The Fiduciary Standard and Why It Matters

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Blaine F. Aikin, CEO of fi360, presented this topic during the 2013 Ball State Foundation PAC Seminar.

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The Fiduciary Standard and Why It Matters

  1. 1. The Fiduciary Standard And Why It Matters Blaine F. Aikin, AIFA®, CFA, CFP® CEO, fi360
  2. 2. Who is a fiduciary? • Someone who stands in a special relationship of trust, confidence, and/or legal responsibility • Fiduciaries act in roles that involve: – reliance upon them by virtue of their special knowledge or skills – control over property 3© 2013 fi360 Inc. All Rights Reserved
  3. 3. Historical Perspective …[W]e cannot do everything ourselves; different people are more capable in different matters. …[I]n cases where we ourselves cannot be present, the vicarious faith of friends is substituted; and he who impairs that confidence, attacks the common bulwark of all men, and as far as depends on him, disturbs the bonds of society… - Cicero, 106-43 BC, Oration for Sextus Roscius of America 4© 2013 fi360 Inc. All Rights Reserved
  4. 4. High Professional Expectations of the Fiduciary Standard Today “A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor most sensitive, is then the standard of behavior [for fiduciaries]. … Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. … [The fiduciary standard] will not consciously be lowered by any judgment of this court.” - Judge Benjamin Cardozo Meinhard v. Salmon, 1928 5© 2013 fi360 Inc. All Rights Reserved
  5. 5. Common and Statutory Law Define Fiduciary Obligations • Anglo-American law is derived from the “Common Law.” • Origins of the modern fiduciary standard are found in the common law of trusts. • Trust law is codified in most states through uniform laws • Uniform Prudent Management of Institutional Funds Act (UPMIFA) is particularly relevant 6© 2013 fi360 Inc. All Rights Reserved
  6. 6. Fundamental Fiduciary Duties: Loyalty and Care • Loyalty – obligation to serve the client’s best interests • Duty of care – obligation to act with the skill, care, and good judgment of a professional 7© 2013 fi360 Inc. All Rights Reserved
  7. 7. Duties Associated with the Fiduciary Standard Fiduciary Standard Duty of Loyalty Avoid / Manage Conflicts Disclosure Proxy Policy Principal Trades Suitability Both Duties of Loyalty and Care Best Execution Reasonable Fees & Expenses Duty of Care Safeguard Client Assets, Privacy Procedural Prudence Due Diligence Monitoring Record- Keeping 8© 2013 fi360 Inc. All Rights Reserved
  8. 8. Qualities of fiduciary duties • Serve to deter abuse • Apply broadly (because every circumstance can’t be anticipated) • Typically evaluated in hindsight • Involve substantive safeguards that can’t be overridden by agreement – serve client’s best interests – prudence – good faith • Procedural safeguards required to demonstrate conformity 9
  9. 9. What Circumstances Give Rise to Fiduciary Status? 1. “Named fiduciary” in trust or ERISA plan documents 2. Provide advice in a professional context 3. Exercise discretion 4. Have the authority to delegate duties to a co-fiduciary 10© 2013 fi360 Inc. All Rights Reserved
  10. 10. Fiduciary Roles • Stewards – manage the overall decision-making process • Advisors – provide advice that is material to decision-making in a professional context (with compensation, based upon superior skill) • Investment Managers – make investment decisions and select the individual securities to implement a specific investment mandate 11© 2013 fi360 Inc. All Rights Reserved
  11. 11. Functional Fiduciaries • It’s not what you call yourself that’s decisive, it’s what you do. • If you exercise discretion or give personalized advice for compensation, you are a fiduciary. • You are a fiduciary to the extent you perform fiduciary functions. 12© 2013 fi360 Inc. All Rights Reserved
  12. 12. OK, so I’m a fiduciary. Now what? • Determining that you are a fiduciary leads to other key questions*: – To whom am I a fiduciary? – What are my guiding principles (duties) and responsibilities (scope of engagement)? – What are the consequences of failure to exercise fiduciary obligations? *SEC v. Chenery, 318 U.S. 80, 85-86 (1943) 13© 2013 fi360 Inc. All Rights Reserved
  13. 13. The Essential Question Were my actions consistent with fulfillment of the fiduciary duties of loyalty and care? 14© 2013 fi360 Inc. All Rights Reserved
  14. 14. Substantive and Procedural Safeguards of Mandatory Rules* • Substantive safeguards serve to preserve fundamental fiduciary duties such as loyalty and utmost good faith • Even if a client allows an advisor to have a conflict, the advisor must serve the best interest of the client • Procedural safeguards require the advisor to be able to demonstrate that actions taken serve the client’s best interest, i.e., the advisor must be able to show procedural prudence, consistent with the duty of care * Source: The Fiduciary Obligations of Financial Advisors Under the Law of Agency, a paper authored by Robert H. Sitkoff which was sponsored by Federated Investors 15© 2013 fi360 Inc. All Rights Reserved
  15. 15. Global Fiduciary Precepts 1. Know standards, laws, and trust provisions. 2. Diversify assets to specific risk/return profile of client. 3. Prepare investment policy statement. 4. Use “prudent experts” and document due diligence. 5. Control and account for investment expenses. 6. Monitor the activities of “prudent experts.” 7. Avoid conflicts of interest and prohibited transactions.
  16. 16. From Precepts to Practices • Precepts are principles founded in law. • Practices are applications of the precepts, founded in law and research. • A Standard of Practices constitutes a body of knowledge as to what is required for a person or organization to meet recognized expectations.
  17. 17. Why the fiduciary standard matters
  18. 18. Promotes Professionalism 19© 2012 fi360 Inc. All Rights Reserved.
  19. 19. Helps mitigate the risk of fraud
  20. 20. Serves society’s values 21© 2013 fi360 Inc. All Rights Reserved
  21. 21. Thank you! Blaine F. Aikin, AIFA®, CFA, CFP® CEO, fi360 www.fi360.com © 2013 fi360 Inc. All Rights Reserved.

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