What fiduciaries should be reminded of on Valentine’s Day

On Valentine’s Day three years ago, New York Times personal-finance writer Tara Siegel Bernard wrote a column entitled “Will You Be My Fiduciary?” discussing how investors might engage a fiduciary adviser.

The headline was clever enough, but is there any logical link between one’s Valentine and one’s fiduciary?

Not at first sight. The romantic spirit of Valentine’s Day, emotion leavened with passion and mystery, might well be the antithesis of the fiduciary, whose watchword is “prudence.”

Below the surface, though, it is a different story. A fiduciary relationship and a committed personal relationship have a common background.

At their core, both are relationships of trust and confidence based on loyalty and due care. Both describe the human experience at its best: devotion, respect, trust and visions of best possible outcomes devoid of conflicts.

Fiduciary law and Valentine’s Day go back centuries.

Although the precise origin of the holiday is uncertain, several legends chronicle its beginning during the Roman Empire.

Fiduciary principles, on the other hand, are found in the Code of Hammurabi (circa 1780 BC) and the writings of Aristotle (fourth century BC). Fiduciary law was established to mitigate the knowledge gap between expert pro-viders of socially important services — such as law, finance and medicine — and consumers of the services. Mitigation is accomplished by legally requiring those experts to put consumers’ interests first, ahead of their own interests.

Fiduciary law, then, is the foundation of trustworthy advice and the practical explanation as to why investors should trust experts.

More recently, the Investment Advisers Act of 1940 largely was written to address one of the advisory profession’s fundamental concerns coming out of the 1929 stock market crash: conflicts of interest.

As explained by Rutgers School of Law professor Arthur Laby, “so-called tipster organizations were disguising themselves as legitimate advisory organizations. Certain firms providing advice were affiliated with investment banks or brokerage firms and therefore had a vested interest in recommending particular securities.”

There is no better time than this week of hearts and hugs, and no better way, to detail the meaning of “fiduciary” than by noting the attributes in six core duties identified by the Institute for the Fiduciary Standard.

These are the six core duties:

Serve in the client’s best interests. Loyalty means that fiduciaries put clients’ best interests first, ahead of the adviser’s interests, the firm’s interests and the interests of all others at all times. Loyalty separates, in part, a fiduciary from a product salesperson, whose obligation is to provide information or opinions about products or services and who generally operates with divided loyalties at best. The best fiduciary advice for the client means that under the circumstances, no available option is materially better.

Act in the utmost good faith. This is fundamental to loyalty. Advisers must be truthful, honest and accurate in all communications. This includes everything that they say or write about themselves or about their firm, experience or recommendations. This is especially important regarding potential and actual conflicts, “bad news” about the portfolio or mistakes that an adviser might make serving the client.

Avoid conflicts of interest. As noted, the Advisers Act was born of concerns about confusion in the marketplace between advisers and salespeople. At the Institute for the Fiduciary Standard’s Fiduciary Forum in 2011, Daylian Cain, assistant professor of organizational behavior at the Yale School of Management, said: “Conflicts of interest are a cancer on objectivity. Even well-meaning advisers often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”

Although no one can avoid every conflict, all advisers should avoid material conflicts of interest and must, through their fastidiousness, sharply minimize unavoidable ones and effectively mitigate or manage conflicts in the best interests of the client.

Disclose all material facts and conflicts, and manage all material conflicts. Disclosure is a cornerstone of securities regulation. The precise nature of the requirement changes with the facts and circumstances. Advisers are obligated to make clear, complete and timely disclosure of all material facts and conflicts. These disclosures typically are set out in Form ADV. Material conflicts, defined as those that may be expected to influence a client’s decision to proceed with a transaction, require even greater attention.

Material conflicts must be managed. That entails clear, complete and timely disclosure; a reasonable basis for the adviser to think that clients fully understand the disclosure and the implications of the conflict(s); prior informed written consent if the client wishes to proceed with a transaction; and continued demonstration by the adviser that the recommendation is reasonable, fair and in the client’s best interests. 

Act prudently, with the care, skill and judgment of a professional. To act prudently is to act with due care, which requires following a prudent process and having the knowledge to make appropriate recommendations. A prudent process requires investigating and assessing an investment’s or firm’s characteristics based on objective criteria; it also requires using industry best practices to investigate, evaluate and construct a portfolio or recommendation.

Advisers also must have and regularly update their knowledge and expertise. Faithfully developing and monitoring an investment or financial strategy based on a client’s objectives and essential investment criteria require these attributes.

Control investment expenses. Controlling costs is an essential practice. Inappropriate or unnecessary expenses are prima facie breaches of the duty of loyalty. Advisers are required to ensure that all fees, costs and expenses passed on to the investor are fair and reasonable in relation to the services and investments offered.

FIDUCIARIES AND VALENTINE’S

Fiduciaries must be able to tell pro-spective clients and others how fiduciary and sales relationships differ. This is challenging, not just because product salespeople work hard to sound like fiduciaries (and are permitted to do so) but because, research suggests, fewer in-vestors today have a fiduciary point of reference.

Fewer have experienced a relationship of trust and confidence with a professional. With no experience, investors are hard-pressed to explain, much less identify or recognize, adviser conduct of “loyalty,” “utmost good faith” or “due care” as they review and discuss a practitioner’s capabilities.

Valentine’s Day serves as a reminder to fiduciaries that investors’ fiduciary reference point is more likely derived from personal relationships. Be it a spouse or partner, parent, sibling or best friend, most people have someone they trust, whom they know always tells them the truth, always has their back and always offers objective advice.

Fiduciaries may note, “This is what I do, so …” The “so” is the imperative to remind policymakers what you do -— as did those investment advisers who helped shape the profession.

In 1940, one witness described the investment advisory field to Congress as “a personal service profession [that] depends … upon a close personal and confidential relationship.”

The nexus between personal and fiduciary relationships is trust and a unifying vision.

Mr. Laby said the essence of fiduciary duty is “to adopt the principal’s goals, objectives or ends.” His words echo another scholar, Aristotle, who said, “Love is composed of a single soul inhabiting two bodies.”

Knut A. Rostad is president of the Institute for the Fiduciary Standard, a nonprofit formed to advance fiduciary principles through research, advocacy and education.