Fiduciary Duty
Fiduciary duty is one of the key concepts in finance, investment, and corporate governance. It is essential because it ensures that an individual or organisation will handle the business of great concern to the best interest of other parties, especially where finances or professional advice is concerned. Knowledge of fiduciary duty is reasonably necessary for investors, business owners, and generally all those involved in financial decision-making since it protects a person’s rights and interests. The blog will outline what fiduciary duty is, discuss some different types, and see what happens when that duty has been breached, particularly within the financial sector.
Table of Contents
What Is Fiduciary Duty?
It means an agreement in which one party owes the other some legal or moral responsibility. It mainly comes into view in relationships where a party is entrusted with assets or charged with decision-making powers wherein another party may be concerned. In a fiduciary relationship, specific duties are on the party fiduciary, who must conduct himself with prudence, loyalty, and good faith towards the beneficiary. Fiduciary duty is important in the financial world, where an adviser, corporate director, or trustee usually assumes responsibility for ultimate decision-making in the best interest of his client, shareholder, or beneficiary.
The fiduciary relationship begins with formal arrangements, such as when a financial adviser is employed to manage investments. However, the duty can also be implicit in specific professional roles, such as corporate directors who must act in the best interest of the shareholders.
Understanding Fiduciary Duty
Fiduciary duty is a type of relationship based on trust. The fiduciary is trusted to act on another party’s behalf and set aside one’s interest. This will protect people who are not able to handle their financial or business decisions with their own expertise.
Fiduciary duty means a case whereby, in financial markets, transparency and protection are provided to the clients. For example, an investment advisor is known as a fiduciary. They need to advise on the investment strategy or financial product that would serve the interest of the client rather than one that would get them higher commissions. Failure to put the client’s interests first has legal consequences and leads to loss of trust.
The essential elements of fiduciary duty include:
- Duty of care: The fiduciary must perform the care and diligence a prudent man would use in similar circumstances.
- Duty of loyalty: It forces the fiduciary to always act in the beneficiary’s best interest and, consequently, avoid conflicts of interest.
- Duty of good faith: The fiduciary is supposed to act honestly and in good faith that he must not exploit the situation for personal benefit.
Types of Fiduciary Duty
The form of the fiduciary duty may differ, depending on the nature of the relationship between parties. Some of the typical forms are as follows:
- Trustees and Beneficiaries
Trustees are responsible for accounting for the principal underlying assets of a trust for the beneficiaries. They also owe a fiduciary duty of prudence in managing the trust assets so that they may be available for the beneficiaries.
- Corporate Directors and Shareholders
Corporate directors establish a fiduciary relationship with the company’s shareholders. To achieve the company’s success, such decisions need to be in the best interest and welfare of the concerned shareholders. This means making efficient business decisions and avoiding conflicts of interest, but even an act is compelled when it is, in the long run, in the company’s best interest.
- The Financial Advisers and Their Clients
Other financial advisers owe this fiduciary duty because they also manage and make investment decisions on behalf of their clients. This means that the adviser is supposed to recommend investment types that a client needs to achieve their objectives in keeping with the client’s risk tolerance, as opposed to those investments that would generate higher fees for the adviser.
- Executors and Estate Beneficiaries
An executor is named in a will to oversee the estate in the instance of one’s death. There is an assumption that the relationship is fiduciary because it must distribute the property under the terms of the will to serve the beneficiaries’ best interests.
- Attorneys and their Clients
A lawyer owes a client a fiduciary relationship and, therefore, the duty to provide competent legal representation in the best interests of the client throughout the representation.
Breach of Fiduciary Duty
A breach of fiduciary duty means a failure of the fiduciary to act in the interest of the beneficiary. There are many ways this can occur: negligent acts, self-dealing, and any other concealment or failure to disclose a conflict of interest. These breaches usually result in significant monetary loss to the beneficiary, while the fiduciary faces legal action.
For example, a financial adviser’s recommendation of specific investments that benefit their financial interest rather than that of their client could breach fiduciary duty. Likewise, in company matters, a director will be in breach of fiduciary duty in using confidential information for their benefit rather than benefiting the shareholders.
