You may have heard the term fiduciary, but do you know what it means? Maybe you know that fiduciaries are people who can help with financial situations. Part of the confusion may stem from the fact that there are both fiduciaries and fiduciary funds, which are related concepts, but not the same thing.
A fiduciary is anyone who is legally bound to act solely in the best interests of their client or “beneficiary.” Technically speaking, there are a number of professionals, such as attorneys, real estate agents and doctors, who are all bound by a fiduciary duty to put the needs of their clients ahead of their own.
In the world of finance, a fiduciary is typically someone who has been tasked with managing, holding or investing someone else’s money. Financial fiduciaries can be individuals, committees or entire organizations. Let’s take a closer look at what a fiduciary is, the important legal standards that fiduciaries are bound to uphold, and how this all relates to fiduciary funds.
Acting as a fiduciary is not as simple as “acting in the best interest of your client.” Instead, there are a specific set of duties that fiduciaries are bound to uphold. The specific duties of a fiduciary may vary according to the situation, but the ways in which they fulfill those duties should always meet certain standards. Various pieces of legislation specify that fiduciaries are bound to meet certain standards. These include:
Duty of Care
Fiduciaries have a duty to always make the most informed possible decision. For instance, a fiduciary financial advisor wouldn’t recommend a certain investment fund to a client simply because a fund manager recommended it. The advisor would first be bound to conduct thorough research into the fund and its competitors to ensure that it was the best possible choice for that particular client’s needs.
Duty of Loyalty
Duty of loyalty goes back to a fiduciary’s duty to always put the best interests of the beneficiary first. For example, a company’s fiduciary committee should not offer company stock as a retirement plan option if they know that the company is in financial trouble and that the stock will likely suffer as a result.
Duty of Good Faith
The directors and officers of a corporation that offers publicly traded stock are bound to fulfill their duties, act in the company’s best interests, and avoid intentionally breaking the law.
Duty of Confidentiality
Fiduciaries such as lawyers, doctors, and corporate board members are bound by client confidentiality privileges and must not disclose any privileged information without their client’s consent. In the case of corporations, the duty of confidentiality also extends to confidential business information.
Duty of Prudence
The duty of prudence obligates a fiduciary trustee to make decisions with both caution and care. Over the past few decades, litigation against retirement plan fiduciary committees has become common.
In cases like Hughes v. Northwestern University or Tussey vs. ABB, retirement plan participants argued that their fiduciary committees had failed to act in their best interests by allowing excessive plan fees to eat away at participants’ investments.
These committees made mistakes such as allowing excessive record keeping fees to go unchecked or offering more expensive funds when cheaper but otherwise identical funds were available. Such mistakes ended up costing both companies millions in settlements.
Duty of Disclosure
The duty of disclosure basically means that fiduciaries must be completely honest with their beneficiaries. They are not allowed to withhold information that could influence a client’s decision or directions in any way.
Are All Financial Advisors Fiduciaries?
Fiduciary funds refer to the money that beneficiaries entrust fiduciaries to oversee. When entrusting anyone with this responsibility, it’s vital to ensure that they will agree to work as a fiduciary. In some cases, it’s even best to get this guarantee in writing. Certain types of professionals are always required to act as fiduciaries, while others are not. For example members of retirement plan committees are always bound by a fiduciary duty, this is not always true for financial advisors. While it’s shocking for many people to learn that not all financial professionals are bound to act in their clients’ best interests, this unfortunately can happen.
Certified financial planners (CFPs) and advisors registered with the SEC are indeed bound to act as fiduciaries. These advisors generally work on a “fee-only” basis, which means that they solely receive compensation from their clients.
Broker-dealers, on the other hand, often work on a “fee-based” or commission basis. These advisors commonly receive financial incentives by recommending certain funds or investments to their clients, which presents a clear conflict of interest.
Though broker-dealers are bound by FINRA’s suitability standards, these standards are admittedly pretty lax. While they must recommend products they “reasonably” believe will be suitable for their customers, these conditions are wide open for interpretation.
Examples of Fiduciary Funds
Fiduciary funds can take a variety of forms, but all involve someone trusting another person or organization to take care of their money. Some common examples of fiduciary funds include:
Pension and Retirement Funds
While everyone wants to save for retirement, we don’t all have time to develop the financial skills needed to make solid investment choices. That’s why companies will commonly elect a fiduciary committee to manage and oversee the company’s retirement plan.
Trust funds are established when a grantor enlists a neutral third party, such as a bank or money manager, to hold and manage certain assets for another party who is known as the trustee.
Insurance agents are bound to a fiduciary duty to use their knowledge to recommend products to their clients, ensure that their payments are properly invested, and legally act on their clients’ behalf if necessary.
Corporate Shareholder Investments
The board of directors of a publicly traded company has a fiduciary duty to its shareholders. By purchasing stock in the company, shareholders become partial owners even though they have little control over the running of the company itself. It’s therefore up to the board of directors to run the company in a way that best ensures its odds of success.
These are just a few of the examples of funds that can be set up to legally allow someone else to invest or manage your money on your behalf.