Three years ago, for Valentines Day, NYT personal finance writer Tara Siegel Bernard wrote a column, “Will you be my Fiduciary?” and discussed how investors might engage a fiduciary advisor. Bernard’s headline was clever enough, but is there is any logical link between one’s Valentine and one’s fiduciary?
Not at first sight. The romantic spirit of Valentines Day, emotion leavened with passion and mystery, might well be, in fact, the antithesis of the fiduciary whose watch word is prudence.
Below the surface, though, is a different story. Both describe the human experience at its best: devotion, care, respect, reliance and visions of best possible outcomes devoid of conflicts.
Fiduciary law and Valentines Day go back centuries. While the precise origin of St. Valentines Day is uncertain, differing legends chronicle its beginning during the Roman Empire. Fiduciary principles, on the other hand, are seen in the Code of Hammurabi (circa.1780 BC), and the writings of Aristotle (in the 4th Century BC). Fiduciary law has existed to mitigate the “knowledge gap” between expert providers of socially important services – such as law, finance and medicine – and consumers of these services. Mitigation by legally requiring experts to put consumers’ interests first, ahead of their own interests. Fiduciary law, then, is the foundation of trustworthy advice, and the practical explanation as to why investors should trust experts.
More recently, the Advisers Act of 1940 was largely enacted to address one of two fundamental concerns of the advisory profession that came out of the 1929 stock market crash: conflicts of interest. It was, as explained by law professor Arthur Laby, that “so-called tipster organizations were disguising themselves as legitimate advisory organizations. Certain firms providing advice were affiliated with investment banks or brokerage firms, and therefore had a vested interest in recommending particular securities.”
There is no better time than during this week of hearts and hugs to note the attributes in the six core duties identified by the Institute for the Fiduciary Standard to describe what fiduciary means. Here are the six duties:
Serve in the Client’s Best Interest
Loyalty means that fiduciaries put the best interests of clients first, ahead of the advisor’s interests, the interests of their firm, and the interests of all others at all times. Loyalty separates, in part, fiduciaries from a product salesperson. A product salesperson’s obligation is to provide information or opinions about products or services and generally operates with divided loyalties – at best. Fiduciary advice best for clients means that no materially better available option exists under the circumstance.
Act in Utmost Good Faith
Utmost good faith is fundamental to being loyal. The advisor must be truthful, honest and accurate in all communications. This includes everything the advisor says or writes about himself, his firm, his experience and his recommendations. This is especially important regarding the existence and nature of potential and actual conflicts and any “bad news” about the portfolio or mistakes the advisor might make in serving the client.
Avoid Conflicts of Interest
As noted, the Advisers Act was born of concerns of the confusion in the market place between advisors and product salespersons. At the Institute for the Fiduciary Standard Fiduciary Forum, 2011, Yale Management Professor Daylian Cain concluded:
“Conflicts of interest are a cancer on objectivity. Even well-meaning advisors often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”
While no advisor can avoid all conflicts, all advisors should avoid material conflicts of interest, and must, through their fastidiousness, sharply minimize unavoidable conflicts and effectively mitigate or manage conflicts in the best interest of the client.
Disclose All Material Facts and Conflicts;Manage All Material Conflicts
Disclosure is a cornerstone of securities regulation. The precise nature of the disclosure requirement changes with the facts and circumstances. Advisors are required to make clear, complete and timely disclosure of all material facts and conflicts. These disclosures are typically set out in Form ADV. Material conflicts, conflicts defined as those that may be expected to influence a client’s decision to proceed or not proceed with a transaction, require greater care.
Material conflicts must be managed. Managing material conflicts must at least entail clear: complete and timely disclosure; a reasonable basis for the advisor believing that clients fully understand the disclosure, and the implications of the conflict(s); if a client wishes to proceed with the transaction, the client must provide informed consent in writing prior to the transaction; and, the advisor must continue to demonstrate that the recommendation is reasonable and fair and in the client’s best interest.
Act Prudently — With the Care, Skill and Judgment of a Professional
To act prudently is to act with due care, with the skill, judgment and care of a professional. Due care requires following a prudent process and having the knowledge to make appropriate recommendations. A prudent process requires investigating and assessing an investment’s or firm’s characteristics based on objective criteria. A prudent process requires using industry best practices to investigate, evaluate, and construct a portfolio or recommendation.
Advisors must also have and continuously update their knowledge, expertise, education and experience. Faithfully developing and monitoring an investment or financial strategy based on a client’s objectives and essential investment criteria requires these attributes.
Control Investment Expenses
Controlling costs is inherent to being loyal. Inappropriate or unnecessary costs are prima facie breeches of the duty of loyalty. Advisors are required to ensure that all investment expenses — all fees, costs and expenses passed on to the investor — are fair and reasonable in relation to the services and investments offered.
Fiduciaries and Valentines
Fiduciaries must be able to explain to prospective clients and others how fiduciary relationships differ from a sales relationship. This is a challenge not just because product salespersons work hard to sound just like fiduciaries (and are permitted to do so), but also because, research suggests, fewer investors today have a fiduciary reference point. Fewer investors have experienced a fiduciary relationship — with a professional — of trust and confidence. With no experience, investors are hard pressed to describe, much less identify or recognize, advisor conduct of ‘loyalty’ ‘utmost good faith’ or ‘due care’ as they review and discuss a firm or practitioner’s capabilities.
St. Valentines Day serves as a reminder to fiduciaries that investors’ fiduciary reference point is more likely derived from personal relationships. Be it a spouse or partner, or parent, sibling or best friend – most people have someone who they trust, who they know always tells them the truth, regardless, always has their back, and always offers objective advice. Fiduciaries may note, “This is what I do, so...” The “so” is the imperative to remind policymakers – again and again – what it is you do. As did those investment advisors who helped shape the profession. In 1940 one witness described the investment advisory profession to Congress as, “a personal service profession …. (that) depends … upon a close personal and confidential relationship…”
The nexus between personal and fiduciary relationships is trust and a vision that connects or unites two individuals. Professor Laby describes the essence of fiduciary duty this way, “The fiduciary’s obligation (is) to adopt the principal’s goals, objectives or ends.” These words echo the sentiment of another scholar, Aristotle, when he opined on love “Love is composed of a single soul inhabiting two bodies.”
Knut A. Rostad is president of the Institute for the Fiduciary Standard, a non profit formed to advance fiduciary principles through research, advocacy sand education.
