Fiduciary
What is a Fiduciary
A fiduciary is an individual or an organization that has the legal and ethical responsibility to act in the best interest of their client, or beneficiary – this could be an individual, a group of people, or an entity. Fiduciaries are required to put their clients’ interests before their own, seeking the best prices and terms. Their primary objective is to preserve and enhance the value of client assets over the long term. A fiduciary must avoid conflicts of interest.
Key Learning Points
- A fiduciary is legally required to act in their clients’ best interest and manage client assets in the best possible way to achieve stable and positive outcomes – they must aim to preserve and enhance the long-term value of client
- Fiduciaries must also avoid any conflict of interest that may prevent them from acting in their clients’ best interest.
- Professionals who have a fiduciary duty to clients include trustees, registered investment advisors, insurance providers, and members of boards of directors.
- Most often fiduciaries are required to charge a fee for their services, expressed either as a flat fee or a percentage of client assets under management.
Fiduciary Duty
While fiduciary duties can be clearly defined, regulation can be subjective. An investment fiduciary could be a financial professional such as a fund manager or banker, but may also be anyone who has the legal responsibility to manage assets on behalf of someone else. For example, the board members of a charity still have a fiduciary duty after appointing an investment manager. They remain responsible for oversight and make decisions to protect the organization’s interests.
Suitability Standard
Broker-dealers (financial houses or professionals that trade investment instruments on behalf of their clients, but also for their own accounts) are not considered fiduciaries but instead must ensure that clients are presented with products suitable for their specific circumstances. To determine suitability, they must consider risk tolerance, investment horizon, objectives, personal circumstances, and more. However, broker-dealers are not legally bound to act in the best interest of clients and their primary responsibility is to their employer. Compensation presents one area with potential for conflicts of interest to arise – independent financial advisors must act in the best interest of their clients and are prohibited from recommending products that would generate additional commissions or fees. Brokers-dealers are free to recommend products upon which they receive commissions as long as the products they recommend are “suitable” for the client.
Agency Problem
Within the world of corporate governance, board members are expected to act as agents of the shareholders and act in their best interest. Agency problems, or the conflict of interest between the principals (shareholders) and agents (corporate directors), are not uncommon, especially within large entities where ownership and management are separated. To prevent such conflicts of interest, mechanisms such as Key Performance Indicators (KPIs) aim to align board members’ interests with those of shareholders. One example is linking executive pay to business performance.
Please access the free downloads for examples of fiduciary documents, including outlining the key features of investment philosophy.
Enroll on our online portfolio management course to further explore and understand the fiduciary responsibilities of financial advisors, and the standards for managing an investment portfolio.