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I recently attended the 2011 Fi360 Conference, at which Ron Rhoades, JD, CFP®, CCO of an RIA firm and soon a professor at Alfred State College (NY), spoke on the topic “What Are Your Specific Fiduciary Duties.” Ron shared several fiduciary best practices, some of which are often overlooked by advisers:

 

Fees/Costs. Advisors should evaluate all of the costs (including “transaction” costs) of pooled investment vehicles or managed accounts, and then disclose this “total fee and cost” estimate to clients.

 

Taxes, Taxes. The “tax drag” on investments should also be considered, and portfolios structured tax-efficiently where such efficiency is likely to pay off (taxable accounts for high income taxpayers). Disclaimers that “we don’t give tax advice” are likely to be ineffective.

 

Conflicts of Interest. Disclosures of conflicts must be robust and affirmative, in order to secure the understanding by, and informed judgment of, the client. Even then, conflicts must always be managed to the best interest of the client, for judges believe that “no client would ever consent to harm.”

 

Nature of Your Relationship. Many registered reps are already fiduciaries under state common law – which applies fiduciary duties to those in relationships of trust and confidence with clients. Even if you do not consider yourself a fiduciary (i.e., you are not an RIA), be aware that courts increasingly impose broad fiduciary duties on financial advisers in relationships of trust and confidence with their clients. How you are regulated, or licensed, is not determinative. If you use terms like “financial advisor” or “wealth manager” or even “CFP®” you are more likely to be found to be a fiduciary. In essence, if you possess an ongoing relationship with a client in which you provide financial or investment advice, then you are likely a fiduciary under state common law (under which private lawsuits are brought) and you should act accordingly.

 

It should also be noted that the law determines the nature of the relationship as fiduciary or not, rather than the terms of any agreement the client signs. While reasonable limits on the scope of an engagement are permitted, you cannot ask clients to sign away your broad fiduciary responsibilities. 

 

IPS – Important. A key best practice is the investment policy statement (IPS). Possess a comprehensive, yet easy to understand IPS. Disclose all of the potential risks. Disclose the historic volatility of the recommended portfolio (or as simulated using indices). Have clients sign the IPS. Gather information about the client’s situation at least annually and record whether an IPS update is in order. In other words, don’t let the IPS get old and cold.

 

Investment Strategy Due Diligence. As a fiduciary you are held to the “expert” standard of due care. Research and document both your investment strategy due diligence and your investment product due diligence. If challenged, you will need expert testimony; your investment strategies should be supported by either strong academic research or by back-testing. If your investment strategy is not supportable in these ways, such as if you exercise your own qualitative judgment and active management strategies, disclose these facts in your ADV. Also, most clients assume you will recommend a “prudent” investment strategy; if your investment strategy does not meet the Prudent Man Rule test of being broadly diversified, disclose this fact in your Form ADV Part 2A.

 

Regardless of whether fiduciary duties apply to you, following the practices of a fiduciary is simply good business. It is also is the manner by which you can build a practice with staying power. As I have learned over the years … love your clients and they’ll love you back!

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