What is a Fiduciary? And Why are they Important?

Navigating life as an adult can be a daunting task especially if you are not familiar with the law to a certain extent. In this article, we are going to be introducing you to an extreme degree of information on Fiduciary and all of the common things associated with this aspect. In simple words, a Fiduciary is a person that is supposed to put the best interest of their clients ahead of their own.

People that accept the responsibilities mentioned above are both legally and ethically bound to always put the needs of their clients before their own. This kind of relationship can be seen in many walks of life such as attorney and a client, guardian and a ward, Board member and a shareholder and many more.

Legal aspects covering the relationships stated above are huge and obviously you do not have to be aware of all the intricacies involved. Nonetheless, there are certain points that you need to be enlightened about and all of them will be discussed in detail in the following paragraphs.

If you are involved with managing funds or running portfolios, then the things discussed in this post are going to be extremely helpful for you. After all, one needs to be aware of all the angles associated with a career and there is no way around that, right?

Fiduciary Definition

Fiduciary is a person that is supposed to carry out certain activities that are predetermined and the main responsibility they need to uphold is the Trust factor. They are the people that should think and act on behalf of the clients while doing enough due diligence to reach the goals of their clients. Whenever a person intentionally accepts a fiduciary duty, they are governed by the prudent-person rule.

To satisfy the condition of the prudent-person rule, individuals that accept the duty should always put the needs of the clients before them and they should not have any kind of conflict of interest. In some cases, if conflict of interest is unavoidable, then the person accepting the role must inform the client before the agreement is made.

Generally speaking, fiduciaries will not make any money off of their relationship with the client unless the move is consented by the principal. Note that, the compensation need not be confined to monetary rewards only.

As you can already tell by now, the main underlying point required to hold a valid relation is to eliminate all kinds of conflict of interest and to uphold transparency in every way possible. Though this duty can be seen in a variety of sectors, one of the main fields it is implemented with great care is the financial sector. We will discuss more about this later in the article. 

Basic Duties of a Fiduciary

As Fiduciary covers a wide range of sectors, the exact duties one has to perform mainly depends upon the niche they are in. Remember, not all of the rules are applicable at all the times, and sometimes documentation or gathering of data to support certain aspects are mandatory.

Take a close look at the following cases and you will understand everything you need to know about them. In case, if you have any other questions on the topic, then feel free to mention them down below and we will get back to you. 

Board Members and Shareholders

This is perhaps the best way of explaining the Fiduciary rule. Board members that are responsible for taking crucial decisions that affect a firm are always required to conduct in-depth research and proceed with taking any actions only if they think it works in the favor of the shareholders. They are not supposed to be involved with anything that goes against the collective interest such as insider trading, hiring people without doing background checks, etc,. 

Duty of Care – Running a business is hard and it requires people at the top to make difficult decisions from time to time. However, as all of their decisions can literally make or break their company, all of them need to be evaluated carefully.

For example, if a firm wants to hire a new marketing consultant or sales executive, then they need to perform a thorough check not only of the candidate that is hired, but of all the candidates in order to find the one that is qualified enough for the position. The main goal of this clause is to minimize the margin of error and to enforce key members to act in a way that can never be categorised as intentional or unintentional self-destructive mechanism. 

Duty of Loyalty – Every successful business needs to instill trust among its investors and employees in order to enhance their longevity. Directors and other important members of a company cannot be engaged in any personal or professional activity that creates conflict of interest with the shareholders.

They should not buy or sell securities primarily based upon the exclusive information they might have received. If any of the board members are caught dealing with things outside the boundaries of law, then they can be sued by the other members within the organisation itself or by the shareholders. 

Guardian and a Ward

This relationship exists as soon as the adult is appointed as a legal guardian to a child. People that undertake this responsibility are supposed to take care of all the needs of a kid. Guardian should make sure that the ward attends school, gets appropriate levels of medical attention(if needed) and more importantly has got all the resources that enables him or her to stick to certain standards.

