What does Fiduciary mean, and why does it matter?

You may have heard the term fiduciary.  Perhaps you even have a sense that there is something important about it, but you are not quite clear on exactly what it means or why it is important.  Let’s help you with that, starting with a little history.

The story of this word probably started at the dawn of humanity, but we can knowingly document it’s conceptually history back to about 3,800 years ago, with the Code of Hammurabi (Circa 1790 BC).  Within the Code, about half of the laws dealt with trade, liability, and care of other’s property.  Later, Aristotle gave input in the mid 350 B.C.  The concept of Fiduciary was solidified in Roman Law.  Cicero (106 B.C. to 43 B.C) was quoted as saying: 

“Therefore, legal proceedings for betrayal of a commission are established, involving penalties no less disgraceful than those for theft. I suppose because in cases where we ourselves cannot be present, the vicarious faith of friends is substituted; and he who impairs that confidence attacks the common bulwark of all men and, as far as depends on him, disturbs the bonds of society. For we cannot do everything ourselves; different people are more capable in different matters” (“Oration for Sextus Roscius of America”).

In it’s current form, the word Fiduciary comes from the Latin rood Fiducia, which means “trust, confidence, assurance, and reliance.”

With the very rich and deep history, it is safe to infer that the fiduciary is fundamental to human nature.  The word has been put to the test through court cases in many jurisdictions, with predictably similar results.  Arguably the current standard in the United States is best represented by the Uniform Prudent Investor Act of 1994.  Technically this act is model legislation, and not a uniform law.  However, the Uniform Prudent Investor Act or the similar Uniform Trust Code, are widely adopted in several states, and referred to by the courts frequently.  In particular, it is instructive to view the Duties that are inherent in the Uniform Prudent Investors Act.

Here we will comment on these duties, but do so with a filter towards the financial advisory business, rather than being a Trustee.  The two duties that shine through are:

·         Duty of Care (or Standard of Care) - the duty to make reasonable decisions based upon proper due diligence.  In plain English, this standard asks the question:  “Would a person, of similar responsibility and professionalism, find the recommendations and actions made to be reasonable, given the same available information.”  I think it is important to reiterate that this duty requires due diligence.  Not asking basic questions about a client’s situation would be a failure of this duty, as would placing clients in strange or concentrated investments without a good reason to do so. 

·         Duty of Loyalty – the duty to place the client’s interest as primary.  If there are conflicts, they must be avoided and/or reduced, and they must be disclosed.  If a trustee, or an advisor, recommends something because of their own benefit, that is a conflict.  The advisor must attempt to be impartial in their dealings. 

There are other named duties in the act, such as to diversify, to control costs, and to monitor, although each of these can be inferred from the Duty of Care.

Almost all our engagements and recommendations with clients are Fiduciary.  Why does that matter to you?  Ironically, many advisors were not required or did not follow a Fiduciary standard.  Under current regulations, all advisors are now required to act as Fiduciaries for new recommendations in retirement accounts (for example IRA accounts).  However, they were not required to do that until very recently, and your account might be grandfathered, with some specific exceptions, under the old, weaker, “suitability” rules.

We have seen situations where people have come to us to “fix the mess” from other advisors.  In the last year we have seen prospective clients with portfolios that were inappropriate for a variety of reasons, including portfolios that were too aggressive, very illiquid, over-concentrated in certain sectors, or locked up in products with high surrender fees.  None of these situations would have passed a fiduciary standard.  Unfortunately, they were all sold by someone following the lower suitability standard.

We’d love to implement your financial plan with the diligence and process that a fiduciary standard calls for.  If you have any questions, please feel free to reach out to us.

 

- Patrick Stoa