Fiduciary Duties
Investment advisers owe fiduciary duties to their clients. This is the highest standard of care recognized by law, requiring advisers to act in the best interests of their clients at all times.
The Fiduciary Standard
The fiduciary standard for investment advisers flows from the Investment Advisers Act of 1940 and SEC interpretations. The SEC has affirmed that advisers owe their clients a fiduciary duty comprising two core components.
Core Fiduciary Duties
| Duty | Description | Practical Application |
|---|---|---|
| Duty of Care | Obligation to act with reasonable care, skill, and diligence | Suitable recommendations, due diligence, monitoring |
| Duty of Loyalty | Obligation to put client interests first | Avoid conflicts, disclose material conflicts, no self-dealing |
Duty of Care
The duty of care requires advisers to act with the care, competence, and diligence that would be expected from a reasonably prudent professional.
Elements of the Duty of Care
| Element | Requirement |
|---|---|
| Reasonable Inquiry | Understand client's financial situation, objectives, and risk tolerance |
| Investment Analysis | Investigate investments before recommending |
| Suitability | Recommendations must be suitable for each specific client |
| Monitoring | Ongoing obligation to monitor client accounts and advice |
| Best Execution | Seek favorable execution of client transactions |
The Suitability Obligation
When making recommendations, advisers must consider:
- Client's current financial situation
- Investment objectives (growth, income, preservation)
- Risk tolerance and capacity
- Time horizon
- Liquidity needs
- Tax considerations
- Other investments (for portfolio suitability)
Duty of Loyalty
The duty of loyalty requires advisers to put their clients' interests ahead of their own. This means:
What the Duty of Loyalty Requires
| Obligation | Description |
|---|---|
| Client First | Client interests come before adviser's, firm's, or third parties' interests |
| Conflict Avoidance | Eliminate conflicts of interest where possible |
| Conflict Disclosure | Disclose all material conflicts that cannot be eliminated |
| Fair Dealing | Deal fairly with all clients; no favoritism |
| No Self-Dealing | Cannot use client assets for personal benefit |
Disclosure Obligations
Full and fair disclosure requires:
- All material facts must be disclosed
- Plain language that clients can understand
- No material omissions
- Affirmative duty to disclose—can't wait for client to ask
Fiduciary vs. Suitability vs. Regulation Best Interest
Understanding the differences between these standards is critical for the exam:
| Standard | Applies To | Obligation | Timing |
|---|---|---|---|
| Fiduciary | Investment Advisers | Act in client's best interest | Ongoing relationship |
| Suitability | Broker-Dealers (traditional) | Recommendation suitable for client | At time of recommendation |
| Regulation BI | Broker-Dealers (current) | Best interest of retail customer | At time of recommendation |
Key Differences
| Aspect | Fiduciary Standard | Suitability/Reg BI |
|---|---|---|
| Conflicts | Must avoid or eliminate where possible | Must disclose and mitigate |
| Relationship | Ongoing monitoring obligation | Obligation at point of sale |
| Standard | Best interest | Suitable (suitability) / Best interest (Reg BI) |
| Compensation | Compensation structures must not compromise client interests | May receive transaction-based compensation |
Enhanced Fiduciary Duties
ERISA Plans (Retirement Accounts)
Fiduciaries to ERISA plans are held to the "prudent expert" standard:
- Diversification requirement
- Following plan documents
- Exclusive benefit rule
- Prohibited transaction rules
Trust Accounts
Advisers managing trusts must follow:
- Prudent investor rule (modern portfolio theory)
- Impartiality between income and remainder beneficiaries
- Following trust terms and purposes
On the Exam: The exam frequently tests the difference between fiduciary duty (investment advisers) and suitability/Reg BI (broker-dealers). Remember that the fiduciary standard is ongoing and requires avoiding conflicts, while suitability only applies at the point of recommendation.
Key Takeaways
- Investment advisers owe fiduciary duties (duty of care + duty of loyalty)
- Fiduciary standard is higher than suitability standard
- Advisers must put client interests first—always
- Conflicts must be avoided where possible; disclosed if unavoidable
- The obligation is ongoing, not just at the time of recommendation
The duty of loyalty requires an investment adviser to:
The fiduciary standard differs from the suitability standard because the fiduciary duty:
Under the duty of care, an investment adviser must:
18.2 Prohibited Practices
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