Broker Check
Words for the week #8

Words for the week #8

March 27, 2023

Words for the week # 8

Fiduciary Advisor

What is a Fiduciary Advisor?  

A fiduciary is a person or organization that acts on behalf of another person or persons, putting their clients’ interests ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary requires being bound both legally and ethically to act in the other’s best interests.

A fiduciary may be responsible for the general well-being of another (e.g., a child’s legal guardian), but the task often involves finances—for example, managing the assets of another person or a group of people. Money managers, financial advisors, bankers, insurance agents, accountants, executors, board members, and corporate officers all have fiduciary responsibility. 

A fiduciary’s responsibilities and duties are both ethical and legal. When a party knowingly accepts a fiduciary duty, on behalf of another party, they are required to act in the best interest of the principal (i.e., the client or party whose assets they are managing). This is what is known as a “prudent person standard of care,” a standard that originally stems from an 1830 court ruling. This formulation of the prudent-person rule required that a person acting as fiduciary was required to act first and foremost with the needs of beneficiaries in mind. Strict care must be taken to ensure that no conflict of interest arises between the fiduciary and their principal.

Investment Fiduciary

While it may seem as if an investment fiduciary would be a financial professional (money manager, banker, and so on), an investment fiduciary is actually any person who has the legal responsibility for managing somebody else’s money.

That means if you volunteered to sit on the investment committee of the board of your local charity or other organization, you have a fiduciary responsibility. You have been placed in a position of trust, and there may be consequences for the betrayal of that trust. Also, hiring a financial or investment expert does not relieve the committee members of all of their duties. They still have an obligation to prudently select and monitor the activities of the expert. 

The Suitability Rule

Broker Dealers, who are often compensated by commission or Fees, generally only have to fulfill a suitability obligation. This is defined as making recommendations that are consistent with the needs and preferences of the underlying customer. Broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA) under standards that require them to make suitable recommendations to their clients.

Instead of having to place their interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for the client, in terms of the client’s financial needs, objectives, and unique circumstances. A key distinction in terms of loyalty is also important: A broker’s primary duty is to their employer, the broker-dealer for whom they work, not to their clients.

Other descriptions of suitability include making sure that transaction costs are not excessive and that their recommendations are not unsuitable for the client. Examples that may violate suitability include excessive trading, Churning, the account simply to generate more commissions, and frequently switching account assets to generate transaction income for the broker-dealer.

The suitability standard can end up causing conflicts between a broker-dealer and a client. The most obvious conflict has to do with compensation. Under a fiduciary standard, an investment advisor would be strictly prohibited from buying a mutual fund or other investment for a client because it would garner the broker a higher fee or commission than an option that would cost the client less—or yield more for the client.

Suitability vs Fiduciary Standard

Investment advisors, who are usually a combination of fee-based or commission, are bound to a fiduciary standard that was established as part of the Investment Advisors Act of 1940. They can be regulated by the U.S. Securities and Exchange Commission (SEC) or state securities regulators. The act is pretty specific in defining what a fiduciary means, and it stipulates a duty of loyalty and care, which means that the advisor must put their client’s interests above their own.

For example: the advisor cannot buy securities for their account prior to buying them for a client and is prohibited from making trades that may result in higher commissions for the advisor or their investment firm.

It also means that the advisor must do their best to make sure investment advice is made using accurate and complete information—basically, that the analysis is thorough and as accurate as possible. Avoiding conflicts of interest is important when acting as a fiduciary, and it means that an advisor must disclose any potential conflicts to placing the client’s interests ahead of the advisor’s.  Additionally, the advisor needs to place trades under a “best execution” standard, meaning that they must strive to trade securities with the best combination of low cost and efficient execution.

Working with a fiduciary means that you can be assured that a financial professional will always be putting your interest first, and not their own.  This means that you don't have to worry about conflicts of interest, misplaced incentives, or aggressive sales tactics.

The Bottom Line 

A fiduciary is a person or other entity who is put in a position of control and influence over another persons property or finances.  The concept of fiduciaries can be found in a wide array of legal contexts in the United States and throughout the world.  Fiduciary relationships are most often found when individuals are entrusted with carrying out a particular act for another, such as a trustee handling assets on behalf of a trust beneficiary.

The term "Fiduciary" is widely used in the context of financial advising and brokerage relationships, whereby the clients best interests must be put first and foremost.  Because of the significance of these fiduciary relationships, new legal challenges have arisen in the ever-changing rules regarding fair dealing and fair information requirements.

Much of the above information was  selected from Investopedia definition of Financial Terms and is believed to be accurate but cannot be considered to be all inclusive and complete.  It is a synopsis of a current item or term of interest The opinions expressed are mine and not to be  considered an investment recommendation or solicitation of any specific product or program.

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