Whenever you are dealing with someone to whom you will entrust your money, such as a registered investment advisor or a bank trust department, it is nice to know that, in the United States, they owe you what is known as a "fiduciary duty." This is not to be taken lightly because, under the American legal system, a fiduciary duty is the highest duty owed to another person. It requires the fiduciary (the person with the obligation) to put the interest of the principal (the person to whom they owe the fiduciary duty) above their own.
This requirement to act in their best interest includes disclosing any conflicts of interest that may arise so they can be known ahead of time, leveling the playing field. Breaching the fiduciary duty can result in punishments, including being barred from employment in certain fields, being banned from working with certain types of securities, being forced to pay significant civil and criminal penalties, the loss of employment, and, in some cases, felony conviction with accompanying jail time. To put it bluntly, the fiduciary duty has teeth.
The fiduciary duty differs significantly from the so-called "suitability standard," which is a lower form of accountability. Under the suitability standard, the person or institution working with you need only make recommendations that are generally thought to be in your best interest. This is a much more lax requirement that offers some protection. For example, it's clearly a violation for a broker to recommend the purchase of out-of-the-money short-dated call options with 40% of the account value of a retired widow who indicates she needs a capital preservation investment mandate, but you'd be astonished the extent to which a person can justify questionable things when it is in their own self-interest.
One area of abuse I've seen personally many, many times in my career pertains to annuities. An individual or family is convinced to buy this miracle-sounding product (at a time of record low interest rates, to make it worse) that, in my opinion, effectively robs them of nearly all of the advantages of compounding while offering nearly no offsetting benefit that can justify the layers of excessive investment fees and loss of capital that could have gone to their heirs tax-free through the stepped-up basis loophole. (There are times, situations and circumstances in which a particular annuity product makes sense, but it is often never close to those in which I see someone hand over their savings for one.)
Meanwhile, the person who gives the sales pitch walks away richer, sometimes earning incredible commissions of up to 10% of your money, hidden in a way that you don't even realize you've given it to them (e.g., the statement shows the full principal value, but if you cancel the annuity contract, you owe substantial surrender charges). This is one of the primary reasons state legislatures often require a cancellation period of a few business days, during which a person can terminate a newly signed annuity agreement with no penalty.
Many new investors don't know whether they are dealing with someone bound to a fiduciary duty or a suitability standard. Take, by way of illustration, your neighborhood stockbroker. They listen to your concerns. They help you construct a portfolio. They may even help you pick out your own collection of individual blue-chip stocks or mutual funds. They aren't bound by a fiduciary duty, though. Their primary loyalty is to the financial institution that provides them with a paycheck. There are some who go above and beyond the call of duty, truly caring for their clients and working tirelessly to help them build wealth even if it means less income for themselves, but it is solely because they are inherently generous people of integrity, not because there is any requirement for them to put your best interest ahead of their own, or the firm's, best interest.
One of the things that can complicate this is the tricky practice of having multiple institutions under a single corporate umbrella, such as a broker-dealer that is also effectively controlling an affiliated registered investment advisor or bank trust department, the latter two of which are bound by a fiduciary duty.
Examples of Fiduciary Duty
There are many situations in which a fiduciary duty arises and they should not be taken lightly. Some common fiduciary duty scenarios include:
Custodians of UTMA / UGMA Accounts
If you make a UTMA gift to a minor child, the custodian is responsible for protecting, preserving, investing and, perhaps, spending the money in the best interest of the child that actually owns the property (stocks, bonds, real estate, cash, certificates of deposit, mutual fund shares, or whatever it may be) and will receive title upon the age of maturity. (The age of maturity depends on the state. South Dakota sets it at a maximum of 18 years old; most states set it at a maximum of 21 years old, but a few states — such as Nevada, Pennsylvania and Oregon — allow the person making the gift to restrict it until the age of 25 years old.) The person overseeing the UTMA cannot enrich themselves at the child's expense, take the money back (if they were the original one gifting it), or otherwise treat it as if it were their own.
Trust Funds Trustees / Beneficiaries
If you establish a trust fund, the trustee you name owes a fiduciary duty to the beneficiaries. This is one of the reasons it is so important you ask the right questions to ensure a good fit prior to naming a trustee.
Attorney / Client Relationships
An attorney is required to put the best interest of the client ahead of his or her own best interest at all times with very few, clearly defined exceptions.
Guardianship of a Minor Child
In some cases, an adult may not be granted custody of a minor child, but rather, guardianship, which allows the person for a variety of reasons to make decisions about everything from the type of education the boy or girl will receive to the religious tradition in which he or she is raised. Guardians are required to act in the best interest of the minor or minors in their care. Guardianships are appointed by the court on behalf of parents who decide they cannot care for their children for one reason or another yet want to retain their parental right to revoke this authority at any time.
Work With Advisors Who Owe You a Fiduciary Duty
Though it isn't a guarantee of good treatment, if it is at all possible, investors should only work with those who are bound by a fiduciary duty. For example, if you are looking to invest your money, it's probably a better idea to try and find an ethical, highly regarded registered investment advisor than to use a stockbroker, unless you have a compelling reason to behave otherwise.