If you are unable to manage your assets and need assistance to make the right financial decisions, professional fiduciaries can provide you with critical services. Care to know how? Read the full article to understand what is a fiduciary and how does it work?
You may often hear the term Fiduciary, especially when friends and family advise you on who to choose as a financial adviser. The challenge is that it can denote different meanings to different people. So, you would wonder, what is a fiduciary? A fiduciary is a person who is a trustee for someone else’s assets (usually money). If you work with a CFP professional, the standard is that they must act solely in the client’s best interest about financial planning advice.
Finding a professional to trust with your finances is an important task. Financial advisors deemed fiduciaries are legally and ethically bound to put your interests ahead of their own. When hiring someone to manage your money or provide financial advice, a healthy dose of rationalism is usually advisable. However, the ability to trust someone with your financial future sure would be excellent.
Money corrupts, and you want to ensure that your financial advisor acts in your best interest, even before their own. Fortunately, the law agrees, and thus, we have the concept of a fiduciary. A fiduciary has legal and ethical responsibilities to act solely in someone else’s best interest, typically a client.
A fiduciary is an individual who acts in the best interest of a particular person or beneficiary. In the world of financial services, that means fiduciary advisors must only buy and sell investments that are the best fit for their clients.
The Fiduciary plays a pivotal role because clients need to trust that financial advisors are selling or recommending investments in the clients’ best interest or are not making deals to earn commissions merely. Clients must have an assurance that their advisors are making decisions with the sole purpose of benefiting them. Moreover, their advisors do not have conflicts that would cloud their judgments on any decision.
Now that you have an understanding of What is a fiduciary. You must know the Fiduciary’s duties and how it benefits you. To understand these details, you need to continue reading this article.
Table of Contents
- 1 What is a fiduciary financial advisor?
- 2 How to find a fiduciary financial advisor?
- 3 What is the fiduciary rule?
- 4 What is a fiduciary relationship?
- 5 Fiduciary relationship example
- 6 What is the fiduciary oath?
- 7 What is a fiduciary duty?
- 8 Aren’t all financial advisors fiduciaries?
- 9 Conclusion
What is a fiduciary financial advisor?
A fiduciary financial advisor is an investment professional who legally compels to put their clients’ interests ahead of their own. Investment advisors registered by the Securities and Exchange Commission and certified financial planners are fiduciary financial advisors. Other financial advisors must make suitable recommendations for clients.
Choosing a fiduciary financial advisor can give you greater peace of mind. With a fiduciary financial advisor, you will know that the person managing your money must make decisions in your best interest. In general, fiduciary financial advisors tend to have fewer conflicts of interest. However, they legally must disclose any potential conflicts of interest.
Financial professionals who earn commissions may seek incentives for selling their own products even if comparable products are available at a lower cost. Fiduciaries must seek the best prices and terms for their clients. Thus, if you work with a fiduciary, you’re more likely to end up with the product or recommendation that’s genuinely right for you.
For the most part, financial professionals bound by fiduciary duty tend to be more transparent. Fiduciaries must thoroughly discuss their decisions with their clients, providing all relevant information and pertinent facts. This makes it easier to ensure you understand your assets and future financial decisions.
While not all non-fiduciaries are necessarily bad actors, it is easier to ensure that you are working with someone who has your best interest if you opt to work with a fiduciary. Moreover, if you are working with someone who doesn’t have a fiduciary duty to you, you have fewer legal options if you discover your interests haven’t been served.
An advisor that calls themselves a fiduciary seeks to minimize conflicts of interest, be transparent and live up to the trust placed in them by clients. More specifically, fiduciary financial advisors must:
- Put their clients’ best interests before their own, seeking the best prices and terms.
- Act in good faith and provide all relevant facts to clients.
- Avoid conflicts of interest and disclose any potential conflicts of interest to clients.
- Do their best to ensure the advice they provide is accurate and thorough.
- Avoid using a client’s assets to benefit themselves, such as purchasing securities for their own account before buying them for a client.
How to find a fiduciary financial advisor?
There are multiple options to find the fiduciary financial advisor for your financial matters. Let’s walk you through these options to help you make an informed decision.
Ask a friend or family member, or colleague
The best way to obtain the fiduciary financial advisor recommendation is from friends, family members, or colleagues. You may or may not get recommendations for a fiduciary specifically, but you will get honest feedback from someone you trust. Be sure to ask any advisors referred to you if they are fiduciaries.
Check online sources
The Securities and Exchange Commission (SEC) regulates Advisory firms who are Registered Investment Advisors (RIAs). The SEC has strict rules and regulations governing advisors, and by law, RIAs must be fiduciaries and are required to act only in the best interests of their clients. You can use a few online databases to find firms registered as RIAs.
