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CFP® | FP511 > LO 6.1.3: Discuss the fiduciary duty and its importance to the client-planner relationship. > Flashcards

LO 6.1.3: Discuss the fiduciary duty and its importance to the client-planner relationship. Flashcards

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1
Q

What are the 3 types of fiduciary standards related to investment and retirement advice?

A
  1. Department of Labor (DOL) fiduciary standards
  2. Registered investment advisor (RIA) fiduciary standard
  3. Registered representatives (RRs) and agents suitability standard
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2
Q

Who administers the DOL Fiduciary Standard?

A

Administered by the U.S. Dept. of Labor (DOL)

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3
Q

DOL Fiduciary Standard | What kind of advice does this standard apply to?

A
  • Applied to (financial) advice given to qualified retirement accts such as
    • defined benefit and
    • defined contribution plans.
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4
Q

DOL fiduciary standard | What policy was enacted to address concerns private pension plans were being mismanaged and abused?

A

ERISA in 1974.

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5
Q

DOL fiduciary standard | What kind of investors does this standard apply to?

A

Retirement investors

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6
Q

DOL Fiduciary Standard | Why did individual states start to implement their own version of the fiduciary rule?

A
  • Key provisions of standards went into effect June 9, 2017
  • Final requirements set to go into effect January 1, 2018
  • Overturned by U.S. Fifth Circuit Court of Appeals ruling on June 18, 2018
  • Recognizing the importance of the fiduciary standard, individual states started to implement their own version of the fiduciary rule
  • As of the date of this publication, Connecticut, Nevada, New Jersey, and New York have created their own version of the fiduciary rule based on the overturned DOL version.
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7
Q

DOL Fiduciary Standard | What is being done to address the variety of state standards?

A
  • National Association of Insurance Commissioners (NAIC) has been developing a model legislation.
  • Expand the application of fiduciary standards to life insurance sales.
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8
Q

RIA Fiduciary Standard | Who developed the fiduciary standard upheld by RIAs?

A

Case law since the landmark Supreme Court case ruling of SEC v. Capital Gains Research Bureau in 1963.

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9
Q

RIA Fiduciary Standard | What did SEC v. Capital Gains Research Bureau find?

A

This ruling found that Section 206 of the Advisors Act imposed a fiduciary duty on all RIAs.

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10
Q

RIA Fiduciary Standard | What must RIAs do w/regard to this standard?

A
  • Act in the best interest of their clients;
  • Written disclosure of compensation and conflicts of interest;
  • Contract is required;
  • Abide by brochure rule, every client receives copy of Form ADV Part 2.
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11
Q

RIA Fiduciary Standard | Since 2010, how does Form ADV Part 2 have to be presented?

A
  • In “plain English” narrative form.
  • A fiduciary must not only provide disclosure but should also ensure that the client understands what is being disclosed.
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12
Q

Suitability Standard | Who is held to this standard?

A

Registered representatives and insurance agents.

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13
Q

Suitability Standard | How does this standard differ from the fiduciary standard?

A
  • Investment can be suitable but not necessarily in the best interests of clients; allows the opportunity for advisers to offer a suitable product that may be more in the advisors best interests rather than the client’s.
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14
Q

Suitability Standard | What is one key difference with regard to disclosures when compared to the Fiduciary Standard?

A

Registered representatives can deliver verbal disclosures, where as fiduciaries have written disclosure and contract requirements. (208)

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15
Q

Suitability vs. Fiduciary Standard | General approach

A
  • Suitability: Product driven

* Fiduciary: Solution driven

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16
Q

Suitability vs. Fiduciary Standard | Adviser disclosure

A
  • Suitability: Verbal

* Fiduciary: Written

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17
Q

Suitability vs. Fiduciary Standard | Legal

A
  • Suitability: Arbitration

* Fiduciary: Public courts

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18
Q

Suitability vs. Fiduciary Standard | Benchmark

A
  • Suitability: Suitable recommendation based on risk profile, age, objectives, and time horizon
  • Fiduciary: Align recommendations with the best interests of the client, taking into account all relevant factors
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19
Q

