Is My Financial Advisor a Fiduciary?
When you invest, you expect your investment professional to have your best interests at heart. It is distressing if that turns out not to be true. The most common customer complaint submitted to FINRA, the Financial Industry Regulatory Authority, involves “breach of fiduciary duty.” But what is fiduciary duty, and what happens when a broker or investment adviser breaches that duty?
A fiduciary is someone who owes a legal responsibility to another party (known in this context as the “principal” or “beneficiary”). Fiduciary duty comprises two primary components:
· Duty of care states that a fiduciary must do due diligence and become informed before acting on behalf of a primary or beneficiary (the person to whom the duty of care is owed). A fiduciary must act in the same manner as a reasonably prudent individual in their position. As part of the duty of care, a fiduciary must execute a reasonable, informed, rational, good faith judgement with no conflicts of interest.
· Duty of loyalty states that a fiduciary must not be swayed by personal economic interests when recommending that a primary or beneficiary take a certain course of action. If a party makes a self-interested transaction without proper approval, that would constitute a breach of the duty of loyalty, and thus a breach of fiduciary duty. If a fiduciary does want to make a self-interested transaction, they must fully disclose all of the facts and details, and then the transaction must be approved by a disinterested party.
What happens if an investment professional, such as a stockbroker or investment adviser, breaches their fiduciary duty? Becoming more informed about fiduciary duty will help you understand the roles and responsibilities of investment professionals, well as how you can protect yourself from fraud.
You may hear the term “investment advisor” tossed around. When “investment advisor” is spelled with an “o,” it is a generic term, but when it is spelled with an “e” it is a legal term that carries with it legal obligations — including the mandate to act as a fiduciary. Not all investment advisors are registered with the SEC, but those that are manage more than $100 million in assets. All investment advisers registered with the SEC are fiduciaries. They receive fee-based compensation based on a percentage of assets under management (AUM), generally 1%. If they breach their fiduciary duty, they can be sued in a court of law. Investment advisers who are also brokers can have a complaint filed against them through FINRA, the Financial Industry Regulatory Authority.
What about the obligations of stockbrokers? When a broker recommends an investment, customers want to know that it is suitable for them given their needs. Stockbrokers are subject to a “suitability” standard of conflict, but conflicts of interest do still arise. Because brokers receive commission-based compensation, many brokers recommend investments that will generate commissions for them; these investments must be “suitable” for a given investor based on that investor’s income, investment goals, need for liquidity, and other factors. While these investments may be “suitable,” they may not be in a client’s best interests. For example, a broker may not put a client into the best possible investments if a very similar investment will yield a higher commission. If an investor later files a complaint against a broker, the matter could end up before a FINRA arbitration panel. For more information on the differences between stockbrokers and investment advisers, please see our previous article, “Stockbroker vs. Investment Adviser: Understanding the Difference.”
Why does fiduciary duty exist? At its heart, the fiduciary rule helps ensure that a spirit of trust exists between the fiduciary and the beneficiary or primary, the adviser and the client. Fiduciary duty exists because the fiduciary must exercise their discretion and expertise in providing investment advice. In these service relationships, fiduciaries are entrusted with power over their clients so that they can do their jobs effectively. Fiduciaries must be the ones to make decisions because they know more than the primary or beneficiary. For example, in the relationship between a financial professional and a client, the financial professional ostensibly knows more than the client about financial matters and investment planning, and so the client defers to the professional. If the adviser’s interests conflict with those of the beneficiary or primary, the value of the advice is doubtful (according to Tamar Fankel in the New Palgrave Dictionary of Economics and the Law, under the definition of “fiduciary duties”).
The Investment Advisers Act of 1940 lays out how advisers should treat their clients; courts have found these to be the obligations of a fiduciary. The five responsibilities of a fiduciary are as follows:
1. A fiduciary must put the client’s interests ahead of their own.
2. A fiduciary must act in good faith.
3. A fiduciary must disclose all material facts.
4. A fiduciary must not mislead clients.
5. A fiduciary must expose all conflicts of interest.
A fiduciary must set aside their own interests in the pursuit of what is best for the client. In an investment advisory context, a fiduciary must act with sincerity and be honest. How does that sincerity manifest itself? A fiduciary must not deceive clients. To that end, they must disclose all relevant facts. When you work with a fiduciary, you want to be able to trust them. Fiduciary duty ensures that they are legally bound to work in your best interest.
How can you know if someone is a fiduciary? Just ask! When choosing an investment professional, ask Are you a fiduciary? If they are, that’s a good sign. If they’re not, consider looking elsewhere.
If you have questions about breach of fiduciary duty, don’t hesitate to contact a securities attorney. Call (877) 238–4175, email info@fkesq.com, or visit www.stopbrokerfraud.com for your free case consultation with the securities attorneys of Fitapelli Kurta.