The national association of personal financial advisors (NAPFA)
The National Association of Personal Financial Advisors (NAPFA) is the country’s leading professional association of Fee-Only financial advisors, who have highly trained and committed professionals working in the best interests of those they serve.
The National Association of Personal Financial Advisors (NAPFA) has an online search tool that makes it easy to find certified financial planners in your area. Every advisor in that system operates on a fee-only basis and promises to act as a fiduciary.
FPA (The Financial Planning Association)
The FPA also has a database of financial planners that you can search according to location and compensation type. Not all planners are fee-only, but you can easily filter the database to highlight fee-only planners. To search the FPA database, visit plannersearch.org.
The process does not end here. Once you find your potential fiduciary financial advisor, you must ask the following questions to ensure that they fit best to your needs and have relatively fewer conflicts of interest.
- How do they earn money?
- What certifications and licenses do they hold?
- What services do they offer? Who is their conventional client?
- How often do they usually communicate with clients?
- Can they provide a written guarantee of their fiduciary duty?
You may also request a copy of a financial advisor’s ‘Form ADV’ and ‘Form CRS,’ which is paperwork the SEC requires advisory firms to file. This will provide information about an advisor’s business, pay structure, educational background, potential conflicts of interest, and disciplinary history.
You can also find this information online through the SEC’s Investment Advisor Public Disclosure (IAPD) tool. Moreover, you can also request a performance record and a list of client references to contact.
What is the fiduciary rule?
The fiduciary rule is a regulation underpinning fiduciary duty or the legal requirement for financial advisors to work in their customers’ best interests. Issued by the U.S Department of Labor, the agenda behind the fiduciary rule is to save billions of dollars of US citizens by regulating the types of actions fiduciaries can perform.
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 work with retirement plans and offer retirement advice. Specifically, the 1023-page rule would have required brokers to let their clients know about any conflicts of interest and commissions, and other incentives they received from selling products like annuities.
The Fifth Circuit Court of Appeals demolished the rule in March 2018, by releasing Prohibited Transaction Exemption 2020-02, Improving Investment Advice for Workers & Retirees (PTE 2020-02). After the fiduciary rule was demolished, the Securities and Exchange Commission adopted Regulation Best Interest, which requires brokers to act in the best interests of their clients.
However, critics argue that Regulation Best Interest is weaker than the fiduciary rule. They say it sets a standard for brokers to require them to put the client’s interests ahead of their own, whereas the fiduciary rule mandates brokers to act without regard to their own interests.
What is a fiduciary relationship?
The term “fiduciary” applies to an incredibly diverse range of situations. As a result, there are several different types of fiduciary relationships. We discussed some of the most prominent ones below.
Financial advisors and their clients
When you begin a working relationship with a financial advisor, you essentially give them access to your money and investments. Furthermore, many advisors have discretionary control of your assets, which means they can make decisions on their own without your approval.
Because of this, an advisor’s role as a fiduciary is significant. You need to trust your advisor explicitly to make investment decisions that are in your best interest. Moreover, if your advisor tries to sell you something, like an insurance policy, you need to trust that they believe it is the right one for you.
Guardians and wards
In the eyes of the law, a minor cannot make many decisions independently. In turn, a government will appoint a guardian to be their decision-maker. To trust a guardian, the government selecting them must feel that they will put the ward’s best interest first until they come of age. That’s why guardians are considered fiduciaries in the eyes of the law.
In the corporate world, board members manage the direction in which a company goes. Because companies are often owned by a pool of shareholders, these board members must act as fiduciary when making these decisions. This is done to protect shareholders from a board that could potentially choose things that somehow benefit themselves.
To meet its fiduciary standard, board members are required to probe every possible option that’s available to them. By doing this, shareholders can feel confident that every potential avenue was explored before a final decision was made.
Lawyers and their clients
The attorney-client relationship is one of the most fiduciary-dependent ones. Lawyers and those they represent have incredibly close relationships, with important information being shared in both directions. In turn, if a lawyer breached their fiduciary duty, it’s an incredibly serious offense.
Fiduciary relationship example
Fiduciary examples are based upon only trust. It’s the fiduciary’s utmost duty to act in the best interest of another person or client, or company. The fiduciary has to act honestly to manage the client’s assets; otherwise, they will be held liable.
These are some common examples of fiduciary relationships:
- Fiduciary financial advisor-client
- Corporate officer-shareholder
- Real estate agent-client
- An executor of a will to the will beneficiaries
- A business partner to the other partners
- A stockbroker to a client
What is the fiduciary oath?
The Committee for the Fiduciary Standard created a fiduciary oath that clients can ask their advisors to sign. Signees pledge to always put their clients’ best interests first and act with good judgment, skill, care, and diligence. They also promise not to mislead clients and fully disclose all essential facts. Finally, they agree to avoid conflicts of interest and provide information about any unavoidable conflicts.
