Investment Advice and Fiduciary Duties

Most of us rely on accredited professionals for a range of services. Doctors, lawyers, accountants and so on play a huge role in our lives, giving us advice and rendering services that we would be foolish to provide for ourselves. Some topics, in other words, are beyond the ken of even the dedicated do-it-yourselfer. Financial planning is in that category. If you plan to do anything much beyond storing your money in a mattress, you probably want help from a professional. And you hope — really, really hope — that that professional is on the ball and has your best interests at heart.

A recent story highlights some of the difficulties in this regard. The story is about an independent insurance agent facing jail time for selling a particular kind of investment — an indexed annuity — to an 83-year-old woman. The catch: prosecutors say the woman showed signs of dementia, and the implication is that the agent took advantage of the fact that the buyer may not have understood the limits and disadvantages of the investment instrument she was buying.

Even minus the question of the buyer’s competency, there are worries here. For perspective on this story, I talked to Prof. John Boatright, who literally wrote the book on ethics in finance. He pointed out to me that Equity-Indexed Annuities are so complex that they’re a dubious product quite generally. He also pointed out that such annuities are investment instruments sold by people in the insurance industry who are not truly investment specialists. Most investment instruments are regulated such that they can only be sold by investment professionals with suitable training and credentials.

But regardless of the kind of professional you go to for investment advice, the underlying ethical question is whether that professional is going to have your best interests at heart. When the thing you’re buying is too complex to understand, you have to put your trust in the seller. Such trust is best underpinned by what are called fiduciary duties. A fiduciary, roughly speaking, is someone to whom something of value is entrusted. And a professional who bears a fiduciary duty has a stronger obligation than a mere salesman. Someone out to sell you something — a car, a stereo, whatever — has a plain obligation not to deceive you, but generally isn’t obligated to make sure that the product is right for you. Whether the product is right for you is up to you to decide. But a fiduciary is held to a higher standard. As Alexei Marcoux points out, we are vulnerable in various ways to professionals of various kinds, and that vulnerability generates duties on the part of those professionals, not just to be honest to us but to put our interests first. The transaction between a professional and a client is not a regular market transaction; rather, it is (or ought to be) governed by the higher standard implied by a fiduciary relationship.

Whether financial advisors and financial planners proclaim and live up to such a high standard is another matter. It certainly seems they should. In some places, financial professionals are explicitly expected to live up to the standard applied by a fiduciary duty, and other jurisdictions are moving in that direction. If ever there were a circumstance in which we were vulnerable, a situation in which we are trusting a stranger to tell us what to do with our life’s savings seems to fit the bill.

6 comments so far

  1. Jonathan Breslin on

    The important difference between those with fiduciary duties and those without (the mere salesmen) is that the fiduciary duty arises out of a relationship that is based in dependency and vulnerability. I don’t depend on the salesman who knocks on my door because I don’t need his services and I have the freedom to turn him away. But when I visit a doctor, or seek advice from a lawyer, accountant, financial advisor or whatever, I am doing so because I need their expertise – thus rendering me dependent and vulnerable. Any such relationship creates a corresponding obligation on the part of the professional maintain my trust by serving my interests and not taking advantage of my vulnerability and dependency.

  2. David L Harris, PhD ChFC CFP on

    Excellent advice for all investors. Thanks, Chris MacDonald. You and I are on the same page.

  3. Pete Bresnahan on

    The implementation of the IIROC’s Client Relationship Model will raise the standard for investment suitability by focusing on the dependency and vulnerability of the client. This is a mandate that will certainly move Investment Advisors (IA) towards a fiduciary standard and will further ‘professionalize’ the industry. However, I believe that there will continue to be a problem with the objectivity of the Advisor until the issue of IA compensation is resolved. Although there is a trend towards fee based accounts there is an inherent conflict with a fiduciary standard and compensation based on commissions. The thought of other professional bodies being compensated via commissions seems absurd. If the securities industry want to move towards a fiduciary standard the issue of commission income will have to be dealt with.

    • Chris MacDonald on


      Thanks for your comment.
      But the compensation problem is far from unique to this field. Physicians are typically paid per prescription, per scan/scope, and per referral. And lawyers bill you for as many hours work as THEY say you need. That doesn’t mean there isn’t a problem; just perhaps that investment advisors (etc.) could benefit from looking at other professions for how they handle the inherent conflict.


  4. wolfgang on

    Everybody should responsible for himself in every situation and should not delegate it to a professional. Whenever I do not understand a financial construct, i keep my hands off. Also a prof cannot overtaken the responsibility for my own things. In other case we would go beyond Kant, we should not do that.

  5. […] blogged recently on a California case about an insurance agent who was sentenced to jail for selling an Indexed […]

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