In case a person appointed as the legal guardian for any reason is unable to continue his duties, then the court will appoint a new custodian and all the same rules will be applicable till the child reaches the age of maturity. 

Attorney and Client Fiduciary Element

The relationship with attorneys and the clients should always be confidential and stringent. Lawyers should uphold loyalty and ensure fair treatment to all of their clients. They should take actions that benefit clients at every possible level and they should never be the cause for any kind of information leak. If the attorney is found guilty for breaching the fiduciary, they can be sued and the consequences for their actions will be severe to say the least. 

Insurance Agent and Buyer

Insurance is the small premium we have to pay in order to bring our risk exposure levels to a very acceptable limit. Though insurance generally is beneficial for the sellers, the price tag every contract has is decent and at the end of the day, it is worth it for the majority of the clients. Agents hired by the firm to sell the insurance policies should always understand, analyse the situation of the clients well before making them buy any packages.

Though most of the agents make money via selling the contracts, they just cannot make blind suggestions in order to buff up their paychecks. While there is nothing wrong with making a commission by selling a product or a service, agents do need to act in good faith and their recommendations should be apt to the needs of the clients. 

Investment Fiduciary

There are a lot of misconceptions and myths surrounding Investment fiduciaries. For starters, people generally assume that only money managers are bound by this law, but we can assure you that it is not the case. Basically, anyone that handles funds on behalf of people should follow certain guidelines in order to avoid any kind of litigation.

One might think that it is possible to delegate the entire duty by hiring a financial professional, but that is not the way these rules work. At the end of the day, the responsibility is not something that is transferable and that is a fact. 

Suitability Rule

As the name hints, this rule states that people though they might not be fiduciaries are obligated to recommend only the kind of products that satisfy the needs of the end consumers and enables them to attain their goals. Brokerages are often the ones that follow these specific guidelines the most. People working as consultants or financial advisers regardless of how great their statistics are, will usually have a conflict of interest.

As analysts or investment advisors their main duty is to their employer and then to cater to the client’s goals. In this case wherein conflict of interest is evident and there is no way around it, advisers should recommend the things that genuinely enhance the client’s portfolio. Analysts should never mislead the investors just for the sake of commissions and they all should do enough analysis before making a recommendation to the clients.

In the past, various people have misused their powers and did things like churning accounts, making unnecessary trades only to increase the trading costs that benefits the brokerages. Sometimes money managers may need to buy custom options or exotic options in order to hedge the long term risk exposure and the process might create a scenario wherein they might get hefty commissions for opening the position.

Before pulling any kind of trigger, they need to re-evaluate the decision, make sure that the derivative position really helps the client get more out of the market and then have to proceed with it. Note that anything that increases the incentives for the advisers should be brought to the attention of the clients in order to maintain full transparency.

To turn fiduciary guidelines into their favor, many brokers usually offer their own products at competitive costs to the clients thereby growing both the revenue and the user experience factor. 

Is there any risk associated with being a Fiduciary?

Almost everything in life carries a level of risk and it is impossible to eradicate it completely. Any person that puts their own needs above the interest of the client can be categorised as fiduciary risk. Selling stocks before placing a huge sell order for the client, making the client buy unnecessary products that have little to no significance on the performance of the portfolio are certain examples that highlight the actions of the culprits.

Note that just because a portfolio is experiencing a drawdown does not necessarily mean that the person in charge is acting outside the boundaries of law. However, if a manager is caught red handed or if there is enough evidence to prove the case, then the incident is termed as “Fiduciary Fraud”.

Investment Fiduciary Guidelines

As we all know, the world of finance is a chaotic space and it needs close monitoring or else, the retail side is going to lose a lot of money. In the last few decades a lot of scams have surprised us, though the loopholes are being closed swifty, it still has a long way to go before becoming impeccable. There are certain guidelines that govern this space and they are as follows.

