What is Fiduciary Duty?

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Definition:

A fiduciary duty is a responsibility that one party has to act in the best interests of another party.

🤔 Understanding fiduciary duty

A fiduciary is an individual who has a legal and ethical responsibility to act in the best interest of another party — That responsibility is a fiduciary duty. The party that the fiduciary has this duty to is the principal or the beneficiary. Professionals who may have fiduciary obligations include attorneys, corporate board members, trustees, and some financial advisors. There are legal consequences for failing to comply with one’s fiduciary duty. Someone who breaches his or her duty might have to pay damages to the other party. Two examples of fiduciary duties are a duty of care, which requires a fiduciary to take reasonable care when performing acts for the other party, and a duty of loyalty which requires a fiduciary to remain loyal to his or her beneficiary.

Example

Suppose you were going to see a financial advisor, but you had concerns about whom to hire. You’re worried about hiring someone who is more concerned about making money for him or herself than looking out for your interests. In that case, you might decide to hire a financial advisor who is a fiduciary. Not all financial advisors have a fiduciary duty, but those that do have to act in their clients’ best interests and put your financial well being ahead of his or her own.

If the fiduciary fails to act in your interests, that person may have breached his or her fiduciary duty. There could be legal or financial consequences, such as having to pay you damages for any money that he or she has cost you.

Takeaway

A fiduciary duty is like the oath that police officers take…

Many police officers have to take an oath where they promise to uphold the law and the “public trust.” While the duties of fiduciaries don’t require them to put their lives on the line, they still have a legal duty to act in the best interests of their clients, even when those interests conflict with their own.

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What is a fiduciary duty?

A fiduciary duty is a legal and ethical responsibility that certain individuals have to act in the best interests of the clients, companies, or organizations they serve. A fiduciary has a duty of care and a duty of loyalty to someone else. Among other things, this duty requires that fiduciaries be transparent with the parties they serve and avoid putting their own interests ahead of their clients.

When fiduciaries fail to meet the fiduciary standard of care to which they are held, the entity they had the fiduciary duty to may be able to sue them for a breach of duty.

Who can act as a fiduciary?

Many professionals act as fiduciaries. In some cases, someone is automatically a fiduciary as a result of the position they hold. Individuals such as attorneys, trustees, and guardians are often automatically fiduciaries under law, meaning that they always have a fiduciary responsibility to their beneficiaries and clients.

Others, such as financial advisors, can be fiduciaries, but don’t necessarily have to be depending on the circumstances. Knowing whether the other party in a professional relationship is acting as a fiduciary is critical, as it’s a necessary element for claiming a breach of fiduciary duty in court.

What are some examples of fiduciary duties?

The two primary responsibilities that fiduciaries have are the duty of care and the duty of loyalty. A duty of care requires fiduciaries to act in the best interests of the client. In the example of an investment adviser who is a fiduciary, that professional can only make investment recommendations to the client that are in that client’s absolute best interest, not just one that would be suitable. To do this, that adviser would have to develop an understanding of the client’s financial situation and investment portfolio. The advisor also must provide products and services that minimize costs for the client, regardless of what compensation the advisor receives. The duty of care also requires advisers to take certain steps to provide prudent recommendations or investment management.

The other primary duty is the duty of loyalty. Under a duty of loyalty, a fiduciary always has to put the interests of a client ahead of his or her own interests. A professional should also actively avoid entering into situations that would create a conflict of interest. For example, an attorney representing one spouse in a divorce can’t also represent the other spouse — That would create a clear conflict of interest. Anytime a conflict does exist, a fiduciary has the responsibility to make the client aware of it.

There are other types of duties that various types of fiduciaries have to follow as well. Some examples include:

  • The duty of good faith, which requires fiduciaries to do their best work without violating the law
  • The duty of confidentiality, which requires fiduciaries not to disclose confidential information
  • The duty of prudence, which requires fiduciaries to act reasonably and responsibly
  • A duty of disclosure, which requires fiduciaries to be fully transparent with clients

What are the elements of a fiduciary breach claim?

