What is a Fiduciary?

In law, a person in a position of authority whom the law obligates to act in good faith and solely on behalf of the person he or she represents. Unlike people in ordinary business relationships, fiduciaries may not seek personal benefit from their transactions with those they represent.

Examples of fiduciaries include attorneys, executors, trustees and guardians.

The concept of a fiduciary has been around for generations. In the past, it primarily related to attorneys, executors, trustees and guardians.

Then, in 2007, the Certified Financial Planner Board of Standards implemented a requirement that their members must adhere to a fiduciary standard—in other words, putting their clients’ interests first, before their own.

Congress is currently weighing a proposal to make the fiduciary standard uniform for all financial advisors.

This proposal aims to eliminate a double standard that currently prevails when dispensing personalized advice to investors.

Under the Dodd-Frank law, Congress has given the SEC authority to establish this standard as a uniform rule for all “financial advisors”.

There has been significant pushback from the Wall Street brokerage industry whose lobbyists have thus far thwarted any attempt to establish a uniform standard across the industry.

Two new industry groups—the Institute for the Fiduciary Standard and the Committee for the Fiduciary Standard—have also evolved.

The consensus among all these groups is that the fiduciary standard is good for investors and that it is needed to restore confidence in our capital markets.

Registered Investment Advisers (RIAs) usually provide their services for an annual fee calculated as a percentage of assets under management.

They are required to act as "fiduciaries". This means they must put their clients' interests first. In other words, they must by law disclose all expenses and potential conflicts of interest.

On the other hand, when brokers and insurance agents give investment advice, they are obligated only to make sure that what they are recommending is "suitable" for the investor involved.

This suitability standard represents a lower standard than the fiduciary standard. More importantly, there is no requirement on the part of brokers and insurance agents to explain possible conflicts of interest that may arise between what is in their own personal best interest by offering a particular investment and the interest of the client who is being placed into the investment.

All three groups (RIAs, brokers and insurance agents) at times call themselves "advisers." U.S. surveys have shown that individual investors—even highly sophisticated ones—find it difficult to distinguish between them.

Critics say the current framework means brokers can recommend investments that enrich themselves and their companies at their clients' expense. These may include, for example, mutual funds or fixed-income products that result in higher commissions to the person selling them.

“Dealing with other people's money is a very important trust, not like selling Budweiser or Kraft cheese or diamonds," said John Bogle, founder of Pennsylvania-based Vanguard Group. According to Bogle, “We've developed a financial system in the U.S. and around the world where too many of us are serving two masters. One is the company for whom we work, and the other is the client you're pledged to serve."

Presently, the boundary line is quite vague as to what differentiates authentic fiduciaries from sales professionals at brokerage houses, insurance companies or banks. In a true fiduciary relationship, trustworthy financial advice is the basis for—not incidental to—product and service recommendations.

Another way to look at it is the authentic fiduciary standard is principles-driven (versus rules-based) and requires absolute and undivided loyalty to the “clients’ best interests”, whereas the suitability standard is rules-based (versus principles-driven) and requires only “fair dealings” on the part of the advisor. This difference is explained more fully in the next section.

Adopting the Fiduciary Standard means an advisor should strive to fulfill the following four principles:

• Loyalty- this means placing the client’s best interest first (as contrasted with the suitability or “fair dealings” standard). Inherently, a broker has conflicting loyalty to his employer because his compensation from the employer is tied directly to sales of products to investors.
• Due Care- this principle is tied to the “prudent expert” standard—the advisor is expected to use the care and skill, and to exhibit the diligence, of a professional (as contrasted with the suitability side which is to merely to understand the virtues of particular investments, and whether or not an investment is suitable for a client).
• Utmost Good Faith- this is associated with fair and full disclosure—this is the one item most shared with the suitability standard. That being said, there are nevertheless more robust requirements on the fiduciary level.
• Avoid (or at least manage) conflicts of interest- this means the fiduciary advisor maintains an undivided duty of loyalty in putting the investor-client’s interests first. A true fiduciary cannot allow any incentive, particularly a financial incentive, to accrue to him or her based upon a recommendation of one investment over another, and especially if the incentive results in financial gain or return to the fiduciary advisor.

The question is: Whose Interests Should Come First? The advisor? Or the client? There is a difference.