Organise – First and foremost, fiduciary have to create a solid blueprint and create a set of laws that applies to them depending upon the situation. This step creates awareness in the people at the top and enables a smooth working model.

In case, investment advisers or other financial professionals are to be hired, then there needs to be an exact outline and job description and any and all service agreement needs to be in the written format. 

Formalise – Once the foundation is set, the next step is to create a plan of action and that involves creating a specific set of goals and objectives. People have to construct a diversified portfolio that has set parameters and predetermined levels of risk. As we all know there is no free lunch in the market so less risk means less rewards and more risk translates into higher rewards.

Making money in the markets carries enormous risk and to mitigate it, money managers have to invest in correlated assets and also build derivatives positions. Most of the advisers use Modern Portfolio Theory as it is a proven approach, but remember no strategy can accurately predict the exact drawdowns of the market and anyone that says otherwise is either not well informed or aware of the facts.

Once the approach is finalised, advisers have to create investment policies and make the clients aware of the entire situation with accurate disclaimers. 

Implement – Though plans or the allocation of funds can be predetermined, the future might not be kind towards all of our goals. In the event wherein unforeseen development occurs, then money managers are required to perform due diligence and divert the funds as they see fit.

The costs should be justified and they have to show enough reasons behind taking the crucial decisions. In case, if the fiduciary does not have the necessary skill to get the job done, then they can delegate the process. However, it is their duty to inform the hired candidate about all the relevant conditions and to make sure they perform satisfactorily. 

Monitor – Monitoring the process is also an important task in portfolio management. Metrics like average volatility, trend trading strategies and other technical tools might provide you enough data to create a strategy, but without active monitoring and tweaking, the desired goal cannot be reached.

Fiduciaries should constantly monitor their positions and create a benchmark to evaluate their performance. Remember, every day is not the same in the markets, but if you have an edge, all it takes is time to build wealth. 

Fiduciary Insurance

Firms usually secure the retirement of fiduciaries and people that enjoy this post usually will be company’s directors, trustees or top employees. Fiduciary liability insurance is also brought by firms in case they have to cover their legal expenses in case of severe litigations.

If the founders or members at the top of the management chain are accused of mis-management of funds, intentional loss booking, reckless spending of resources, etc,. Then the insurance will take care of the financial side of the situation. 

Fiduciary Financial Advisors

As adults we need to take care of our finances and start investing in things that will grow our wealth over the long term. While some people might make tremendous returns. Unfortunately, the majority of people will lose money as they are misinformed about the markets. So, hiring a financial adviser is a safe bet for many people and while doing so just make sure that they are fiduciary financial advisers.

Advisors might sometimes have conflict of interest in some way or form. So, to be on the safer side, ask about the ways they monetize their skills and 9 times out of 10, it will give you a pretty clear picture about the situation. Financial advisors that have fiduciary duty are paid in the following ways.

Commissions – This is the most common type of payments financial advisers receive. Advisers that work on commission basis get money only if they sell a product to a client. Obviously, the conflict of interest is present, but as long as the suitability rule is satisfied, there is nothing to worry about.

Nonetheless, always make sure that you fully understand the product or instrument being sold to you. A lot of times the popular things in the financial sector are going to be short lived and people will end up getting trapped. So, have a firm grasp on risk management and then diversify the portfolio to the maximum extent possible. 

Fee only – Some financial advisors never rely on the commission structure instead they charge clients either based upon the portfolio size or on an hourly basis. Clearly, with these types of advisers, there won’t be any degree of conflict of interest in most cases.

Remember, everyone’s goals are different and the kind of capital injected also differs. Depending upon your goal if you feel like sticking with fee based advisors are better, then go for it. Before you take the final decision, compare the pros and cons list and ask yourself, which option is the one that fulfills most of your needs?

