What a fiduciary is, and when a financial professional is one

"Fiduciary" is a legal term for someone who is trusted to act on another person's behalf and is held to a high standard in doing so. The word appears often in discussions of financial advice and retirement plans, sometimes loosely. This post explains what it means, who is a fiduciary under federal law, and how to find out which standard applies to a particular relationship.

The general meaning

The IRS gives a plain definition: in general terms, a fiduciary is a person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity.

Fiduciary relationships exist in many settings. A trustee manages trust property for beneficiaries. An executor settles an estate for heirs. An agent under a power of attorney acts for the person who appointed them. Those roles are governed mainly by state law. See wills vs. trusts and powers of attorney and health care directives.

In personal finance, the term comes up mostly in two places: investment advice and workplace retirement plans.

Investment advisers

Under federal law, an investment adviser is a fiduciary. The SEC set out its view of what that means in a 2019 interpretation of the Investment Advisers Act. It describes two duties.

Duty of care. According to the SEC, this includes a duty to provide advice that is in the client's best interest, based on the client's objectives; a duty to seek best execution of the client's trades when the adviser selects the broker; and a duty to provide advice and monitoring over the course of the relationship.

Duty of loyalty. An adviser must not place its own interest ahead of its client's. The adviser must make full and fair disclosure of all material facts about the advisory relationship. For conflicts of interest, the SEC says the adviser must eliminate them or disclose them fully and fairly enough that the client can give informed consent.

Broker-dealers and Regulation Best Interest

Brokers, formally broker-dealers, buy and sell securities for customers and may recommend investments. Their recommendations to retail customers are governed by an SEC rule adopted in 2019 called Regulation Best Interest.

The rule's summary says a broker-dealer must act in the retail customer's best interest at the time a recommendation is made, without placing its own financial or other interest ahead of the customer's. The firm must also have policies to identify conflicts of interest and disclose them, and in some cases to mitigate or eliminate them. The SEC states that the standard cannot be satisfied through disclosure alone.

The SEC describes Regulation Best Interest as drawing on fiduciary principles, but it is a separate standard from the adviser's fiduciary duty. Two differences stand out in the SEC's own descriptions.

The SEC also states that whichever type of firm a retail investor chooses, the investor is entitled to a recommendation or advice that is in the investor's best interest and that does not place the firm's interests ahead of the investor's.

Many firms and individuals are registered as both. The SEC calls them dual registrants and suggests that customers understand when the professional is acting as a broker and when as an adviser.

Retirement plan fiduciaries

A workplace retirement plan such as a 401(k) also has fiduciaries, under the federal law known as ERISA. These are the people and firms who control plan assets or use discretion in running the plan. The IRS notes that fiduciary status is based on the functions performed for the plan, not a title.

The IRS lists their basic responsibilities:

• acting solely in the interest of plan participants and their beneficiaries;
• acting for the exclusive purpose of providing benefits and paying reasonable plan expenses;
• acting with the care, skill, prudence and diligence of a prudent person familiar with such matters;
• following the plan documents; and
• diversifying plan investments.

These duties are about process, not results. In the IRS's example, a plan investment does not have to be a "winner" if it was part of a prudent, diversified portfolio.

For a participant, this generally means someone is legally responsible for choosing the plan's investment menu and watching its costs. It generally does not mean anyone is responsible for an individual participant's own choices within that menu.

The Department of Labor publishes more on fiduciary responsibilities under ERISA.

What fiduciary status does not mean

• It is not a guarantee of results. A fiduciary can give careful, loyal advice and the investments can still lose value.
• It does not mean no conflicts exist. The SEC's page on investment advisers says the way advisers make money creates some conflicts with clients' interests, and suggests asking about them.
• It is not a title or credential. Job titles such as "financial advisor" or "wealth manager" do not show which legal standard applies. Registration status and the type of account do.
• It may not cover everything a person does. Someone can be a fiduciary for one account or service and not for another.

How to find out which standard applies

Broker-dealers and investment advisers must give retail investors a short document called a relationship summary, or Form CRS. It states the services offered, the fees, the conflicts of interest, the required standard of conduct and any disciplinary history.

Questions worth asking a financial professional:

• Are you acting as an investment adviser, a broker, or both, for this account?
• Does your obligation continue after a recommendation is made, and will you monitor the account?
• What conflicts of interest do you have, and how are they handled?
• How are you paid? See how financial advisers are paid.