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When it comes to hiring someone to manage your money or provide financial advice, a healthy dose of skepticism is usually advisable. But the ability to trust someone with your financial future sure would be nice.
Money corrupts, and you want to be sure that your financial advisor acts in your best interest, even before his or her own.
Fortunately, the law agrees, and thus, we have the concept of a fiduciary. A fiduciary is someone who has legal and ethical responsibilities to act solely in the best interest of someone else, typically a client.
This is important because clients need to be able to trust that financial advisors are selling or recommending investments that are really best for the clients and not because the advisors receive high commissions or other incentives that have little or nothing to do with the clients’ needs.
Clients also need to know that their financial advisors don’t have conflicts of interest that could cloud their judgment.
- Serve the client’s best interest;
- Act in utmost good faith;
- Act prudently – with the care, skill and judgment of a professional;
- Avoid conflicts of interest;
- Disclose all material facts;
- Control investment expenses.
An example of a fiduciary is a “fee-only” financial planner who charges only for advice and does not get commissions.
Advisors who are fiduciaries are able to manage clients’ finances without advance approval of every transaction. That’s because they are held to the fiduciary standard.
Aren’t All Financial Advisors Fiduciaries?
All trustees are fiduciaries to their trusts. Corporate officers are fiduciaries to shareholders, and attorneys and real estate agents are fiduciaries to their clients.
But not all financial advisors are fiduciaries. Advisors who are not considered fiduciaries may work based on commissions. Often, these are broker-dealers. Their duty is merely to make investments and recommendations that are suitable to the needs of the clients.
Clients need to understand the distinction so they are aware of how their advisors approach their relationships. They should know whether their advisors or financial service providers operate under the fiduciary or the suitability standard.
The suitability standard is lower than fiduciary requirements. But there are still rules that govern suitability determinations.
According to the Financial Industry Regulatory Authority, firms and advisors who are governed by the suitability standard must perform reasonable diligence to understand the customer’s investment profile.
- A broker is required to have a reasonable basis to believe, based on reasonable diligence, that the broker’s recommendation is suitable for at least some investors.
- Based on a particular customer’s investment profile, the broker is required to have a reasonable basis to believe that a recommendation is suitable for that customer. The broker must attempt to obtain and analyze a broad array of customer-specific factors to support this determination.
- A broker with control over a customer’s account must have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer.
What Is the Fiduciary Oath?
The Committee for the Fiduciary Standard has created a fiduciary oath that clients can ask their advisors to sign.
Signees pledge to always put their clients’ best interests first and to act with good judgment, skill, care and diligence. They also promise not to mislead clients and to fully disclose all important facts. Finally, they agree to avoid conflicts of interest and to provide information about any unavoidable conflicts.
The committee includes on its website a list of firms that have committed to the oath.
When it comes to retirement planning, federal law specifies the duties and steps a fiduciary must take.
Fiduciaries are barred by law from acting in their own interest or having conflicts of interest that could harm a retirement plan.
According to the Internal Revenue Service, fiduciaries who oversee retirement plans are in a position of trust.
- Act only in the interest of the participants and their beneficiaries;
- Act for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
- Carry out duties with the care, skill, prudence and diligence of a prudent person familiar with the matters;
- Follow plan documents;
- Diversify plan investments.
What Is the Fiduciary Rule?
Under the administration of Barack Obama, the U.S. Department of Labor proposed the fiduciary rule, which would have imposed fiduciary standards on more financial professionals who offer retirement advice.
Specifically, the 1,023-page rule would have required brokers to let their clients know about commissions and other incentives they received from selling products like annuities.
The Fifth Circuit Court of Appeals threw out the rule in March 2018, and the administration of Donald Trump refused to defend the rule in court.
After the fiduciary rule died, the Securities and Exchange Commission proposed Regulation Best Interest, which would require brokers to act in the best interests of their clients.
In the meantime, lawmakers in some states, including New Jersey, Maryland and Nevada, are considering stricter regulations on brokers and financial advisors.
