How Fiduciary Duty Impacts Financial Advisors

Lawyers advance the interest of their clients, financial advisors get the best investment returns for your goals and corporate executives manage public companies for the benefit of their shareholders. These are all examples of fiduciary duty, the legal and ethical obligation for professionals to act in the best interest of their clients.

In the worlds of business, investing and finance, fiduciary duty requires trustees, executives and advisors to prioritize the interests of others above their own.

What Is a Fiduciary?

A person who is bound by the requirements of fiduciary duty is known as a fiduciary, and the person who benefits from fiduciary duty is referred to as a beneficiary.

U.S. law and standards of professional conduct oblige fiduciaries to exercise a high standard of care, loyalty and honesty in providing services to their clients and stakeholders. The fiduciary is required to prioritize the interests of the beneficiary over their own.

Fiduciary duty is a serious obligation. If a fiduciary doesn’t fulfill their duties, called a breach of fiduciary duty, the beneficiary could be entitled to damages.

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What Is Fiduciary Duty?

The term “fiduciary” comes from the latin word for trust. A person bound by fiduciary duty has an obligation to maintain their beneficiary’s trust and act in their best interest.

Depending on state law and different professional codes of conduct, fiduciary duty may include a range of subsidiary duties. Very broadly, these may include the following:

• Duty of loyalty. Fiduciaries must work in the interests of their beneficiaries and not for their own gain. They should approach all professional responsibilities free of conflicts of interest, and they must fully disclose any potential conflicts that arise.
• Duty of care. Before making any decisions for beneficiaries, fiduciaries must review all material information that’s available to them. Pursuing due diligence is another way to refer to the duty of care.
• Duty of good faith. When taking action, fiduciaries must fulfill their duties without violating the law.
• Duty of confidentiality. Fiduciaries must keep their clients’ information private and not disclose it for their own benefit or personal gain.
• Duty of prudence. All decisions must be made with the highest degree of care, skill and caution.
• Duty to disclose. Fiduciaries must disclose all information that could impact their beneficiary or their own ability to uphold their fiduciary duties.

Fiduciaries may have additional duties, depending on their industry. Professionals who work in the financial services industry, such as chartered financial analysts and corporate directors, must at a minimum abide by the duty of care and the duty of loyalty.

How Fiduciary Duty Works

Fiduciary duty applies to people who fill a wide range of roles and positions. Specific duties and obligations vary depending on state laws and the nature of the relationship.

For example, fiduciary financial advisors are required to act in the best interest of their clients when giving them investment advice or managing their money. But not all financial advisors are bound by fiduciary duty.

Public companies are managed by a team of executives and a board of directors. Directors and executives have a fiduciary duty to act in the best interest of the company’s shareholders, making decisions that aim to increase the value of their shares.

The trustees who manage a trust are required to safeguard assets and property on behalf of the trust’s beneficiaries. Similarly, the executor of an estate must carry out the wishes of the deceased.

Even real estate agents are fiduciaries. They owe their clients full disclosure of any conflicts of interest or concerns that might affect the value of property or their services. They can represent both the buyer and the seller in a transaction, and maintain their fiduciary duty as long as they inform both sides.

In each case, fiduciaries must understand and uphold their obligations. Breach of fiduciary duty carries legal consequences, including lawsuits, penalties and loss of the fiduciary’s professional credentials.

What Is a Fiduciary Financial Advisor?

Financial advisors who are fiduciaries must act in the best interest of their clients, offering the lowest cost financial solutions to fit their clients’ needs. But, it’s important to note, not all financial advisors are fiduciaries.

Anyone can legally call themselves a financial advisor and provide financial advice, making it particularly important you know what standard the person managing your money holds themselves to.

Most financial advisors, even if they aren’t fiduciaries, have to somewhat consider your interests when offering advice. Only fiduciary financial advisors have to place your best interest over theirs, though. Their recommendations must consider your overall financial situation, and they must offer the most economical solutions with the best performance. Because of this, you probably want a financial advisor who is a fiduciary.