The Committee for the Fiduciary Standard believes that investors have a right to know whether or not their advisor is acting in their best interests. For those investors and firms that think the same, the Committee has drafted a straightforward oath declaring an advisor’s commitment to adhere to a fiduciary ethic and, in so doing, be accountable for the advice to their clients.
What is a fiduciary duty?
Fiduciary duty is a legal responsibility to put the interests of another party before your own. If someone has a fiduciary duty to you, they must act solely in your financial interests. A fiduciary cannot recommend a strategy that does not benefit you but provides a kickback.
Fiduciary duty is essential for guiding the actions of the professionals who deal with clients’ money. It’s also important because, when violated, it provides an avenue for legal action. Suppose a financial professional, not a fiduciary, has been knowingly selling you low-performing, high-fee investments. In that case, you do not have the legal standing you would have if the professional were a fiduciary.
According to the Institute of Fiduciary Standard, fiduciaries have the six duties:
- Serve the client’s best interest
- Act in utmost good faith
- Act prudently, which means with the care, skill, and judgment of a professional
- Avoid conflicts of interest
- Disclose all material facts
- Control investment expenses
Advisors who are fiduciaries can manage clients’ finances without advance approval of every transaction as bound by the fiduciary standard.
Some financial professionals such as investment brokers and insurance agents do not abide by fiduciary duty. They are only liable to perform suitability obligations. While fiduciaries must put their clients’ best interests before their own, financial professionals who adhere to the suitability standard must only provide suitable recommendations to their clients.
To determine whether a recommendation is suitable, these professionals must consider your financial situation, goals, and risk tolerance.
Additionally, they must ensure that you will not cause high costs and avoid excessive trades. However, they may still suggest products that are not necessarily in your best interest or benefit them more than you.
See the comparison below to help you understand the fine line between fiduciary duty and suitability rules.
|Rules||Fiduciary Standards||Suitability Standards|
|Recommendation requirements||Recommendations must be in the client’s best interest||Recommendations must be suitable for the client|
|Disclosure requirements||Required to fully disclose conflicts of interest||Less strict rules regarding disclosure of conflicts of interest|
|Loyalty requirements||Maybe loyal to the broker-dealer, not necessarily the client||Must be faithful to the client and act in good faith|
Fiduciary duty towards retirement planning
When it comes to retirement planning, federal law specifies the duties and steps a fiduciary must take. The law bars fiduciaries 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. The agency lists the following basic responsibilities for fiduciaries who manage retirement plans:
- 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 happens if a fiduciary duty is breached?
A breach of fiduciary duty occurs when a fiduciary fails to honor their obligation. Fiduciaries are financially and ethically responsible for any actions they make that are not in your best interest. A breach could happen if a fiduciary benefits from their recommendations, fails to provide proper guidance, or acts in any way that’s adverse to your best interests.
To make you understand more about the breach of fiduciary duty, below are a few examples of a breach of fiduciary duty including
- Account churning: This can consist of making an excessive number of trades to earn a commission for financial advisors.
- Misrepresentation: In the case of a financial advisor, this could involve fabricating a statement about a security transaction.
- Making unauthorized trades: For example, if a financial advisor manages your assets discretionarily and does not ask for your approval before trading.
- Acting negligently: This basically covers any breach of fiduciary duty outside of the above.
4 elements of a breach in fiduciary duty
In order to prove that a duty of care has been breached, four elements must be established in order for a plaintiff to prevail in a breach of duty claim. The details and legal terms of these elements can vary according to state laws, but they generally exist as follows:
Duty: The plaintiff must clearly demonstrate that a fiduciary duty existed.
Breach: The plaintiff must prove that a breach of duty occurred. Examples include a lack of candor in offering legal advice, negligence, or illegal use of funds such as insider trading.
Damages: The plaintiff must demonstrate that the breach resulted in damages.
Causation: In addition to proving damages, the plaintiff must prove that those damages were a direct consequence of the breach of fiduciary duty.
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.
However, not all financial advisors are fiduciaries. Advisors who are not 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. Under the suitability standard, the recommendations of the advisor must be only a good fit for the client, whereas, under the fiduciary standard, the best option available for a client must be recommended. There are specific 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 layperson can never have enough knowledge about making the best financial decisions to yield maximum profits. Unless you master the art of finance, you have no other choice than to employ a financial advisor and that must be the fiduciary financial advisor. You must equip yourself with what is a fiduciary? This will help you identify the real fiduciary and protect you from pretentious fiduciary scams.
Moreover, it is imperative for you to gain some hands-on information such as if your financial advisor follows the fiduciary standard or not, or the source of commission or remuneration. A fiduciary has different obligations than someone bound only by the suitability rule.
Fiduciaries must always act in their clients’ best interest, and if they do not, you have legal options to pursue. Ultimately, when choosing someone to manage your money, you should find someone you can trust.