Fiduciary duty is an important legal and ethical concept that applies to many types of relationships where one party is entrusted to act in the best interest of another party. Understanding what fiduciary duty is and when it applies can help you protect your interests when entering into agreements with financial advisors, investment managers, lawyers, trustees, and other professionals.
What is a Fiduciary Duty?
A fiduciary duty is the highest standard of care imposed by law. A fiduciary is any person or organization that acts on behalf of another party. The fiduciary is entrusted with money, property, sensitive information, or authority that directly impacts the beneficiary. This relationship implies a fiduciary duty to act honestly, in good faith, and in the best interests of the beneficiary at all times.
Fiduciaries have an ethical and legal obligation to avoid conflicts of interest and act responsibly. They must manage the assets or affairs of the beneficiary as carefully as they would their own. Fiduciary relationships require the highest level of trust and confidence between both parties.
Some examples of fiduciary relationships include:
- Board of directors and shareholders
- Executors and beneficiaries of a will
- Trustees and beneficiaries of a trust
- Investment advisors and clients
- Lawyers and clients
- Guardians and wards
In these relationships, one party (the fiduciary) is given power over the assets or legal matters of another (the beneficiary). The fiduciary has a duty to exercise that power responsibly on the beneficiary’s behalf.
Why is Fiduciary Duty Important?
Fiduciary duty helps protect vulnerable parties or beneficiaries who rely on a fiduciary’s specialized skills. The obligations imposed by fiduciary duty aim to promote trust, good faith, and confidence in fiduciary relationships.
Without fiduciary duty, beneficiaries would be at much greater risk of abuse, mismanagement, conflicts of interest, and other breaches that could threaten their interests and assets. Fiduciary duty helps hold fiduciaries accountable for carrying out their obligations responsibly.
Types of Fiduciary Duties
Fiduciaries are bound by several specific duties that reflect the great trust placed in them. The core fiduciary duties include:
Duty of Care
The duty of care requires fiduciaries to act with the level of care that a reasonable person would exercise in the same circumstances. They must exercise reasonable diligence in making decisions and cannot act negligently or recklessly. With a duty of care, strict precautions must be taken to protect the interests of the beneficiary.
For example, corporate directors must carefully review all relevant information and exercise independent judgment before making major decisions. Trustees must manage trust assets as carefully as their own.
Duty of Loyalty
The duty of loyalty means fiduciaries must act in the sole interest of the beneficiary, not themselves. They cannot engage in self-dealing or have conflicts of interest that could divide their loyalty.
Fiduciaries must make decisions based on what is best for the beneficiary, not any personal benefit. Corporate officers cannot usurp business opportunities for personal profit that rightfully belong to the company. Trustees cannot make investments that benefit themselves over the trust.
Duty of Good Faith
Fiduciaries have a duty to act honestly, ethically, and in good faith at all times. They cannot misrepresent facts, conceal information, or act in an underhanded or fraudulent manner. Fiduciaries must have legitimate reasons to support their actions and decisions.
Duty of Confidentiality
Confidential information can only be used for the benefit of the beneficiary, not the fiduciary. Sensitive information must be kept private and only disclosed when necessary or required by law. For example, attorneys cannot share confidential client information without permission.
Duty of Prudence
Fiduciaries must act with caution and care when making decisions that impact the beneficiary. Speculation, risky investments, or acting impulsively could betray this duty. conservative decisions that protect the beneficiary’s interests are required.
Duty to Disclose
Fiduciaries must provide full and accurate disclosure to their beneficiaries. All relevant information, including any potential conflicts of interest, must be openly shared. Ongoing disclosure ensures the beneficiary can sufficiently monitor the fiduciary.
Who Can Be Considered a Fiduciary?
While fiduciary relationships are often formed formally through contracts or legal appointments, according to the Department of Labor, anyone who provides investment advice for a fee is considered a fiduciary. Some of the most common types of fiduciary relationships include:
- Financial and Investment Advisors – Registered investment advisors, brokers, financial consultants, and anyone paid to provide investment advice have a fiduciary duty to act in their clients’ best interests.
- Trustees – Trustees appointed to manage assets in a trust have fiduciary responsibilities to the trust beneficiaries.
- Estate Executors – Executors appointed to manage an estate have a fiduciary duty to the estate beneficiaries.
- Board Members – Board members and directors have a fiduciary duty to the organization they serve and must act in the best interests of the organization.
- Guardians – Court-appointed guardians have a fiduciary duty to care for and protect the assets and interests of a minor or incapacitated adult (their ward).
- Power of Attorney – Someone designated with power of attorney has a fiduciary duty to the person who granted them the power of attorney.
What Happens If Fiduciary Duty is Breached?
When a fiduciary fails to fulfill their obligations and breaches their fiduciary duty, they can be held legally responsible for the consequences by the injured beneficiary. Examples of breaches of fiduciary duty include:
- Mismanagement – Poor investment decisions or oversight
- Lack of disclosure – Failure to disclose a conflict of interest
- Negligence – Failing to act with reasonable care
- Misappropriation – Using funds inappropriately for personal gain
- Co-mingling funds – Mixing fiduciary funds with personal funds
Depending on the details of the specific breach, the fiduciary may face civil litigation, criminal penalties, or regulatory action:
- The injured beneficiary can sue the fiduciary to recover damages. For example, if an investment advisor’s poor recommendations caused losses, the client could sue for those losses.
- In egregious cases, the fiduciary may face criminal fraud charges for willfully misusing funds or deceiving beneficiaries.
- Licensing boards and government regulators may sanction or revoke the licenses of fiduciaries who breach their duties. For example, the SEC often penalizes brokers and advisors for fiduciary breaches.
Avoiding Breaches as a Fiduciary
Serving as a fiduciary comes with substantial obligations. Here are some proactive steps fiduciaries can take to avoid breaches:
- Understand duties: Have clear knowledge of the specific fiduciary duties you owe. Seek guidance from legal counsel if unsure. Ignorance is not a defense.
- Avoid conflicts: Be alert to any conflicts of interest. Have processes to vet situations for potential divided loyalty. Disclose conflicts transparently to beneficiaries.
- Act diligently: Exercise careful oversight of any assets or decisions that impact beneficiaries. Seek expert help if needing guidance on prudent courses of action.
- Document thoroughly: Keep detailed records of actions taken and the logic behind decisions. This evidence can defend against breach claims.
- Limit discretionary decisions: Consult beneficiaries and get approvals for major transactions. Do not take actions beyond your scope.
- Be transparent: Openly communicate with beneficiaries and disclose anything they should be informed on. Promote accountability.
- Get insured: Fiduciary liability insurance can protect against claims made for honest mistakes in judgment. But it will not cover egregious breaches.
By making ethical behavior and the beneficiary’s interests a top priority, fiduciaries can avoid any appearance of impropriety and fulfill their duties with integrity.
Work With a Fiduciary You Can Trust
Fiduciary relationships require high levels of trust, transparency and accountability. At My RIA Lawyer, our team of investment advisor lawyers understands the gravity of this responsibility. We have the expertise to help Registered Investment Advisors, alternative asset managers, financial advisors and other professionals meet their fiduciary obligations and avoid costly missteps. To discuss your fiduciary duty questions and risks, schedule a consultation with us today.