What better topic for the month of Valentine’s Day than that of fiduciary duty? As those once and forever smitten by the arrow of cupid can attest, love means, among other things, putting the interests of another above those of your own. This same moral ethic defines the fiduciary duty.
Of course, it wasn’t always that way. One of the key elements of trust law—from which we derive our definition of fiduciary duty— comes from two provisions of the Magna Carta. When he signed the Magna Carta in 1215, King John agreed estates would be managed only for the benefit of the beneficiaries. This eliminated both outright theft as well as the more sneaky kind of theft known as “self-dealing” transactions.
The definition of fiduciary duty has been finely tuned in the last eight centuries. Since 1940, with an acceleration beginning around 1970, one of the most important fiduciary duties—that of providing investment advice—has shifted from stodgy bank trust departments to “go-go” investment advisers registered with the Securities and Exchange Commission. The Investment Advisers Act of 1940 requires all registered investment advisers to act with the same fiduciary duty as a trustee, even though they are not named as trustees.
Over the last generation, other financial service providers discovered how much more lucrative the investment advisery business was compared to their brokerage or insurance businesses. They began calling themselves “advisors” (notice the “or” ending, as only as SEC registered investment advisers can use the “er” ending).
The distinction goes far beyond the need to irritate English teachers across the nation. Advisers, as fiduciaries, have a legal mandate to place client interests first. Advisors, on the other hand, must only provide “suitable” investments to clients while placing their firm’s interests first. This means a lot of those “self-dealing” types of transactions. Remember, self-dealing transactions are so illegal for trustees, not even disclosure can surmount their prohibition. For a non-fiduciary, however, not only are self-dealing transactions allowed, their inherent conflict of interest often does not have to be disclosed.
In the retail investment market, caveat emptor rules. The same cannot be said of the retirement plan market. This distinction can significantly impact the fiduciary liability of plan sponsors. A 2010 academic study suggests legal self-dealing transactions can actually harm investors. If a plan sponsor fails to hire a fiduciary to provide investment advice, the liability insinuated by this study accrues solely to the plan sponsor who is, by definition, a fiduciary. Even if the plan sponsor hires a fiduciary, the nature of the relationship may or may not limit the liability of the plan sponsor.
There are two types of fiduciary relationships. A non-discretionary (ERISA 3(21)(a)) adviser only makes recommendations and the plan sponsor must make the actual investment decision. In this relationship, the plan sponsor retains nearly all the fiduciary liability. On the other hand, a discretionary (ERISA 3(38)) adviser makes investment decisions and, given the Uniform Prudent Investor Act, assumes most of the fiduciary liability from the plan sponsor.
And you thought love was complicated.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
