In Part 2 of this series, I explored the distinctions between arms-length (sales) and fiduciary (advisory) relationships, the fiduciary principle, several of the public policy rationales for the imposition of fiduciary duties, and briefly touched upon the various fiduciary duties that exist.
Part 3 explored the impact of fees and costs upon investment returns, and the relationship of academic insights in this area to the fiduciary's duty of due care to control fees and costs incurred by the client.
This Part 4 turns the attention of this series to the most distinguishing aspect of the fiduciary standard of conduct - the fiduciary duty of loyalty.
Capitalism vs. Paternalism: Exploring the Need for the Fiduciary Duty of Loyalty.
“If men were angels, no government would be necessary.”
- James Madison
“Opportunism.” The undeniable
truth is that capitalism runs on opportunism. In his landmark work, The Wealth of Nations, Adam Smith
described an economic system based upon self-interest. This system, which later
became known as capitalism, is described in this famous passage:
It is not from
the benevolence of the butcher, the brewer, or the baker, that we expect our
dinner, but from their regard to their own interest. We address ourselves, not
to their humanity but to their self-love, and never talk to them of our own
necessities but of their advantages.
(Smith, p. 14, Modern Library edition,
1937).
As Adam Smith pointed out, capitalism
has its positive effects. Actions based upon self-interest often lead to
positive forces which benefit others or society at large. As capital is formed
into an enterprise, jobs are created. Innovation is spurred forward, often
leading to greater efficiencies in our society and enhancement of standards of
living. As Adam Smith also noted, a person in the pursuit of his own interest
“frequently promotes that of the society more effectually than when he really
intends to promote it.” (Smith, p. 423)
Taken to excess, however, the
self-interest which is so essential to capitalism can lead to opportunism,
defined by Webster’s as the “practice of taking advantage of opportunities or
circumstances often with little regard for principles or consequences.” A
stronger word exists when consequences to others are ignored - “greed.” We
might define “greed” in this context as the selfish desire for the pursuit of
wealth in a manner which risks significant harm to others or to society at
large. Whether through actions intentional or neglectful, when ignorance of
material adverse consequences occurs, the term “greed” is rightfully applied.
Gordon Gekko in the film Wall Street,
who famously declared that “Greed, for lack of a better word, is good,” got it
wrong. Opportunism itself – acting in pursuit of one’s self-interest - does not
always lead to greed. Rather, it is only when the pursuit of wealth causes
significant undue harm to others does such activity arise to the level of
greed, and in such circumstances the rise of greed is not “good.”
What would Adam Smith say today? Even Adam Smith knew that constraints upon
greed were required. While Adam Smith saw virtue in competition, he also
recognized the dangers of the abuse of economic power in his warnings about
combinations of merchants and large mercantilist corporations.
Adam Smith also recognized the
necessity of professional standards of conduct, for he suggested qualifications
“by instituting some sort of probation, even in the higher and more difficult
sciences, to be undergone by every person before he was permitted to exercise
any liberal profession, or before he could be received as a candidate for any
honourable office or profit.” (Smith, p. 748, see also pp. 734-35. As seen,
“Smith embraces both the great society and the judicious hand of the
paternalistic state.” Shearmur, Jeremy and Klein, Daniel B. B., “Good Conduct
in a Great Society: Adam Smith and the Role of Reputation.” D.B Klein,
Reputation: Studies In The Voluntary Elicitation Of Good Conduct, pp. 29-45,
University of Michigan Press, 1997.)
In essence, long before many of the
professions became separate, specialized callings, Adam Smith advanced the
concepts of high conduct standards for those entrusted with other people’s
money.
What would Adam Smith observe regarding the modern forces in our economy? He
would likely opine, given the economic forces that led to the recent Great Recession, that unfettered capitalism can have many ill effects.
Indeed, he would observe that for all of its virtues, capitalism has not
recently been a very pretty sight. And he would likely proscribe many cures –
including prudential regulation through the application of fiduciary principles
of conduct upon those who provide personalized investment advice to retail consumers.
Understanding the Fiduciary Duty of Loyalty.
