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What Is a Fiduciary Duty?

There’s been a lot of talk lately about fiduciary duty as part of the ongoing debate as to which finance professionals should have a fiduciary duty to their clients. Let’s explain the concept of fiduciary duty and why it’s so important to understand who has one and who doesn’t. If you’re taking advice from someone who doesn’t have a fiduciary duty to you, there are risks you should understand. 

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What Is a Fiduciary Duty?

A fiduciary duty is a legal responsibility to put the interests of another party before your own. If someone has a fiduciary duty to you, he or she must act solely in your financial interests and not, for example, recommend a strategy that doesn’t benefit you but instead provides a kickback for the person making the recommendation.

You can think of fiduciary duty like the doctor-patient relationship, where one party has a duty to put the other party’s interests first.

The fiduciary duty is important for guiding the actions of the professionals who deal with clients’ money. It’s also important because, when violated, it provides an avenue to legal action.

If a financial professional who doesn’t have a fiduciary duty to you has been knowingly selling you low-performing, high-fee investments, you don’t have the legal standing that you would have if you were in the same situation with a fiduciary.

Related Article: Can You Trust Your Financial Advisor? 

Fiduciary Duty and Financial Services

What Is a Fiduciary Duty?

Fiduciary duty is a hot topic in the financial planning and investing world. It has come up in the case of investors in fossil fuel companies like Exxon, which stands accused of neglecting its fiduciary duty to protect shareholders from the threats of climate change. But it also comes up in the case of the financial planners and brokers many Americans rely on for money advice.

These days, investment advisors are required by the SEC to abide by fiduciary duty standards and put their clients’ financial interests ahead of their own. They make money by charging fees based on the size of the assets they manage.

Broker-dealers, however, are not bound by fiduciary duty and are only subject to rules requiring them to make “suitable” recommendations. Brokers can make money from commissions on mutual funds and other investments they sell to clients.

That means they may encourage clients to buy funds from the companies that pay the highest commission, not the funds that best suit the needs of the client. Because lots of people rely on brokers for investment advice and retirement planning, some critics say it’s time for fiduciary duty to expand to broker-dealers.

That’s why there have been calls to reform the fiduciary standard included in the landmark 1974 retirement law ERISA, the Employee Retirement Income Security Act. The Department of Labor announced a plan for expanding fiduciary duty to anyone who handles retirement accounts, whether that person is a broker or a financial advisor. Lobbyists and industry spokespeople have fought the move and the debate is still playing out.

Mary Jo White, Chair of the Securities and Exchange Commission (SEC), declared in March 2015 that she was interested in revising fiduciary duty rules to create a uniform standard that applies to broker-dealers and investment advisors. So far, no new rules have come from the SEC.

Related Article: 5 Investment Challenges Even Wealthy Savers Face

Why it Matters

What Is a Fiduciary Duty?

If you’re taking financial advice from someone who doesn’t have a fiduciary duty to you, you’re taking a risk. That’s not to say that brokers and those who aren’t bound by fiduciary standards always take advantage of their clients. But without the legal standard in place, clients face more uncertainty.

If you’re working with someone who doesn’t have a fiduciary duty to you, you have fewer legal options in the event that you discover your interests haven’t been served.

It’s always a good idea to shop around for financial professionals anyway. It’s important to read the fine print and, if you’re not getting a clear answer, ask about whether a professional you’re considering working with is bound by fiduciary duty.

When it comes to safeguarding your investments and retirement savings, it’s wise to err on the side of caution.

Photo credit: ©iStock.com/Christopher Futcher, ©iStock.com/vgajic, ©iStock.com/fotostorm

Amelia Josephson Amelia Josephson is a writer passionate about covering financial literacy topics. Her areas of expertise include retirement and home buying. Amelia's work has appeared across the web, including on AOL, CBS News and The Simple Dollar. She holds degrees from Columbia and Oxford. Originally from Alaska, Amelia now calls Brooklyn home.
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