Breach Consequences:
Some giant consequences may be witnessed in breach of fiduciary duty. The legal liability imposed by the fiduciary for a financial loss incurred by the beneficiary because of the breach can be imposed. This may lead to some penalties, fines, or compensation of damages. Sometimes, the licence of such fiduciaries may be revoked, or they can be prohibited from holding such a position later.
Examples of Fiduciary Duty
- Corporate Director: The directors of a corporation in the US owe a fiduciary relationship to the shareholders to act on behalf of shareholders. Their actions must be directed toward growing the company and enhancing its profitability. It could be like signing a contract with the firm they own; thus, it will be a breach of fiduciary duty.
- Financial planners: Any financial professional in Singapore who manages a client’s portfolio is expected to ensure that the investments selected are appropriate for the client’s risk tolerance and objectives. If the adviser recommended high-risk investments to gain higher commissions, he would have breached his fiduciary relationship.
- Trustees: A trustee who is appointed to invest a US$50,000 trust fund in the education of a child in his best interest should not use those funds for his benefit or neglect to make prudent investment decisions consistent with the fiduciary relationship. In this regard, he would have breached his fiduciary duty.
Frequently Asked Questions
The two central duties of a fiduciary are care, loyalty, and good faith. Whatever the fiduciary does must be done responsibly, without conflict of interest, and always with the beneficiary’s interest in mind.
Breach of fiduciary duty occurs when, with some negligence, self-dealing, or omission in the disclosure of a conflict of interest, the fiduciary does not act in the beneficiary’s best interest. In cases of financial damage, one can seek legal action.
Not every financial professional is a fiduciary. Some advisors may be required to follow only a suitability standard to recommend investments suitable for the client; they do not have to be in the client’s best interest. However, a fiduciary standard binds registered investment advisors.
The corporate director has a fiduciary relationship with a company’s shareholders. They must constantly make decisions for the benefit of the company and the shareholders without taking any action that may put them in a position whereby they may realise some personal profit from the decision to the company’s detriment.
A fiduciary could prevent a conflict of interest by fully disclosing it to the beneficiary and ensuring they act transparently. He should not place himself in a situation where he may have personal interests that will stand in the way of him acting in the beneficiary’s interest.
Related Terms
- Cost of Equity
- Capital Adequacy Ratio (CAR)
- Interest Coverage Ratio
- Industry Groups
- Income Statement
- Historical Volatility (HV)
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- Dynamic Asset Allocation
- Depositary Receipts
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- Financial Futures
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- Calendar Spread
- Cost of Equity
- Capital Adequacy Ratio (CAR)
- Interest Coverage Ratio
- Industry Groups
- Income Statement
- Historical Volatility (HV)
- Embedded Options
- Dynamic Asset Allocation
- Depositary Receipts
- Deferment Payment Option
- Debt-to-Equity Ratio
- Financial Futures
- Contingent Capital
- Conduit Issuers
- Calendar Spread
- Devaluation
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- Cover Order
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- Annual Percentage Yield (APY)
- Excess Equity
- Bought-deal underwriting
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- Acid Test Ratio
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- Finance Charge
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- Trust deed
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- Redemption yield
- Net profit margin
- Fringe benefits
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- Escrow
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- Liquidity coverage ratio
- Hurdle rate
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- Risk Tolerance
- Disbursement
- Bayes’ Theorem
- Amalgamation
- Adverse selection
- Contribution Margin
- Accounting Equation
- Value chain
- Gross Income
- Net present value
- Liability
- Leverage ratio
- Inventory turnover
- Gross margin
- Collateral
- Being Bearish
- Being Bullish
- Commodity
- Exchange rate
- Basis point
- Inception date
- Riskometer
- Trigger Option
- Zeta model
- Racketeering
- Market Indexes
- Short Selling
- Quartile rank
- Defeasance
- Cut-off-time
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- Bankruptcy
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- Turnover Ratio
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- Benchmark
- Pegging
- Illiquidity
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Other Terms
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- Enhanced Index Fund
- EBITDA Margin
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- Distribution Yield
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