March 27, 2013
Fiduciary duty is the highest standard of care at either equity or law. The word itself comes from the Latin fides, meaning faith, and fiducia, trust. When a person or firm agrees to act for another in a fiduciary manner, the law forbids the fiduciary from action that is adverse or contrary to the interests of the client, additionally, the fiduciary must not profit from his position as a fiduciary, unless fully disclosed with the clients consent. It is very straight forward and easy to understand, but the financial services industry has clouded the subject for so long, that is difficult to understand who is and who is not a fiduciary.
Many investors, attorneys, accountants, lawmakers, and even financial advisors are confused about the different standard of care required of brokers/registered representatives and registered investment advisors. According to a 2008 RAND Corporation study which was sponsored by the Securities and Exchange Commission, investors discern absolutely no difference between the two, believing that all financial professionals were acting in their best interest. In that study, 63% of investors believed that brokers/registered representatives are required by law to act in the best interests of their clients, and 70% believed that brokers/registered representatives are required by law to disclose any conflicts of interest in both cases investors are mistaken. At the root of this confusion are two different sets of rules that govern the financial services industry, which create different legal duties to clients. Registered investment advisers are regulated under the Investment Advisers Act of 1940 and are defined as statutory fiduciaries. Brokers, on the other hand, are governed by the Securities Exchange Act of 1934 and are not statutory fiduciaries. Focus groups in the above referenced study also found that the generic titles used by brokers such as advisor, financial advisor, financial consultant, or financial planner are interpreted as being more similar to investment advisers than to brokers in terms of services and duties. No matter how camouflaged by credentials or titles, an investment professional either serves in a capacity of a fiduciary under a written agreement confirming that capacity, or they do not.
If there is a common standard to be adopted, full disclosure should be the centerpiece of that standard. Full disclosure should be in Plain Language and should address and define 1. The type of services being provided (Fiduciary or Non-Fiduciary), and what that means to the investor. 2. The amount and sources of revenue received by the financial professional and/or their firm. 3. All actual and potential conflicts of interest that would exist between the client and the investment professional and/or their firm.
In order for financial markets to operate smoothly, a structure must exist to promote and facilitate transactions between sellers and buyers, and that typically involves a principal or an agent serving clients on both sides of the transaction. In a transactional situation, placing a fiduciary standard on the firm acting as principal or agent doesn't make any sense. However, in an investment management or advice situation, where the perception of fiduciary responsibility exists, it makes a lot of sense to make that perception a reality, and at the very least require full written disclosure as outlined above.