When looking for a financial advisor to work with, an important question to ask is whether they’re a fiduciary. Advisors who are required to adhere to a fiduciary duty are held to different ethical standards than those who are not. Knowing what fiduciary duty means and when an advisor is bound to fulfill that duty can help you find and choose a financial advisor to help manage your money.
Fiduciary Duty Defined
The U.S. Securities and Exchange Commission established the definition of fiduciary duty in 2018 in response to confusion over the much-debated Best Interest Rule for broker-dealers. In a nutshell, an investment advisor who is a fiduciary “is held to the highest standard of conduct and must act in the best interest of its client.”
Fiduciary duty was first established under the Investment Advisers Act of 1940, though it was never formally defined in the Act. Under the act, fiduciaries are expected to exercise a duty of care and a duty of loyalty.
Duty of care
The duty of care standard for fiduciaries has three parts. Advisors who exercise fiduciary duty must:
- Act and provide advice that’s in the best interest of their clients
- Seek the best execution of transactions on behalf of clients
- Provide advice and monitoring as part of the client-advisor relationship
Duty of care requires advisors to be informed and take an interest in their clients’ needs. For example, a fiduciary would ask you what your goals are for investing to help you build an appropriate portfolio. They’d offer financial advice that’s tailored to your needs and situation, updating your financial plan as needed if you experience major life changes, such as a divorce or job loss.
In shaping their advice, fiduciaries are obligated to offer advice that’s designed to produce the best outcomes for you. When making investment transactions, such as buying or selling investments, fiduciaries are required to do so in a way that offers the most favorable costs and value.
Duty of loyalty
The duty of loyalty requires an advisor to put his or her client’s interest first. This means that a fiduciary cannot promote their own interests ahead of their clients or play favorites with their clients.
Specifically, fiduciaries must disclose any potential conflicts of interest to their clients. They must actively seek to avoid conflicts of interest whenever possible.
Fiduciaries disclose conflicts of interest using Form ADV, which must be filed with the SEC. This form is a public document that must include:
- The advisor’s fee schedule and how they’re paid
- Conflicts of interest
- Educational and business background of the advisor and/or key personnel of an advisory firm
- Disciplinary information related to past actions
These forms can be accessed by investors through the Investment Adviser Public Disclosure website.
Who is a Fiduciary?
With financial advising, a fiduciary is an individual or advisory firm that is registered with the Securities and Exchange Commission, required to follow fiduciary duty rules and must file Form ADV to complete their registration.
Someone who’s a broker-dealer, on the other hand, follows a different set of guidelines. In June 2019, the SEC adopted Regulation Best Interest, which applies to broker-dealers. This rule requires them to act in their clients’ interests first and it imposes a stronger set of guidelines than the suitability standard they were previously governed by. That standard dictated that broker-dealers were only required to recommend investments that were suitable for their clients, not necessarily ones that were in their best interests.
In a broader sense, a fiduciary can be anyone who’s held to a higher standard when it comes to managing finances or making financial decisions on someone else’s behalf. For example, any of the following may act as a fiduciary:
- The executor of a will
- Corporate board members and shareholders
- Legal guardians
- Investment corporations
These individuals and entities are subject to legal and ethical rules that dictate how they can and can’t act on behalf of the person whose finances they’re managing.
Fiduciary Duty Myths
There are a few misconceptions about what a fiduciary duty is required to do that are worth clearing up.
First, it’s a misconception that fiduciaries are always required to recommend the lowest cost investment. In reality, fiduciaries are only obligated to recommend investments that are in a client’s best interests while clearly communicating the terms of the investment.
Another myth is that using a fiduciary to manage your money can guarantee you’ll achieve the returns you’re after. The stock market is risky by nature and even though a fiduciary advisor may be experienced, they aren’t perfect. It’s possible that an investment recommendation may not work out as planned and you could lose money. That could just as easily happen if you were investing on your own.
Breach of Fiduciary Duty
When a fiduciary doesn’t follow the rules set down for them by the SEC, they could be committing a breach of fiduciary duty. For example, an advisor may recommend an investment to you based not on how well it serves a purpose in reaching your investment goals but on the commission fee they stand to earn by selling it.
If you believe an advisor has breached their fiduciary duty, there are steps you can take to do something about it. Specifically, you may be able to file a civil lawsuit for negligence or damages, depending on what the breach involved. The fiduciary laws in your state may also spell out a course of action you can follow if you believe your advisor overstepped their bounds.
The Bottom Line
The fiduciary duty applies to registered investment advisors and it means they’re held to a different legal and ethical standard in managing client relationships. It’s important to be aware that not every advisor is a fiduciary and that not every fiduciary will act in the best interests of their clients, despite the rules they’re required to follow. Asking whether an advisor is a fiduciary or not is the first step in finding a professional to help shape your financial strategy.
Tips for Investing
- Finding a fiduciary financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- If you are ready to start investing, you might start by checking out our investment calculator to gauge the risk and potential returns of specific asset allocations.
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