A fiduciary is a person authorized to act on behalf of another party (called a ‘principal) and is legally required to act in the principal’s best interest. There must be no conflict of interest when a fiduciary acts on behalf of their principal. A fiduciary responsibility is a serious duty and must be carried out with the utmost consideration and responsibility.
Types of Fiduciaries
There are several types of fiduciary relationships. Board members of a corporations act as fiduciaries of their stockholders; attorneys are fiduciaries for their clients; guardians are fiduciaries of wards; executors are fiduciaries of legatees, and financial advisors are frequently fiduciaries of their clients.
The responsibilities of these fiduciaries differ some, but these relationships are all alike in that they require the fiduciary to act in the best interest of the principal.
In the context of retirement planning, an investment fiduciary is usually found in the form of a financial advisor. Financial advisors who are fiduciaries are required to provide investment advice that benefits the client the most; whether the advice benefits the advisor or not is of no consequence in a fiduciary relationship.
In the past, nearly all financial advisors were compensated with commissions on sales of investment products. Rightfully or not, this can suggest that advice given to a client to buy a security is motivated by the advisor taking advantage of an opportunity to earn a commission.
Recently, however, many retirement planning advisors have adopted a fee-based compensation model. With fee-based compensation, advisors aren’t paid commissions for investment sales, but instead, collect a fee expressed as a percentage of assets under management. The more money a client makes, the more the advisor makes. This makes for a more transparent model in which everyone wins, and it makes the fiduciary standard easier to carry out.
Fiduciary vs. Suitability Standards
As this article has probably made clear by now, a financial advisor who is a fiduciary may only make investment recommendations that are in the best interest of the client. This requires a good bit of work, as the advisor has to really understand their client’s financial situation and risk tolerance.
Financial professionals who are not fiduciaries may use a suitability standard. This requires the broker to be reasonably sure that the investment is suitable for the client, but the suitability standard is much more forgiving than the fiduciary standard. Under the suitability rule, there is no absolute requirement that the broker act in the client’s best interest. With this in mind, it is easy to see why the fiduciary standard is gaining popularity in the investment and retirement planning industry.
Regulation of Fiduciaries
Fiduciary certifications are given at the state level and may be revoked if the fiduciary has neglected their duty.
For investments, some types of accounts are required to be managed by a fiduciary. Managers of such accounts are subject to requirements of the recent Fiduciary Rule put forth by the U.S. Department of Labor.
Violations of fiduciary duties in investments are subject to punishment by regulatory agencies such as the Securities and Exchange Commission, the Financial Industry Regulatory Authority, and state securities and insurance commissioners.