How Fiduciary Duty Differs From Suitability Standard

BY STEVE DINNEN

 
Some years ago I was invited to join the investment committee of a local nonprofit organization. At the first meeting I saw that most of our unused cash was sitting in two high-fee mutual funds I thought were underperforming. When I questioned how this happened, two committee members said the funds were their recommendations. They had to be so, they explained, because they worked for the financial firm that sponsored the funds, and they had a duty to the employer to recommend only their products.

That should not have happened. But it helps explain how the fiduciary rule and its cousin, the suitability standard, can work both for and against you and your money.

A fiduciary duty is the legal term describing the relationship between two parties that obligates one to act solely in the interest of the other. The fiduciary owes the legal duty to a principal and must ensure that no conflict of interest arises between them.

The guideposts for fiduciary duty are pretty straightforward – a duty of care, and a duty of loyalty. So you have to perform your role in good faith, taking into account the best interest of your business or client, and you must refrain from personal or professional dealings that out your interest ahead of your company or client.

Then there is the suitability standard used when offering financial and investment advice. Advice given by someone using this standard must be suitable to the client’s needs at the time it is given.

In the investment world, financial advisors are either a Registered Investment Advisor (RIA) or a broker-dealer. An RIA abides by the fiduciary rule, while a broker dealer is held to the suitability standard.

Fiduciary duty covers a lot of ground. A doctor has a fiduciary duty to a patient, as does a teacher to a student and a lawyer to a client. Courts are littered with legal spats between insurers and insured and claims of breach of fiduciary duty. Directors of a company have a fiduciary duty, as do senior employees. In Webster City, as aquaculture start-up VeroBlue Farms collapsed late last year under a $98 million mountain of debt, the firm sued five former top executives with allegations they wasted company assets and otherwise breached their fiduciary duty.

So fiduciary duty is not just an esoteric exercise but has real applications. What it boils down to, says a West Des Moines based investment advisor, is “do the right thing by your client.”
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