The Little Known Win-Win Fiduciary “Gotcha”

It is well-established that investment advisers are fiduciaries.  Fiduciary law is based primarily on principles developed under agency law and trust law.  When you mention fiduciary law, most people immediately think of the duty of loyalty, the requirement that a fiduciary always put a client’s interests first.  What many investment advisers do not understand is the extent of that obligation.

I am often asked by investment advisers and attorneys to perform a fiduciary audit on incoming and/or existing accounts.   The prudent investment adviser realizes that even if the actual management of a client’s investment account is outsourced to a third party, the investment adviser still has a responsibility to monitor the account and take actions to redress any wrongs comiitted by a third party asset manager.  What many investment advisers do not realize is that they have a similar duty when they accept a client’s account.

As part of the duty to always act in the best interests of a client, both agency law and trust law require a fiduciary to disclose information that would be beneficial to a client’s interests and to take action, if necessary, to protect and preserve a client’s property.  With regard to the duty to review new fiduciary accounts, Section 76, comment d, of the Restatement, Third, Trusts states that “the trustee ordinarily has the associated responsibility of taking reasonable steps to uncover and redress any breach of duty committed by a predecessor fiduciary.”

Advisers often counter with the objection that they are not attorneys and do not feel comfortable reviewing and/or commenting on another fiduciary’s action for fear of legal consequences.  Both Sections 76 and 77 of the Restatement advise a fiduciary to seek advice of counsel or the court, if appropriate, in order to meet their fiduciary obligations.  Seeking the advice of a compliance officer or a compliance professional may not protect an investment adviser unless the compliance officer/professional understands fiduciary, trust and agency law ands is aware of the relevant legal and regulatory decisions in these areas.

The fiduciary duty to review new accounts and advise clients of potential fiduciary breaches by previous fiduciaries can actually prove beneficial to investment advisers.  In addition to complying with the legal standards for fiduciaries, performing the required review and advising a client helps demonstrate to a new client that the investment adviser is truly watching out for the client’s best interests, which in turn promotes greater trust between the client and the investment adviser.

Furthermore, in the event that any fiduciary breaches resulted in losses, taking action to recover such losses could result in additional assets under management for the adviser and additional management compensation.  Because of the legal and financial issues involved in redressing potential fiduciary breaches, we always recommend that investment advisers fulfill their duty to disclose such concerns to a client and then let the client make the ultimate decision on whether to pursue such matters.  An investent adviser should always document both the disclosure of such information to a client and the client’s decision regarding the matter.

Advertisements
This entry was posted in 401k compliance, 404c compliance, compliance, investments, retirement plans, RIA, RIA Compliance, securities and tagged , , , , , , , , . Bookmark the permalink.