What are the legal aspects of financial advising?

financial advising

A fiduciary financial advisor is one who exercises a duty of care and a duty of loyalty. This means that financial advice given by a fiduciary financial planner must be in the best interest of the person receiving the advice. This differs from a non-fiduciary advisor, who must only fit the much looser definition of suitability. Suitability means that advice must benefit the client, but if you have two investment options available, a non-fiduciary may recommend the option that benefits their own bottom line.

What is ‘duty of care’?

Duty of care means that all advice given by a fiduciary must be in the absolute best interest of the client. In order to do this, a fiduciary first gathers information about your current financial state and forms an understanding of your goals. Then, advice is given to achieve those goals without regard for the interests of the advisor.

A duty of care is ongoing, a fiduciary has a responsibility to monitor your financial state throughout the course of the relationship and adapt advice or recommendations to the changes in the clients life.

What is ‘duty of loyalty’?

Duty of loyalty means that the interests of the advisor can not be placed above those of the client. For example, if your mortgage has a high interest rate, you may ask your advisor if it’s beneficial to pay it off using money from your managed assets. A fiduciary financial advisor will crunch numbers and may make the recommendation to pay off your mortgage. Even though a fiduciary benefits from having a larger pool of assets under management, they are required by law to guide you in a manner that is most beneficial to you.

If the financial advisor determines that paying off your mortgage early using managed assets is not beneficial to you, they will not only advise that it wouldn’t be advantageous, but should also disclose the benefit to the advisor in keeping your assets under management.

What are the requirements of a fiduciary financial advisor?

A fiduciary financial advisor must do the following:

  1. Act with loyalty and good faith.
  2. Give advice that is in the best interest of the client, even if it’s not in the best interest of the advisor.
  3. Avoid conflicts of interest, and disclose any potential conflicts of interest in regards to advice given.
  4. Provide a full and honest disclosure of facts pertaining to finances, including fees.
  5. Not use clients’ assets to benefit the advisor or other clients.
  6. Adhere to fiduciary rules for the duration of the relationship between the advisor and the client.

What is the practical difference between a fiduciary and a non-fiduciary financial advisor?

The underlying difference between a fiduciary and a non-fiduciary is how decisions are made regarding your investments. A fiduciary advisor must act in the best interest of their client, while a non-fiduciary is only required to make recommendations that benefit their client. For example, let’s say your advisor has two investment options to present to you. The first option offers significant growth potential, but doesn’t pay a commission to the advisor. The second option offers less of an opportunity for growth, but pays a commission to the advisor. A fiduciary is required by law to recommend the first option, while a non-fiduciary is able to recommend the second option as long as there is some benefit to the client.

How can you tell if your financial advisor is a fiduciary?

Not all financial advisors are fiduciary. The easiest way to find out if your financial advisor is a fiduciary is to ask. If your advisory is not a fiduciary, they must still uphold suitability standards and should be able to explain why they do not act as a fiduciary.

There are certain designations, however, that require the holder of the designation to act as a fiduciary. Registered Investment Advisors and Certified Financial Planners® both have a fiduciary duty to their clients, enforced by the Securities and Exchange Commission.

How are the responsibilities of a fiduciary financial advisor enforced?

Fiduciary financial advisors are overseen by the Securities and Exchange Commission. The SEC periodically examines and monitors the practices of fiduciaries to ensure that the standards of fiduciary practice are upheld.

Should fiduciary duties be neglected or breached, recourse is available to clients. A fiduciary duty lawsuit will typically cover out of pocket damages. In some instances, if the breach can be proven to have been committed via fraud or malicious intent, punitive damages and lost market gains can be recovered by the plaintiff.

Why don’t all financial advisors operate as fiduciaries?

Simply put, not all financial advisors are required to act as fiduciaries by law. Some non-fiduciary advisors argue that serving low net worth clients without a commission is not possible, and enforcing fiduciary duties on all advisors means that these clients would have to be turned away for lack of profitability and therefore won’t receive financial advice.

Research credit: Article research based on original content written by Kevin P. Sweeney, JD, CFP® of Modera Fee-Only Financial Planners