Fiduciary Definition: Examples and Why They Are Important?

What Is a Fiduciary?

A fiduciary is a person or organization that acts on behalf of another person or persons, putting their client’s interests ahead of their own, with a duty to preserve good faith and trust. Being a fiduciary thus requires being bound both legally and ethically to act in the other’s best interests.

A fiduciary may be responsible for the general well-being of another (e.g., a child’s legal guardian), but the task often involves finances—for example, managing the assets of another person or a group of people. Money managers, financial advisors, bankers, insurance agents, accountants, executors, board members, and corporate officers all have fiduciary responsibilities.

Understanding Fiduciaries

A fiduciary’s responsibilities and duties are both ethical and legal. When a party knowingly accepts a fiduciary duty on behalf of another party, they are required to act in the best interest of the principal (i.e., the client or party whose assets they are managing). This is what is known as a “prudent person standard of care,” a standard that originally stems from an 1830 court ruling.

This formulation of the prudent-person rule required that a person acting as fiduciary was required to act first and foremost with the needs of beneficiaries in mind. Strict care must be taken to ensure that no conflict of interest arises between the fiduciary and their principal.

In many cases, no profit is to be made from the relationship unless explicit consent is granted when the relationship begins. As an example, in the United Kingdom, fiduciaries cannot profit from their position, according to an English High Court ruling, Keech vs. Sandford (1726). If the principal provides consent, then the fiduciary can keep whatever benefit they have received; these benefits can be either monetary or defined more broadly as an “opportunity.”

Fiduciary duties appear in a wide variety of common business relationships, including:

Trustee and beneficiary (the most common type)
Corporate board members and shareholders
Executors and legatees
Guardians and wards
Promoters and stock subscribers
Lawyers and clients
Investment corporations and investors
Insurance companies/agents and policyholders

Fiduciary Relationship Between Trustee and Beneficiary

Estate arrangements and implemented trusts involve both a trustee and a beneficiary. An individual named as a trust or estate trustee is the fiduciary, and the beneficiary is the principal. Under a trustee/beneficiary duty, the fiduciary has legal ownership of the property or assets and holds the power necessary to handle assets held in the name of the trust. In estate law, the trustee may also be known as the estate’s executor.

Note that the trustee must make decisions that are in the best interest of the beneficiary, as the latter holds equitable title to the property. The trustee/beneficiary relationship is an important aspect of comprehensive estate planning, and special care should be taken to determine who is designated as trustee.

Politicians often set up blind trusts to avoid real or perceived conflict-of-interest scandals. A blind trust is a relationship in which a trustee is in charge of all of the investment of a beneficiary’s corpus (assets) without the beneficiary knowing how the corpus is being invested. Even while the beneficiary has no knowledge, the trustee has a fiduciary duty to invest the corpus according to the prudent person's standard of conduct.

Fiduciary Relationship Between Board Members and Shareholders

A similar fiduciary duty can be held by corporate directors, as they can be considered trustees for stockholders if on the board of a corporation, or trustees of depositors if they serve as the director of a bank. Specific duties include the following:

Duty of Care

Duty of care applies to the way the board makes decisions that affect the future of the business. The board has the duty to fully investigate all possible decisions and how they may impact the business. If the board is voting to elect a new chief executive officer (CEO), for example, the decision should not be made based solely on the board’s knowledge or opinion of one possible candidate; it is the board’s responsibility to investigate all viable applicants to ensure that the best person for the job is chosen.

Duty to Act in Good Faith

Even after it reasonably investigates all the options before it, the board has the responsibility to choose the option that it believes best serves the interests of the business and its shareholders.

Duty of Loyalty

Duty of loyalty means the board is required to put no other causes, interests, or affiliations above its allegiance to the company and the company’s investors. Board members must refrain from personal or professional dealings that might put their own self-interest or that of another person or business above the interest of the company.

If a member of a board of directors is found to be in breach of their fiduciary duty, they can be held liable in a court of law by the company itself or its shareholders.

Fiduciary Relationship Between Executor and Legatee

Fiduciary activities can also apply to specific or one-time transactions. For example, a fiduciary deed is used to transfer property rights in a sale when a fiduciary must act as an executor of the sale on behalf of the property owner. A fiduciary deed is useful when a property owner wishes to sell but is unable to handle their affairs due to illness, incompetence, or other circumstances, and needs someone to act in their stead.

A fiduciary is required by law to disclose to the potential buyer the true condition of the property being sold, and they cannot receive any financial benefits from the sale. A fiduciary deed is also useful when the property owner is deceased and their property is part of an estate that needs oversight or management.