Fee Based – Financial advisors that charge hourly rates and also get compensated by the commissions or referrals can be categorised as fee based advisors. Note that just because they charge commissions does not necessarily mean they are churning the account of their clients.

There are few exceptions to the rules and whenever things like insurance are brought, all the parties involved will benefit. Some blunders by these types of advisors have happened in the past, but not all of the losses can be blamed on the greed factor alone.

How to Choose the Perfect Financial Advisor?

Choosing the perfect financial advisor is a difficult task and one needs to be aware of a lot of metrics. Keep in mind that past data necessarily does not translate into future gains. So, all we can do is rely on the best approach, find the advisor that will help us attain our goals and more importantly, make sure that they are faithful to the cause. 

Goals – Investing from an early age is a very good thing and the compounding efforts indeed does miracle over the long run. Choosing the perfect advisor has a lot to do with your goals and risk appetite. For example, if you are young, then you can be building positions on particular stock aggressively instead of going for diversification.

On the flip side, advisors also have a specific approach and it should not contradict with your goals for obvious reasons. To make sure that you get the one that truly understands your needs, discuss your goals precisely and then decide for yourself whether to proceed with them or not based upon the answers you get. 

Research and Recommendations – Researching is important to find a reputable financial planner. The most obvious choice is to search the databases or networks of well established organisations. Alternatively, you can ask your friends and family too.

Planners that are building their client base mainly via word of mouth marketing will usually be exceptional. After all, why would anyone suggest the name of that professional, if they were not good in the first place? Nonetheless, just make sure you take a look at their qualifications too. 

One on One meeting – There is something about the personal human contact that the digital world just cannot provide. If you have narrowed out your options, then make it a point to visit every one of them and spend some time with them.

Try to understand their investing principles and style of tackling the markets. The numbers will tell you everything you need to know about them. Once you feel confident, then you can proceed with the desired planner and hope for the best. 

How to know whether your financial planner is Fiduciary or Not?

The transparency aspect in the world of finance is very flimsy and people often spread misinformation for their own benefit. Nowadays, many people are claiming to be professional money managers and wealth managers. Thanks to the social media platforms, literally anyone can open a channel, show some documents to back up their statements or manufactured back stories and start taking money from people in the name of investments.

To ensure the safety of your funds, you need to be extremely careful while looking for a reliable manager and as a general rule, stick with licensed financial advisers only. Most licensed advisers charge extra fees compared to their counterparts, but the cost involved will always be worth it because of the reliability factor alone. We know that people that are not qualified enough might enhance their profiles artificially and claim to achieve extraordinary results and income.

However, when asked for proof and audited reports they will never be able to provide them as their statements are nothing more than pure fantasy. The best way to find an answer to this question is to figure out the incentives of the advisor and the level of conflict of interest he or she has. If the incentives are not present, then it is safe to assume that they only work for the benefit of the client and nothing else. 

Is trading softwares a Fiduciary?

The great thing about automated softwares is that it takes out emotions out of the process. Needless to say, it does not lie to anyone. However, the results they get will not be consistent over time and as the market evolves, a lot of trading algorithms will become absolute.

As far as the question is considered, the trading algorithms itself cannot be held liable because it has a lot of flaws and it never qualifies as a Fiduciary by any means unless they are run by broker dealers with human intervention. Moreover, remember that technical glitches and a wide variety of other mishaps can make or break the portfolios it was running. So, it is advisable for the retail side not to employ pure quant based models because of the inherent risk present. 

Have you experienced any breach of contract?

Hiring a lawyer is undoubtedly expensive and most of the time especially when less money is involved, one might not feel like taking the matter in the professional manner. On the flip side, they might also be worried about the legitimacy of the case or might have problems with gathering evidence and building a case on their own.

Regardless of what your query might be, fill the contact form below and get free consultation on the matter from our experts. If your case turns out to be genuine, then our team will do the grunting work for you and move towards getting back the funds that rightfully belong to you.