Suitability vs. Fiduciary Standard | Major categories

A
  • Suitability: Registered Reps, Agents

* Fiduciary: RIAs, trustees, and individuals advising ERISA plans if five-part test is met

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20
Q

Suitability vs. Fiduciary Standard | Regulators

A
  • Suitability: FINRA/states

* Fiduciary: SEC/states/DOL (overturned)

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21
Q

What are the manners in which a fiduciary standard is defined?

A

There are 2 possible approaches: either rules-based or principle based.

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22
Q

What is a rules-based approach to a fiduciary standard?

A

A series of rules and guidelines — essentially a checklist of dos and don’ts.

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23
Q

What are the challenges with a rules-based approach?

A
  • There are several challenges, as the numbers of rules increase.
  • Having numerous rules-
    • increases complexity;
    • creates opportunities for possible loopholes;
    • and leads to enforcement issues.
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24
Q

How does the principle-based approach compare to the rules-based approach instituted by RIAs and CFP professionals?

A
  • Principle-based approach is more aspirational in nature than rules-based;
  • Principle-based is the current approach instituted by RIAs and CFP professionals.
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25
Q

Where does the word fiduciary come from?

A

Latin fiducia, which means trust.

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26
Q

What the definition of a fiduciary relationship?

A
  • According to Black’s Law Dictionary, a fiduciary relationship arises whenever one person trusts or relies upon another.
  • More specifically, a fiduciary relationship arises whenever “confidence is reposed on one side, and domination and influence result on the other.”
  • The U.S. Supreme Court described the adviser’s duty as “an affirmative duty of utmost good faith, and full and fair disclosure of all material facts”
    • (SEC v. Capital Gains Research Bureau, 375 U.S., 180, 1963 — the case of fiduciary relationships) (209)
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27
Q

What is fiduciary duty as defined by statutory law?

A
  • As defined by the Investment Advisors Act of 1940, there is a fiduciary duty owed by investment advisors to their clients.
    • Defines investment advisor — Any person who, for compensation, engages in the business of advising others, as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.”
28
Q

What does the Investment Advisors Act of 1940 require investment advisors to do with regard to the SEC?

A

Register by filing Form ADV.

29
Q

What does the investment advisor have to do disclosure in registering with the SEC?

A

Backgrounds, business affiliations, and the compensation charged for their services.

30
Q

What does the IA Act of 1940 include prohibitions of?

A

Certain advertising practices and certain requirements of disclosure.

31
Q

Does registering under the IA Act of 1940 convey or imply anything account the competency of the advisor?

A

No.

32
Q

To function as a fiduciary, a planer must uphold and remain committed to which duties according to the CFP Board Code and Standards?

A
  • Duty of Loyalty
  • Duty of Care
  • Duty to Follow Client Instructions
33
Q

What is the Duty of Loyalty?

A
  • Place interest of the client above own and firm’s interest

* Also avoid conflicts of interest or fully disclose, obtain client’s informed consent, and manage the conflict.

34
Q

What is the Duty of Care?

A

Act with care, skill, prudence, and diligence that a prudent professional would exercise in light of the client’s goals, risk tolerance, objectives, and financial and personal circumstances.

35
Q

What is the Duty to Follow Client Instructions?

A

Comply with the terms of the client engagement and follow all directions of the client that are reasonable and lawful.

36
Q

What are the duties in addition to acting in the best interest of the client, that are upheld by all fiduciaries in the financial services industry?

A
  • the duty of loyalty,
  • the duty of care,
  • the duty to disclose,
  • the duty to diagnose,
  • the duty to consult, and
  • the duty to keep current. (210)
37
Q

What does the Duty of Loyalty require?