Fiduciary Relationship Between Guardian and Ward

Under a guardian/ward relationship, the legal guardianship of a minor is transferred to an appointed adult. As the fiduciary, the guardian is tasked with ensuring the minor child or ward has appropriate care, which can include deciding where the minor attends school, that the minor has suitable medical care, that they are disciplined in a reasonable manner, and that their daily welfare remains intact.

A guardian is appointed by the state court when the natural guardian of a minor child is not able to care for the child any longer. In most states, a guardian/ward relationship remains intact until the minor child reaches the age of majority.

Fiduciary Relationship Between Attorney and Client

The attorney/client fiduciary relationship is arguably one of the most stringent. The U.S. Supreme Court states that the highest level of trust and confidence must exist between an attorney and a client—and that an attorney, as fiduciary, must act in complete fairness, loyalty, and fidelity in each representation of, and dealing with, clients.

Attorneys are held liable for breaches of their fiduciary duties by the client and are accountable to the court in which that client is represented when a breach occurs.

Fiduciary Relationship Between Principal and Agent

A more generic example of fiduciary duty lies in the principal/agent relationship. Any individual person, corporation, partnership, or government agency can act as a principal or agent as long as the person or business has the legal capacity to do so. Under a principal/agent duty, an agent is legally appointed to act on behalf of the principal without conflict of interest.

A common example of a principal/agent relationship that implies fiduciary duty is a group of shareholders as principals electing management or C-suite individuals to act as agents. Similarly, investors act as principals when selecting investment fund managers as agents to manage assets.

Investment Fiduciary

While it may seem as if an investment fiduciary would be a financial professional (money manager, banker, and so on), an investment fiduciary is actually any person who has legal responsibility for managing somebody else’s money.

That means if you volunteered to sit on the investment committee of the board of your local charity or other organization, you have a fiduciary responsibility. You have been placed in a position of trust, and there may be consequences for the betrayal of that trust. Also, hiring a financial or investment expert does not relieve the committee members of all of their duties. They still have an obligation to prudently select and monitor the activities of the expert.

The Suitability Rule

Broker-dealers, who are often compensated by commission, generally only have to fulfill a suitability obligation. This is defined as making recommendations that are consistent with the needs and preferences of the underlying customer. Broker-dealers are regulated by the Financial Industry Regulatory Authority (FINRA) under standards that require them to make suitable recommendations to their clients.

Instead of having to place their interests below that of the client, the suitability standard only details that the broker-dealer has to reasonably believe that any recommendations made are suitable for the client, in terms of the client’s financial needs, objectives, and unique circumstances. A key distinction in terms of loyalty is also important: A broker’s primary duty is to their employer, the broker-dealer for whom they work, not to their clients.

Other descriptions of suitability include making sure that transaction costs are not excessive and that their recommendations are not unsuitable for the client. Examples that may violate suitability include excessive trading, churning the account simply to generate more commissions, and frequently switching account assets to generate transaction income for the broker-dealer.

Also, the need to disclose potential conflicts of interest is not as strict a requirement for brokers—an investment only has to be suitable; it doesn’t necessarily have to be consistent with the individual investor’s objectives and profile.

The suitability standard can end up causing conflicts between a broker-dealer and a client. The most obvious conflict has to do with compensation. Under a fiduciary standard, an investment advisor would be strictly prohibited from buying a mutual fund or other investment for a client because it would garner the broker a higher fee or commission than an option that would cost the client less—or yield more for the client.

Suitability vs. Fiduciary Standard

If your investment advisor is a Registered Investment Advisor (RIA), they share fiduciary responsibility with the investment committee. On the other hand, a broker, who works for a broker-dealer, may not. Some brokerage firms don’t want or allow their brokers to be fiduciaries.

Investment advisors, who are usually fee-based, are bound to a fiduciary standard that was established as part of the Investment Advisers Act of 1940. They can be regulated by the U.S. Securities and Exchange Commission (SEC) or state securities regulators. The act is pretty specific in defining what a fiduciary means, and it stipulates a duty of loyalty and care, which means that the advisor must put their client’s interests above their own.

For example, the advisor cannot buy securities for their account prior to buying them for a client and is prohibited from making trades that may result in higher commissions for the advisor or their investment firm.

It also means that the advisor must do their best to make sure investment advice is made using accurate and complete information—basically, that the analysis is thorough and as accurate as possible. Avoiding conflicts of interest is important when acting as a fiduciary, and it means that an advisor must disclose any potential conflicts to placing the client’s interests ahead of the advisor’s.

Additionally, the advisor needs to place trades under a “best execution” standard, meaning that they must strive to trade securities with the best combination of low cost and efficient execution.