Different types of fiduciary duties have different requirements and rules, and not all breaches of fiduciary duty have a private right of action. Speaking generally, there are often four elements for fiduciary breach claims where there is a private right of action:

  1. A fiduciary duty must exist. In some cases, this duty is automatic, and the plaintiff simply has to prove the relationship existed. In other situations, it might be a bit murkier, and the plaintiff will have to prove the other party was knowingly acting as a fiduciary.
  2. There was a breach of fiduciary duty. Once a plaintiff has proved that the other party had a fiduciary duty to them, they next have to prove that the fiduciary breached that duty. They might be able to show this by proving that the fiduciary put his or her own interest above the party they had the duty to, or that they failed to provide the other party with critical information.
  3. There was damage as a result of the breach of duty. Often, one requirement is that there must be damage caused to the plaintiff, such as lost profits.
  4. The breach of contract must have caused the damage. Often, the plaintiff also has to prove that the breach of duty is what actually caused the damage.

What are the consequences of a breach of fiduciary duty?

If a plaintiff sues another party for a breach of fiduciary duty and the plaintiff wins, there are several possible remedies, including financial damages or the fiduciary losing their ability to act in a fiduciary capacity for a period of time. If the plaintiff incurred a financial loss, the fiduciary might have to pay compensatory damages. Compensatory damages pay the victim back for the money he or she lost.

Suppose you hired a financial advisor who operates in a fiduciary capacity, and they put your money into an investment that was later determined to be not in the best interests of the client. If you then lost money on that investment, the trade may be reversed with the advisor having to pay for the losses.

Another type of compensatory damages might reimburse you for the fee that you paid to a financial professional who didn’t provide the service they promised you. If you hire an attorney, and they don’t devote the necessary loyalty and care to your case, they may have to pay back the retainer on top of any other financial damages they caused you.

Another potential consequence of a breach of fiduciary duty is punitive damages. Rather than compensating someone for a financial loss, punitive damages serve as a punishment. Punitive damages aren’t a given in a breach of fiduciary duty case — Often they only come up in particularly egregious cases. For example, suppose that a fiduciary didn’t just make bad recommendations, but also actively stole money from clients. That action may arise to a level above and beyond just breaching his or her duty.

Finally, a fiduciary who breaches his or her duty may have to pay prejudgment interest to a plaintiff. Prejudgment interest is similar to interest on a credit card. Suppose you buy a new computer with a credit card, but can’t afford to pay it off right away. Over the six months you owe the credit card company money for that computer; the company charges you interest. If a court finds a fiduciary owes money to a plaintiff for a breach of duty, they may have to pay interest to account for the time that passed from when the plaintiff actually lost the money to the time the fiduciary pays up.

In some cases, a fiduciary might face consequences that aren’t financial in nature, but are far more permanent. For example, a court might rule that a licensed professional can no longer hold that license. For a professional such as an attorney, this may mean that person loses his or her career.

What are some examples of fiduciary-defined relationships?

There are many relationships where one party has a fiduciary duty to the other. Some examples of those relationships are:

  • Financial advisor and client: A financial advisor is someone who provides financial guidance to clients. Financial advisors often help clients to manage their money, prepare their taxes, plan for retirement, and manage their investments. Not all financial advisors are fiduciaries, but those who are have a fiduciary duty to clients, meaning they must always put the clients’ needs first. Investment advisers registered with the Securities and Exchange Commission (SEC) are always fiduciaries, but many brokers are not. Financial services professionals who are not fiduciaries must still abide by a suitability standard, meaning they can only recommend investments they reasonably believe are suitable for a client.
  • Trustee and beneficiary: A trustee is a person or a company that manages a trust (meaning a tool or account where someone can transfer control of his or her assets to be held for a time before ultimately being transferred to a beneficiary). The trustee has a fiduciary duty to the beneficiary of the trust, meaning the person who will benefit from it.
  • Board member and organization: Board members of both corporations and nonprofit organizations have a fiduciary duty to the organizations they serve. Not only does this mean they have to put the interests of the entity above their own interests, but it also means they have to understand the ins and outs of the organization to ensure they’re making the best decisions.
  • Attorney and client: An attorney is someone with a license to practice law in his or her state. There are many types of law someone can practice — Public defenders, estate attorneys, and corporate attorneys are all examples. The clients of attorneys can be individuals, the government, or companies. All attorneys have a fiduciary duty to their clients.
  • Executor and heir: An executor (aka personal representative) is someone appointed to settle someone’s estate after death. An executor can be an individual or a company, such as a bank. An executor has a fiduciary duty to the heir or beneficiary of the estate.
  • Guardian and ward: A guardian is someone a court appoints to care for an individual who isn’t capable of caring for themselves. The person a guardian cares for (aka a ward) is often a child, but can also be an incapacitated adult. Guardians have a fiduciary duty to the wards for whom they care.
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What is a Fiduciary?
Updated August 17, 2021

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