A
  • Cf. Standard A.1 of Code and Standards
  • Obligation to look first to the client’s best interests is the fundamental duty.
  • All actions be made solely for the benefit for the client.
  • If interests of the firm, the investment professional, and client compete, client’s interests come first.
38
Q

What are examples of other than CFP professionals who must uphold the fiduciary duty of loyalty?

A
  • pension manager;
  • investment manager;
  • custodian of a child’s account;
  • Trustee of a college endowment;
  • investment professional with discretion,
  • or anybody in a fiduciary position.
39
Q

Under ERISA, can there be various parties held to the fiduciary duty?

A

Yes, such as the company itself, the plan admin, and the investment manager.

40
Q

Under ERISA, what if there are conflicts of interest between the various parties with fiduciary duty?

A

Conflicts of interest must be recognized by all parties and should be mitigated as much as possible to make sure that the client’s best interests always come first.

41
Q

How does the Duty of Care relate to the classic definition of the “prudent man”?

A
  • Cf. Standard A.1 of Code and Standards
  • Concept of reasonable care, which is the prudent man rule — articulated in the famous Harvard College v. Armory case of 1830:
    • All that can be required of a trustee to invest is that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of capital to be invested.
42
Q

What does the Duty of Care require?

A
  • Have the competency to give fiduciary advice.
  • Level of knowledge and skill to know what is in the best interests to the client.
  • Be discerning and thoroughly vet other experts they enlist for advice and services.
43
Q

Uniform Prudent Investor Act (UPIA)

A
  • Adopted into law in 1994 by the National Conference of Commissions of Uniform State Laws
  • Widely adopted by state legislatures, elevates the prudent man rule to the prudent investor rule, focusing on total return of a portfolio rather than individual investments.
44
Q

How does the prudent man rule compare to the prudent investor rule?

A
  • Prudent man rule states a prudent man is measures the risk of an individual investment to the nominal dollar value of the portfolio (emphasis on cash and cash equivalents).
  • Prudent investor rule states prudent investing is measured by the appropriate asset mix and total return of the portfolio, rather than individual investments.
45
Q

How did the prudent investor rule affect the statutory approved list of investments?

A
  • Raised the bar on what would satisfy a trustee’s fiduciary duty, expanded beyond just choosing from the list.
  • The investments on such a list might not produce a prudent mix, expanding the definition of prudent investing.
46
Q

Uniform Prudent Investor Act | What are the five fundamental alterations in the former criteria for prudent investing?

A
  1. standard of prudence is applied to total portfolio (all assets).
  2. risk and return tradeoff is identified as the fiduciaries central consideration.
  3. no restrictions on types of investments, trustee has discretion as long as meets risk/return objectives of trust and prudent investing requirements.
  4. prudent investing means fiduciaries diversify their investments.
  5. trustees can delegate of trust investment and management functions subject to safeguards.
47
Q

Uniform Prudent Investor Act | How does the the prudent investor rule affect the role of the trustee as a fiduciary?

A

Individual trustees who don’t have investment sophistication may need to rely on a professional to fulfill their fiduciary duty.

48
Q

What is the Duty to Disclose?

A
  • All material facts and conflicts of interest.
  • Dealt with extensively in gov’t regulation ad professional codes of conduct.
  • Examples:
    • ’33 Act: Any company wanting to sell stock publicly must disclose its financials and any potential risks.
    • Not to emphasize to an inexperienced investor the repayment of 30-year Treasuries backed by full faith, while failing to explain how market value fluctuates represents such failure to disclose.
49
Q

Does disclosure in and of itself meet the fiduciary duty?

A
  • No, disclosure is an important fiduciary duty, but disclosure in and of itself will not necessarily meet the fiduciary standard.
  • Client’s best interests must come first.
  • Example: If an adviser will receive a generous commission from an investment that a client purchases, and the adviser disclosed the fee conflict is not enough to fulfill a fiduciary duty to disclose — the adviser must also necessarily present any other investments that have the same return and lower fees, to keep in the client’s best interest. (212)
50
Q

What does the Duty to Disclose include under SEC Rules?