Financial Advisors and Fiduciary Duty

Fiduciary financial advisors commonly work for RIAs. Certified financial planners are also nearly always fiduciaries, but check to make sure your CFP is acting as a fiduciary before starting business with them.

Financial advisors who work for brokerages are typically not fiduciaries. They are held to a lesser legal standard of care called the suitability standard. These non-fiduciary advisors must offer investment advice and product recommendations that are suitable for you. This means that the products generally fit your needs but may have higher fees or offer the advisor a bigger commission.

“When you have a fiduciary requirement, you have the highest standard for client service for advice and planning,” says Wes Brown, a fiduciary and certified financial planner at CogentBlue Wealth Advisors in Knoxville, Tenn.

How Are Fiduciary Financial Advisors Paid?

Financial advisors may be paid on commission, with fees or through a combination of the two. When you hire a new financial advisor, it’s important to ask if they are a fiduciary and how they make their money. This helps you gauge for yourself any potential conflicts of interest. Advisors are commonly paid in the following ways:

Commission-Only Financial Advisors

Commission-only advisors only make money when they sell investments or a particular financial product. Often, commission-only financial advisors are employed by broker-dealers and are only held to a suitability standard. Make sure a commission-only financial advisor is a fiduciary or that you fully understand the products and fees being sold to you before doing business with them.

Fee-Only Financial Advisors

Fee-only advisors only make money from client fees. These might come as flat or hourly fees or as a percentage of all of the assets they manage for you. They do not earn commissions on investments, nor do they get a fee when you buy or trade securities. Because of this, fee-only financial advisors generally have fewer conflicts of interest than other advisors, and they still must disclose any conflicts they do have. Fee-only financial advisors are almost always fiduciaries.

Fee-Based Financial Advisors

Fee-based advisors may have fees like fee-only financial advisors, but they also may earn money from commissions or referral fees, like commission-only advisors.

If you choose a fee-based advisor, you want to make sure they are always acting as a fiduciary. Some fee-based advisors may not act as a fiduciary when they perform certain tasks.

It’s important to note that just because an advisor receives a commission for a product, that doesn’t necessarily mean it’s not in your best interest. Certain products, like life insurance, may only be sold with a commission-based model, says Karen Van Voorhis, a certified financial planner and Director of Financial Planning at Daniel J. Galli & Associates in Norwell, Mass.

Many financial advising professionals advocate for people to use fee-based and fee-only advisors. That’s because someone who you are paying a fee to, instead of someone being paid a commission by a company, may prioritize your financial wellness more than someone who will make money regardless of if you return to them in the future.

How to Choose a Fiduciary Financial Advisor

To find a fiduciary financial advisor, follow these steps:

• Think about your goals. Before researching advisors, establish what your financial goals are. For instance, you may be planning on retiring early, funding your child’s college education or buying a home within the next five years. Some financial advisors specialize in particular areas, so you want to make sure you find an advisor whose experience matches your goals and background.
• Research financial advisors. Word-of-mouth from family and friends can help you find a reputable fiduciary financial advisor. You can also search for advisors on the National Association of Personal Financial Advisors (NAPFA) database, Garrett Planning Network, XY Planning Network or the Alliance of Comprehensive Planners (ACP).
• Review potential advisors’ Form ADV. Investment firms are required to file The Uniform Application for Investment Adviser Registration (Form ADV) with the SEC annually. This form, available for review on the SEC website, outlines the firm’s services, fees, credentials and disciplinary history. FINRA’s BrokerCheck also lets you research any complaints filed against fiduciary financial advisors.
• Meet with the advisor. You need to feel comfortable with your financial advisor, so you should meet with your prospective advisors to ensure you agree with their investing philosophy and that they understand your goals and risk tolerance. Your relationship with your financial advisor is ongoing, so feel free to ask questions and request more information. Make sure you leave any first meeting knowing how your advisor makes money and if they are a fiduciary.