While there have been many judicial elicitations of the fiduciary standard, including Justice Benjamin Cardozo’s lofty early 20th Century elaboration, a more recent and concise recitation of the fiduciary principle can be found in dictum within the 1998 English (U.K.) case of Bristol and West Building Society v. Matthew, in which Lord Millet undertook what has been described as a “masterful survey” of the fiduciary principle:
A fiduciary
is someone who has undertaken to act for and on behalf of another in a
particular matter in circumstances which give rise to a relationship of trust
and confidence. The distinguishing obligation of a fiduciary is the obligation
of loyalty. The principle is entitled to the single-minded loyalty of his
fiduciary. This core liability has several facets. A fiduciary must act in good
faith; he must not place himself in a position where his duty and his interest
may conflict; he may not act for his own benefit or the benefit of a third
person without the informed consent of his principal. This is not intended to
be an exhaustive list, but it is sufficient to indicate the nature of the
fiduciary obligations. They are the defining characteristics of a fiduciary.[1]
In the U.S.,
the “triad” of fiduciary duties is most commonly referred to as the duties of
due care, good faith and loyalty. But other fiduciary duties are said to exist,
including but not limited to the “duty of obedience” and the “duty of confidentiality.”
A further
elicitation of fiduciary duties can be discerned from English law, from which
the U.S. system of jurisprudence was initially derived. Under English law, it
is reasonably well established that fiduciary status gives rise to five principal
duties:
(1) the “no
conflict” principle preventing a fiduciary placing himself in a position where
his own interests conflict or may conflict with those of his client or
beneficiary;
(2) the “no
profit” principle which requires a fiduciary not to profit from his position at
the expense of his client or beneficiary;
(3) the
“undivided loyalty” principle which requires undivided loyalty from a fiduciary
to his client or beneficiary;
(4) the
“duty of confidentiality” which prohibits the fiduciary from using information
obtained in confidence from his client or beneficiary other than for the
benefit of that client or beneficiary; and
(5) the
“duty of due care,” to act with reasonable diligence and with requisite
knowledge, experience and attention.
When one is
engaged as a fiduciary, the fiduciary steps into the shoes of the client, in
order to act on the client’s behalf. As Professor Arthur Laby observed: “What
generally sets the fiduciary apart from other agents or service providers is a
core duty, when acting on the principal’s behalf, to adopt the objectives or
ends of the principal as the fiduciary’s own.”[2]
In fiduciary
relationships, a transfer of power occurs – if not the actual transfer of
assets (as may occur in a trust or custody relationship), then the transfer of
power through the taking, by the client, of the fiduciary’s advice and counsel
(as may occur in a lawyer-client or investment adviser-client relationship).
The client
permits this close, confidential relationship to exist in recognition that the
expertise of the fiduciary, brought to bear for the benefit of the client, can
lead to much more positive outcomes.
But such
expertise, if improperly applied, can be used to take advantage of the client.
The fiduciary, as a expert, possess a much greater knowledge of investments,
portfolio management, etc. Also, the client’s guard is down; due to a variety
of behavioral biases, client consent to action by the fiduciary is easily
secured.
