A fiduciary is a person or organization that owes a client or customer a duty of trust when dealing with their financials.
A fiduciary’s duty to their client is a legal and ethical requirement to act in the best interest of their client when making decisions or offering advice on their behalf.
While a fiduciary can have a wide variety of responsibilities, in investing terms a fiduciary generally manages assets for a client or advises on asset management issues.
Some common examples of investment fiduciaries include bankers, money managers, accountants, corporate officers, board members and executors.
Legal Basis for Fiduciary Responsibility Fiduciary responsibility has its basis in two legal rulings from the English common law tradition.
The first legal basis for fiduciary responsibility is what is known as the prudent person standard of care. This means that the fiduciary must always maintain a reasonable standard of caution and forethought when acting in the interest of their client.
The second legal basis is the need to avoid any conflict of interest. This means that there can never be an incentive for the fiduciary to act in a way that is not in the best interest of a client.
Therefore, a fiduciary cannot benefit in any way from the decisions made on a client’s behalf outside of their regular fee, unless expressly waived by the client. Even if a fiduciary can ignore the conflict of interest, the mere existence of any conflicting interest is enough to invalidate the fiduciary responsibility.
Potential conflicts of interest are very common in the investing world, particularly when fiduciaries are on the ‘sell-side’ of the market, and have a direct monetary incentive to sell certain products or services to their customers and clients.
The investing world is filled with a wide range of complex client-based relationships, some that are fiduciaries and others that are not. Many fiduciary and non-fiduciary relationships share similar features, and are often so similar as to be effectively indistinguishable.
This can lead to situations where clients believe that their advisors are fiduciaries, when in fact they are not.
Generally speaking, broker-dealers are not fiduciaries, and many brokerages have strict rules against their dealers acting as fiduciaries.
Brokerages will have their own individual and explicit rules for managing client relationships, but these rules are completely voluntary, except insofar as they do not allow actions that would also be liable for criminal or civil punishments.
Therefore, the degree to which a brokerage ensures the best interests of their clients is largely voluntary and will vary between different brokerages.
Some brokerages will tout a strong standard of client care that borders on the fiduciary as a means of attracting customers, while others will merely act within the confines of legal and regulatory standards for the brokerage business.
Investment advisors, on the other hand, are fiduciaries with an ethical and legal obligation to act in the best interest of their clients and to avoid any conflicts of interest, such as remuneration for selling certain products, making excessive trades to generate unnecessary commissions or making proprietary trades based on privileged client information.
Trading and Fiduciary
It is important for traders to know the nature of the client-based relationships that they are engaged in. Traders will often be dealing with agents who do not owe them a fiduciary duty, but who pose as if they have the trader’s best interests in mind.
Even when an agent truly believes that their advice, products or services are in their client’s best interest, they are not bound by the same legal and ethical standards of fiduciaries that eliminate even the appearance of impropriety.
Even when dealing with fiduciaries, traders should be careful to consider the advice and actions of their agents.
Even the fiduciary responsibility cannot eliminate human error and fraud, and it is ultimately the responsibility of each individual trader to ensure that their fiduciaries are actually acting or advising in their best interests.
Fiduciaries are an important feature of the modern investing landscape. Even traders with decades of experience in a range of financial areas will need to rely on the services of fiduciaries when dealing with areas outside of their ken.
Therefore, it is important for traders to understand the nature of the fiduciary relationship, and to know which professionals are bound by its legal and ethical standards.