22 Cited Research Articles
- Brooks, A. (2019, September 6). What Is a Fiduciary? Understanding This Important Financial Advisor Distinction. Retrieved from https://www.rasmussen.edu/degrees/business/blog/what-is-fiduciary/
- Center for the Study of Market Evolution. (2015, May 12). The Origins of Trusts and Fiduciary Duties. Retrieved from http://csfme.org/Traditions/the-origins-of-trusts-and-fiduciary-duties-1
- Certified Financial Planner Board of Standards. (n.d.). Fiduciary Standard. Retrieved from https://www.cfp.net/public-policy/public-policy-issues/fiduciary-standard
- Corbin, K. (2019, March 1). As states clash with feds over fiduciary, regulation jitters rise. Retrieved from https://www.financial-planning.com/news/nevada-maryland-new-jersey-push-fiduciary-proposal-as-iaa-seeks-to-shield-advisors-from-new-regulation
- Elkins, K. (2017, September 13). Most Americans cannot define this key financial term, and it could cost them. Retrieved from https://www.cnbc.com/2017/09/13/why-its-important-to-know-what-fiduciary-means.html
- Financial Industry Regulatory Authority. (n.d.). Suitability. Retrieved from http://www.finra.org/industry/suitability
- Frankel, T. (2018, September 10). The Rise of Fiduciary Law. Retrieved from https://corpgov.law.harvard.edu/2018/09/10/the-rise-of-fiduciary-law/
- Garber, J. (2019, January 7). The Role of A Fiduciary in Your Estate. Retrieved from https://www.thebalance.com/what-is-a-fiduciary-3505114
- Hicks, C. (2018, March 21). What Is a Fiduciary Financial Advisor? Retrieved from https://money.usnews.com/investing/investing-101/articles/what-is-a-fiduciary-financial-advisor-a-guide-to-the-fiduciary-duty
- Institute for the Fiduciary Standard. (n.d.). About. Retrieved from https://thefiduciaryinstitute.org/about/
- Institute for the Fiduciary Standard. (n.d.). Fiduciary Law. Retrieved from https://thefiduciaryinstitute.org/fiduciary-law/
- Internal Revenue Service. (n.d.). Retirement Plan Fiduciary Responsibilities. Retrieved from https://www.irs.gov/retirement-plans/retirement-plan-fiduciary-responsibilities
- Kagan, J. (2018, February 23). Doctrine Of Utmost Good Faith. Retrieved from https://www.investopedia.com/terms/d/doctrineofutmostgoodfaith.asp
- Kagan, J. (2019, February 17). Fiduciary. Retrieved from https://www.investopedia.com/terms/f/fiduciary.asp
- Kitces, M. (2017, January 12). The 4 Different Types Of Fiduciary Financial Advisors. Retrieved from https://www.kitces.com/blog/the-4-different-types-of-financial-advisor-fiduciaries/
- Krase, S. (2018, August 27). What exactly is a ‘fiduciary’ advisor? Retrieved from https://www.cnbc.com/2018/08/27/understanding-how-fiduciary-advisors-work.html
- O’Connell, B. (2018, August 15). What Is a Fiduciary and What Are Their Responsibilities? Retrieved from https://www.thestreet.com/personal-finance/education/what-is-a-fiduciary-14677659
- Peirce, H.M. (2018, July 24). What’s in a Name? Regulation Best Interest v. Fiduciary. Retrieved from https://www.sec.gov/news/speech/speech-peirce-072418
- Stanek, B. (2018, August 2). What Is a Fiduciary? Retrieved from https://smartasset.com/financial-advisor/what-is-fiduciary-financial-advisor
- Stanger, T. (2016, June 3). What the Heck Is a Fiduciary? Retrieved from https://www.consumerreports.org/money/what-the-heck-is-a-fiduciary/
- The Committee for The Fiduciary Standard. (n.d.). Fiduciary Oath. Retrieved from http://www.thefiduciarystandard.org/fiduciary-oath/
- The Motley Fool. (n.d.). What Is a Fiduciary? Retrieved from https://www.fool.com/knowledge-center/what-is-a-fiduciary.aspx