Hence, U.S. fiduciary
law applicable to investment advisers guards against the abuse of the consumer through
its "no conflict" rule. Reflective of English law’s “no benefit” and
“no conflict” principles, the Restatement (Third) of Agency (all agents are, to
a degree, fiduciaries) dictates that the duty of loyalty is a duty to not
obtain a benefit through actions taken for the principal (client) or to
otherwise benefit through use of the fiduciary’s position.[3]
The “no
conflict” rule has nothing to do with good or bad motive. The U.S. Supreme Court,
in discussing conflicts of interest, stated:
The reason of the rule inhibiting a party who occupies
confidential and fiduciary relations toward another from assuming antagonistic
positions to his principal in matters involving the subject matter of the trust
is sometimes said to rest in a sound public policy, but it also is justified in
a recognition of the authoritative declaration that no man can serve two
masters; and considering that human nature must be dealt with, the rule does
not stop with actual violations of such trust relations, but includes within
its purpose the removal of any temptation to violate them ....[4]
And, as the
U.S. Supreme Court said a hundred years ago, the law “acts not on the
possibility, that, in some cases the sense of duty may prevail over the motive
of self-interest, but it provides against the probability in many cases, and
the danger in all cases, that the dictates of self-interest will exercise a
predominant influence, and supersede that of duty.”[5]
And, in the
seminal case addressing the fiduciary duties of investment advisers under the
Investment Advisers Act of 1940, the U.S. Supreme Court observed:
This Court, in discussing conflicts of interest, has
said: ‘The reason of the rule inhibiting a party who occupies confidential and
fiduciary relations toward another from assuming antagonistic positions to his
principal in matters involving the subject matter of the trust is sometimes
said to rest in a sound public policy, but it also is justified in a
recognition of the authoritative declaration that no man can serve two masters;
and considering that human nature must be dealt with, the rule does not stop
with actual violations of such trust relations, but includes within its purpose
the removal of any temptation to violate them ….’[6]
Or, as an
eloquent Tennessee jurist put it before the Civil War, the doctrine “has its
foundation, not so much in the commission of actual fraud, but in that profound
knowledge of the human heart which dictated that hallowed petition, “Lead us not
into temptation, but deliver us from evil,” and that caused the announcement of
the infallible truth, that “a man cannot serve two masters.”[7]
[2] Arthur B. Laby, SEC v. Capital Gains Research Bureau and
the Investment Advisers Act Of 1940, 91 Boston Univ. L.Rev. 1051, 1055 (2011).
[3] See
Restatement (Third) of Agency § 8.02 cmt. a (2006)
(explaining that under duty of loyalty, “an agent has a duty not to acquire
material benefits in disconnection with transactions or other actions
undertaken on the principal’s behalf or through the agent’s use of position”).
[4] CITATION NEEDED
[5] Michoud v. Girod,
45 U.S. 503 555 (1846). The U.S. Supreme Court also stated in that decision:
“if persons having a confidential character were permitted to avail themselves
of any knowledge acquired in that capacity, they might be induced to conceal
their information and not to exercise it for the benefit of the persons relying
upon their integrity. The characters are inconsistent. Emptor emit quam minimo potest, venditor vendit quam maximo potest.”
Id. at 554.
[6] SEC v. Capital Gains Research Bureau,
375 U.S. 180; 84 S. Ct. 275; 11 L. Ed. 2d 237; 1963 U.S. LEXIS 2446 (1963). The
principle is also found in early Christianity: “Christ said: ‘No man can serve
two masters, for either he will hate the one and love the other, or else he
will hold to the one and despise the other. Ye cannot serve God and Mammon
[money].’" Beasley v. Swinton,
46 S.C. 426; 24 S.E. 313; 1896 S.C. LEXIS 67 (S.C. 1896), quoting Matthew 6:24.
[7] Tisdale v. Tisdale, 2 Sneed 596 (Tenn.
1855).
Summary Recitation of a Financial Adviser's Duties of Loyalty and Utmost Good Faith.
There are many possible ways to recite the essence of a financial adviser's fiduciary duty of loyalty. In this section I suggest one such elicitation. A more detailed elicitation of fiduciary standards of conduct, including both additional commentary and sources of law, can be found in one of my prior blog posts.
[I use the term "financial adviser" herein generically, to refer to any actor who is providing personalized financial or investment advice to a retail consumer. Given the remedial nature of regulation in this area, the terms "personalized" and "retail consumer" should be given the greatest breadth of definition.]
There are many possible ways to recite the essence of a financial adviser's fiduciary duty of loyalty. In this section I suggest one such elicitation. A more detailed elicitation of fiduciary standards of conduct, including both additional commentary and sources of law, can be found in one of my prior blog posts.
[I use the term "financial adviser" herein generically, to refer to any actor who is providing personalized financial or investment advice to a retail consumer. Given the remedial nature of regulation in this area, the terms "personalized" and "retail consumer" should be given the greatest breadth of definition.]
Generally. A financial advisor, who is given the highest
degree of trust and confidence by the financial advisor’s client, is a
fiduciary and possesses the duty of undivided loyalty to the client. A financial advisor shall at all times act in
the best interests of his or her clients, in utmost good faith, and honestly.
- The greater the knowledge, experience, and required degree of expertise of the fiduciary, relative to the knowledge and experience of the client, the more significant the fiduciary association becomes as a protector of the client's interest.