A
  • Relating to the Securities Exchange At of 1934 (SEC Rule 10b-5), it’s unlawful to provide false or misleading statements in connection wit the purchase or sale of a security.
  • Antifraud provisions apply to the failure to disclose.
51
Q

When are conflicts of interest unethical?

A

Only when they are not disclosed to all concerned.

52
Q

What is the ethical duty to diagnose?

A

Includes the obligation to know your customer and to investigate the suitability of any products recommended as investments.

53
Q

What are the formal requirements of the ethical duty to diagnose?

A
  • NYSE Rule 405 stresses the importance of learning all the essential facts about a client and that client’s account
  • FINRA suitability rule requires a B-D to have reasonable grounds for believing that a recommended investment is suitable for the particular client.
54
Q

What does FINRA’s suitability rule with regard to the ethical duty to diagnose?

A

Suitable in terms of the client’s other security holdings, financial situation, and needs.

55
Q

How does the duty to diagnose relate to when an investment professional makes a recommendation?

A
  • Recommendations to a client are made in light of
    • current economic environment,
    • client’s risk tolerance,
    • financial circumstances,
    • existing portfolio of assets, and
    • stated goals
56
Q

Duty to Diagnose | Why is it important to learn all the relevant facts about a client?

A

For analysis; striving to gather and learn all the relevant facts in order to make suitable recommendations that are in the best interests of the client.

57
Q

Duty to Diagnose | How does this relate to financial planning?

A
  • Preparation and implementation of plan
  • Periodic reviews of an investment plan and portfolio
  • Be aware of any changes of financial and tax situation, and larger economic environment.
58
Q

What is the Duty to Consult?

A
  • Consult with others w/specialized knowledge.

* Specialists in financial departments need to be consultant when discussions with clients get beyond the basics.

59
Q

Does making a recommendation on the strength of one’s recollections between two fairly complex retirement plans meet the ethical duty to clients?

A

No, violates (1) duty to diagnose the technical requirements of the recommendation; and (2) the duty to consult with others who have specialized knowledge of the issue.

60
Q

What is the Duty to Keep Current?

A
  • As a professional in the financial services industry, keep current on changing tax laws, product offerings, and the fortunes of individual securities issuers, entire industries, etc. and how those developments affect clients.
61
Q

How do B-Ds fulfill the Duty to Keep Current?

A
  • Firm element — formal training to keep brokers up to date on job and -product-related subjects.
  • B-Ds must have a written training plan based on an annual needs analysis, and must maintain records documenting the content and completion of the program.
62
Q

How do professional orgs fulfill the Duty to Keep Current?

A
  • The CFP Board and American Institute of Certified Public Accountants (AICPA) require regular and ongoing training and professional development for continued membership/certification.
  • Large financial services firms have periodic training.
63
Q

How do individuals fulfill the Duty to Keep Current and why?

A
  • If you present yourself to the public as a professional, be aware of the current practice in that field.
  • This protects from liability.
64
Q

How can fiduciaries protect themselves from liability?

A
  1. Keep detailed records of actions taken and the factors that went into the decisions.
  2. Make sure the records describe in detail the relevant circumstances prevailing at this time—that is, outline the conditions under which the action was taken.
  3. Make sure all reasonable steps have been taken to acquire the information needed to make informed decisions.
65
Q

Can an investment professional escape liability if client signs a statement absolving the investment professional from unethical or negligent conduct?

A

No. Courts tend to be cautious in enforcing overly broad exculpatory language, especially if one party (e.g., the investment pro) holds itself out as one expect or if it is likely to be highly influential or persuasive toward the other party (e.g. the client).

CFP® | FP511 (61 decks)

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