planning Network and the XY Planning Network are three examples. NAPFA member advisors are required to sign a fiduciary and reaffirm that oath on a periodic basis for example.
The NAPFA fiduciary oath reads as follows:
“The advisor shall exercise his/her best efforts to act in good faith and in the best interests of the client. The advisor shall provide written disclosure to the client prior to the engagement of the advisor, and thereafter throughout the term of the engagement, of any conflicts of interest, which will or reasonably may compromise the impartiality or independence of the advisor. The advisor, or any party in which the advisor has a financial interest, does not receive any compensation or other remuneration that is contingent on any client’s purchase or sale of a financial product. The advisor does not receive a fee or other compensation from another party based on the referral of a client or the client’s business.”
The Securities and Exchange Commission (SEC) requires investment advisors registered with them to conduct themselves in adherence to a set of standards in terms in dealing with their clients. Advisors are required to act in their client’s best interests and to put these interests above the advisor’s own. They also owe their clients a duty of care in providing their services. The SEC has recently enhanced some of their rules in this area including the new Reg BI rules discussed below and the inclusion of a new disclosure form to be given to retail clients.
Historically, most brokers and those working via a broker-dealer have been held to a lower stand of care in working for their clients. The “suitability standard“ only requires that a recommended financial product be suitable for someone in the general situation of the client. This is a much lower standard of care than a fiduciary duty requiring an advisor to act in their client’s best interests.
In 2019, the SEC enacted their Regulation Best Interest (BI) rules that require broker-dealers to only recommend financial products to their clients that are in those client’s best interests. Further, the BI rules require them to clearly identify any conflicts of interest that may be underlying the recommended products.
The BI rules fall under the Securities and Exchange Act of 1934 that established a standard of conduct for broker-dealers when recommending any type of investment strategy or securities transaction.
These new rules seem to be very closely related to the DOL’s Ill-fated Fiduciary rules that have been dismantled by the Trump administration.
Reaction to these new BI rules is mixed within the industry. Many advisors who already adhere to a fiduciary standard either by rule or by the way they conduct business feel these rules don’t go nearly far enough in protecting the investing public. In fact, one such group recently filed a suit in federal court to block the implementation of the new rules. Their claim is that Congress created the Investment Advisors Act of 1940 to delineate between brokers selling financial products and investment advisors providing advice to clients.
The Importance of Fiduciary Relationships
It is important for all parties in any sort of business or financial to be clear about the nature of the relationship between the two parties.
If you engage the services of a financial advisor, where does the advisor’s loyalty lie? Are they beholding to the preferences of their brier-dealer in terms of financial products or strategies that they might recommend to you as a client? Or do they truly act in your best interests?
If you as a potential client of this financial advisor don’t know the answer to these questions, how can you be sure if this advisor is acting with your best interests in mind? One of the first questions that you should ask of any financial advisor whose services you are considering is, simply, “Are you a fiduciary?”
Take the example of an attorney/client relationship. It’s important for a client to know that their attorney is working solely and exclusively in their best interests in an attempt to get the best result to their legal matter.
What is a breach of fiduciary duty?
A breach of fiduciary duty can quickly become a legal matter and the subject of a lawsuit.
For example, an attorney has a fiduciary duty to act in the best interest of that client. Should they act in a way that is contrary to their client’s best interest, this could be considered a breach of the attorney’s fiduciary obligation to their client. For example, did the attorney do something that benefited one client to the detriment of another? Or did the attorney enter into a business relationship that was beneficial to them but results in a potential conflict of interest in dealing with their client.
In order for there to a breach of fiduciary duty, a fiduciary relationship must exist. Beyond that hurdle, the scope of this relationship must be considered in the context of the alleged breach of fiduciary duty. In other words, did the actions or inactions of the attorney in the example above constitute a breach of the attorney’s fiduciary duty to their client?
How to become a fiduciary
Unlike becoming a Certified Public Accountant (CPA), an attorney or a Certified Financial Planner (CFP®) one does not get a degree or pass a certification exam to become a fiduciary.
Becoming a fiduciary is more about an individual’s role in relation to a client or someone else to whom they have what would be deemed as a fiduciary relationship to. Becoming a fiduciary is more about what a person or individual does and whether the rules say they are a fiduciary in that particular role.
Being a fiduciary will often be designated by the laws, rules, or regulations surrounding the role of the professional to their client. An SEC registered financial advisor will have certain fiduciary requirements they must follow. Likewise, with financial advisors who are part of organizations or networks like NAPFA, Garret Planning Network or the XY Planning Network.
Attorneys, various trustees and others are fiduciaries based on both rules and the nature of what they do.
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