- Clients in receipt of financial planning services will nearly always start off, in discussions with their financial advisors, from a position of contractual weakness and, as to the complexities of tax law, financial planning issues, estate planning issues, insurance, risk management issues, and investments, from the position of relative ignorance. Fiduciary status is thereby imposed by the law upon the party with the greater knowledge and expertise in recognition by the law that the client is in need of protection and care.
Maintaining Objective Judgment. A financial advisor must use reasonable care
and judgment to achieve and maintain independence and objectivity in their
professional activities; accordingly, financial advisors must reasonably act to
avoid conflicts of interest.
- A fiduciary cannot serve two masters. The existence of conflicts of interest, even when they are fully disclosed, can serve to undermine the fiduciary relationship and the relationship of trust and confidence with the client. The existence of substantial or numerous conflicts of interest, which otherwise could have been reasonably avoided by the financial advisor, may lead to not only an erosion of the financial advisor’s relationship with the client, but also an erosion of the reputation of the profession of all financial planners and advisors.
Modes and Amounts of Compensation. Financial advisors must not charge an
excessive fee; the sum total of all fees and costs incurred by the client should be reasonable in light of the services and investments provided. Financial advisors must
not offer, solicit, or accept any gift, benefit, compensation, or consideration
that reasonably could be expected to compromise the financial advisor’s own or
another’s independence and objectivity.
- Many types of compensation are permissible for financial advisors, including commission-based, a percentage of assets under management, a flat or retainer fee, subscription fees, hourly fees, or some combination thereof. However, the term “independence” requires that the financial advisor’s decision is based on the best interests of the client rather than upon extraneous considerations or influences that would convert an otherwise valid decision into a faithless act. Additionally, some forms of fees may be inappropriate in certain instances given the needs of the particular client.
- To avoid disputes with clients relating to conflicts of interest involving compensation, all compensation should be fully and specifically disclosed, in dollar or percentage amounts, in writing and in advance.
- Conflicts of interest involving commission-based compensation might be best addressed through a “level compensation” or “maximum compensation” agreement entered into with the client prior to any recommendation of an investment product.
Disclosures and Management of Conflicts. Financial advisors shall disclose
to clients and properly manage all material conflicts of interest which remain
following financial advisors’ reasonable efforts undertaken to avoid conflicts
of interest.
- Disclosure of conflicts of interest does not, in and of itself, negate the financial advisor's continuing duty to act in the best interests of the client.
- Financial advisors shall adopt and adhere to reasonable policies and procedures for the management of remaining conflicts of interest in order that the financial advisor may continue to act in the best interests of the client. This includes, but is not limited to, the adoption and periodic revision of a code of ethics, appropriate compliance policies and procedures, and sound client engagement practices.
Fairness. Financial advisors shall
reasonably seek to not favor the interests of any one client over the interest
of another client. Since situations may
arise in which the financial advisor’s ability to treat all of the financial
advisor’s clients with equal fairness is compromised, or where it may appear
that the interest of one client is favored over that of another client,
financial advisors shall inform clients in writing and (where possible) in
advance of the limitations which financial advisors possess and how the
financial advisors will address the situation.
Honesty. Financial advisors must not knowingly make any
misrepresentations relating to investment analysis, recommendations, actions,
or other professional activities. Financial advisors must not engage in any professional conduct involving
dishonesty, fraud, or deceit, or commit any act that reflects adversely on
their professional reputation, integrity, or competence.
The Duty of Loyalty Extends Throughout The Relationship. The duty of a financial advisor
to act in the best interests of a client cannot be waived by the client; it
extends to all aspects of the relationship between the financial advisor and
client.
- Fiduciary duties apply to all of the advice and recommendations provided by the fiduciary to his or her client; fiduciary duties cover the entire relationship, not just specific accounts.
- Fiduciary duties, once established, cannot be terminated except through termination of the whole of the relationship.
- The term "fiduciary" is utilized to mark certain relationships where a party with superior knowledge and information acts on behalf of one who usually does not possess such knowledge and information. Financial planning, financial advisory and investment advisory services involve such relationships, as learning the personal details of clients’ financial affairs, their hopes, dreams, and aspirations cultivates confidential and intimate relationships.
Preserve Confidences. Financial advisors shall keep all information
about clients (including prospective clients and former clients) in strict
confidence, including the client’s identity, the client’s financial
circumstances, the client’s security holdings, and advice furnished to the
client by the firm, unless the client consents otherwise or except as required
by the provisions of law.
No Reckless Behavior. A financial advisor shall act responsibly at
all times.
- Traditionally, the duty of utmost good faith has been closely related to the concept of loyalty. However, reckless, irresponsible, or irrational conduct – but not necessarily self-dealing conduct – may implicate concepts of good faith.
Financial Advisors Cannot Negotiate
Away Fiduciary Status.
The courts have consistently held, applying state common law, that a
fiduciary relationship need not be created by contract, and that contract terms
as to whether fiduciary status exists are not controlling.
By way of explanation, fiduciary
status arises out of any relationship where both parties understand that a
special trust or confidence has been reposed. “A fiduciary relation does not
depend on some technical relation created by or defined in law. It may exist
under a variety of circumstances and does exist in cases where there has been a
special confidence reposed in one who, in equity and good conscience, is bound
to act in good faith and with due regard to the interests of the one reposing
the confidence.” In re Clarkeies Market,
L.L.C., 322 B.R. 487, 495 (Bankr. N.H., 2005).
Stated differently, once a relation
between two parties is established, its classification as fiduciary and its
legal consequences are primarily determined by the law rather than the parties.
Legal principles of “waiver” and “estoppel” have limited application in
determining whether fiduciary status is applied.
These guiding principles in the
application of fiduciary status are not recent; they were known early on in
circumstances wherein agreements signed by customers of brokers attempted to
negate fiduciary status. In discussing the decisions of two early cases, FINRA
stated: “In relation to the question of
the capacity in which a broker-dealer acts, the [judicial] opinion quotes from
the Restatement of the Law of Agency:
‘The understanding that one is to act primarily for the benefit of another is
often the determinative feature in distinguishing the agency relationship from
others. *** The name which the parties give the relationship is not
determinative.’ And again: ‘An agency may, of course, arise out of
correspondence and a course of conduct between the parties, despite a
subsequent allegation that the parties acted as principals.’” (N.A.S.D. News, published by the National
Association of Securities Dealers (now known as FINRA), Volume II, Number 1
(Oct. 1, 1941).
Disclaimers and Waivers of Core Fiduciary Obligations are Not Permitted.
Disclaimers and Waivers of Core Fiduciary Obligations are Not Permitted.
The stark
difference between arms-length and fiduciary relationships is found not just in the standards of conduct, but also found in the
treatment of the doctrines of waiver and estoppel. The DOL’s proposed BIC
exemption correctly notes this distinction by prohibiting disclaimer or waiver
of the investment adviser’s fiduciary obligations.
In arms-length
relationship consent by a customer to proceed, when a conflict of interest is
present, is generally permitted. Caveat emptor (“let the buyer beware”) applies
to such merchandiser-customer relationships. The customer is not represented by
the merchandiser but is rather in an adverse relationship - that of seller and
purchaser.
In such
instances, it is a fundamental principle of the common law that volenti non fit injuria – to one who is
willing, no wrong is done. Customer consent to the transaction generally gives
rise to estoppel – i.e., the customer cannot later state the he or she can
escape from the transaction because a conflict of interest was present, or
because full awareness of the ramifications of the conflict of interest were
absent. The customer, in such instances, bears the duty of negotiating a fair
bargain. The law permits customers, in arms-length relationships, to enter into
“dumb bargains.” Generally, jurists will not set aside unfair bargains unless
fraud, misrepresentation, mutual mistake of fact exists or unless the contract
is so unjust and burdensome that it is deemed unconscionable.
But the
fiduciary relationship is altogether different. The entrustor (client) and
fiduciary actor have formed a relationship based upon trust and confidence. In
such a form of relationship, the law guards against the fiduciary taking
advantage of such trust. As a result, judicial scrutiny of aspects of the
relationship occurs with a sharp eye toward any transgressions that might be
committed by the fiduciary.
Hence, mere
consent by a client in writing to a breach of the fiduciary obligation is not,
in itself, sufficient to create waiver or estoppel. If this were the case,
fiduciary obligations – even core obligations of the fiduciary – would be easily
subject to waiver. Instead, to create an estoppel situation, preventing the
client from later challenging the validity of the transaction that occurred,
the fiduciary is required to undertake a series of steps:
First,
disclosure of all material facts to the client must occur. [For some
commentators on the fiduciary obligations of investment advisers, this is all
that is required. Often this erroneous conclusion is derived from
misinterpretations of the landmark decision of
SEC v. Capital Gains Research Bureau.][1]
Second, the
disclosure must be affirmatively made and timely undertaken. In a fiduciary
relationship, the client’s “duty of inquiry” and the client’s “duty to read”
are limited; the burden of ensuring disclosure is received is largely borne by
the fiduciary. Disclosure must also occur in advance of the contemplated
transaction; receipt of a prospectus following a transaction is insufficient.
Third, the
disclosure must lead to the client’s understanding – and the fiduciary must be
aware of the client’s capacity to understand, and match the extent and form of
the disclosure to the client’s knowledge base and cognitive abilities.
Fourth, the
informed consent of the client must be affirmatively secured. Silence must not
occur. Consent is not obtained through coercion nor sales pressure (and silence
is not consent).
Fifth, at
all times, the transaction must be substantively fair to the client. If an
alternative exists which would result in a more favorable outcome to the
client, this would be a material fact which would be required to be disclosed,
and a client who truly understands the situation would likely never
gratuitously make a gift to the advisor where the client would be, in essence,
harmed.[2]
These
requirements of the common law – derived from judicial decisions over hundreds
of years – have found their way into our statutes. For example, ERISA’s
exclusive benefit rule unyieldingly commands employee benefit plan fiduciaries
to discharge their duties with respect to a plan solely in the interest of the
plan’s participants and for the exclusive purpose of providing benefits to them
and their beneficiaries. And the Investment Advisers Act of 1940 was widely
known to impose fiduciary duties upon investment advisers from its very
inception, and it contains an important provision that prevents waiver by the
client of the investment adviser’s duties to that client.
As one
examines the foregoing requirements, it is important to realize that disclosure
is neither a fiduciary duty in itself (although various statutes and regulations impose disclosure requirements), nor is disclosure a cure (without much more) to the breach of
one’s fiduciary obligations.
Rather,
fiduciaries owe the obligation to their client to not be in a position where
there is a substantial possibility of conflict between self-interest and duty. This
is called the “no-conflict” rule, derived from English law. Fiduciaries also
possess the obligation not to derive unauthorized profits from the fiduciary
position. This is called the “no profit” rule, also derived from English law.
While there
is no fiduciary duty of disclosure, questions of disclosure are often central
in the jurisprudence discussing fiduciary law, as many cases involve claims for
breach of the fiduciary duty due to the presence of a conflict of interest. In
essence, a breach of fiduciary obligation – either by possessing a conflict of interest or by making an additional profit – may be averted or cured by the informed consent of the client
(provided all material information is disclosed to the client, the adviser
reasonably expects client understanding to result given all of the facts and
circumstances, the informed consent of the client is affirmatively secured, and
the transaction remains in all circumstances substantially fair to the client).
In essence,
asking a client to consent to a conflict of interest by the fiduciary is
requesting that the client waive the no conflict rule, the no profit rule, or
both rules. Again, clients would only do so in circumstances where the client
is not harmed. It would be difficult to believe that client is so gratuitous to
his or her investment adviser that the client would incur a detriment, beyond
reasonable compensation previously agreed to, in order to provide the adviser
with more lucre or other benefits.
Hence,
disclosure, alone, is not a cure. And disclosure is only one of the five
important requirements, all of which must be met, for a client’s waiver of a
fiduciary obligation to be valid.
Some academics suggest that fiduciary duties are merely default rules, and that fiduciary obligations may be contracted away. But, the application of these views is found mainly in the realm of business relationships, such as those between business partners. The advisor-client relationship is an altogether different relationship, in which there are not two sophisticated parties of relatively equal bargaining power (or at least able to hirer attorneys to assist in same). Rather, in the investment adviser-client relationship there exists a huge gulf of knowledge and sophistication. For this reason, even the “contractualists” academics who argue for a contract theory of fiduciary law (as might be applied in business settings, such as between business partners), accept the proposition that core fiduciary duties cannot be waived, at least in adviser-client settings.
In Conclusion.
Under trust law, the "sole interests" fiduciary standard of conduct (found in most trust law, and under ERISA ) requires the avoidance of conflicts of interest. (ERISA permits the U.S. Department of Labor to provide exemptive relief if the "best interests" of the client is maintained. In addition there are some statutory exemptions from the "sole interests" standard).
Under the "best interests" fiduciary standard (applicable under state common law, and under the Investment Advisers Act of 1940), in contrast, there remains a duty to avoid conflicts of interest. However, in those circumstances in which a conflict of interest is not avoided then a stringent set of requirements is applied to ensure that the client's best interests remain paramount. These procedural safeguards include disclosure of the conflict of interest in proper fashion, ensuring client understanding, and securing the client's informed consent. Even then, the transaction entered into is scrutinized for substantive fairness to the client.
Moreover, since the maintenance of a conflict of interest is regarded as a breach of one's fiduciary duty, the burden of persuasion shifts in the courts to the fiduciary, who must prove that the provided cure to the breach meets the requisite requirements.
Fundamental to the understanding of the duty of loyalty is this notion of avoidance of conflicts of interests. For, as has been said by philosophers, religious scholars, and jurists over the millennia, no many can serve too masters.
There have been those that argue that the Investment Advisers Act of 1940 only requires disclosure of conflicts of interest. As I've written before, this conclusion follows from a wishful, incorrect interpretation of the SEC v. Capital Gains 1963 U.S. Supreme Court decision.
Since early June of this year proposals have been advanced by SIFMA, FSI and other industry lobbyists, subsequently endorsed by FINRA, and now found in Congressional legislative proposals (as of early Jan. 2016), that would create a new "best interests" standard. As I have written previously in several blog posts in 2015, this is but a banal attempt to redefine the term "best interests," and would result in nothing more than an arms-length relationship enhanced by ineffective "casual disclosures." If disclosures worked, there would be no need for the fiduciary standard of conduct, in any legal context. Policy makers should resist any "redefinition" of "best interests" (and, hence, a change to fiduciary law), by resisting, to paraphrase the late great Justice Cardoza, any "particular exceptions" to the strict requirements imposed upon fiduciaries.
Like it or not, the fiduciary standard of conduct acts as a restriction on conduct. Yet, in this modern and complex financial world and era of ever-increasing specialization, the fiduciary standard of conduct is needed more and more as the cure for the vast information asymmetry between financial advisors and their clients.
And, as will be seen in the next post, many current business practices of insurance agents and broker-dealer firms are difficult to reconcile with the fiduciary standard of conduct.
NEXT POST: "Who Moved My Cheese": The Future of Financial Advice (Part 5).
Ron A. Rhoades, JD, CFP® is the Program Director for the Financial Planning Program and an Asst. Professor of Finance at Western Kentucky University, at its beautiful main campus in Bowling Green, KY. He is a CFP certificant, a regional board member of NAPFA, a consultant to the Garrett Planning Network, and a member of the Steering Group for The Committee for the Fiduciary Standard.
This blog represents Ron's personal views and is not necessarily indicative of the views of any institution, organization or firm with whom he may be associated.
Ron is scheduled to provide two presentations in early 2016 on the DOL's rules and the general impact of the fiduciary standard on the financial services industry:
- Feb. 24-25, 2016: FPA of Oregon and S.W. Washington Midwinter Conference 2016, where Ron will discuss: "The DOL's Transformational Conflict of Interest Rule"
- Feb. 26, 2016: FPA of Puget Sound's 2016 Annual Symposium, where Ron will discuss: "Reducing Your Risks in the New Fiduciary Era"
Connect with Ron on LinkedIn.
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Public comments to this blog are welcome, provided that no advertising occurs and that decorum is maintained. To reach Prof. Rhoades directly, please e-mail him at: Ron.Rhoades@WKU.edu. Thank you.
Public comments to this blog are welcome, provided that no advertising occurs and that decorum is maintained. To reach Prof. Rhoades directly, please e-mail him at: Ron.Rhoades@WKU.edu. Thank you.
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