What Fiduciary Duties Does an RIA Owe its Clients?

As an investor, you’ve likely heard the term “fiduciary” thrown around quite a bit. But what does it really mean? And why is it so important when it comes to choosing a financial advisor? Let’s break it down.

A registered investment advisor (RIA) is a firm or individual that provides investment advice and management services to clients for a fee. The RIA is legally obliged to act in the best interests of its clients at all times because a contractual obligation binds them.

The Fiduciary Standard for RIAs

The fiduciary standard for RIAs traces back to the Investment Advisers Act of 1940, which requires investment advisers compensated for providing advice about securities to register with the Securities and Exchange Commission (SEC). As interpreted by the SEC, this Act imposes fiduciary obligations on RIAs, requiring them to act as fiduciaries in their dealings with clients.

At its core, an RIA’s fiduciary duty under the Act consists of a duty of care and a duty of loyalty. The fiduciary standard is principles-based and shaped by case law rather than being defined by a specific SEC regulation. However, the SEC has guided the fiduciary responsibilities RIAs owe their clients.

The duty of care requires RIAs to provide investment advice that is in the client’s best interest, seek the best execution of trades, and monitor client accounts. The duty of loyalty obligates RIAs to make full disclosure of any conflicts of interest and to eliminate conflicts when possible. If a conflict can’t be stopped, the RIA must ensure clients can give informed consent to conflicts that remain.

Duty of Care

An RIA’s duty of care has several vital components. First, under Section 206 of the Investment Advisers Act, an RIA has a fiduciary obligation to provide investment advice that is in the client’s best interest. This means the RIA must provide recommendations based on the client’s investment objectives, risk tolerance, and financial circumstances. The advice must be personalized to the individual client.

Second, an RIA’s duty of care requires seeking the best execution of trades made on the client’s behalf. This means the RIA must make reasonable efforts to execute securities transactions in a manner that maximizes value for the client under the circumstances.

Finally, the RIA’s duty of care involves an ongoing duty to monitor client accounts and investments. This requires periodically reviewing accounts to ensure recommendations remain appropriate and consistent with the client’s goals. According to a 2019 SEC interpretation, the duty to monitor extends to all investment advice concerning the account.

Duty of Loyalty

The duty of loyalty is a bedrock principle underlying an RIA’s fiduciary obligations. At its core, this duty requires RIAs to make full and fair disclosure of all material conflicts of interest. The RIA must provide sufficiently specific facts for a client to make an informed decision whether to consent to a conflict.

The duty of loyalty also requires RIAs to eliminate conflicts of interest where possible. If a conflict can’t feasibly be eliminated, the RIA must ensure the client can give informed consent to any conflicts that remain. Under Section 206 of the Advisers Act, the SEC has the authority to bring enforcement actions against RIAs that breach their duty of loyalty.

Common conflicts faced by RIAs include:

• Fees are based on assets under management.
• Commissions for selling financial products.
• Incentives for investing client assets in proprietary products or funds managed by the RIA.

Practical Implications

For RIAs, fulfilling fiduciary duties has some practical implications. First, RIAs must provide disclosures about their services, fees, and conflicts in Form ADV, which is filed with the SEC. Part 2 of Form ADV serves as a “brochure” that must be provided to prospective clients.

RIAs should also have processes for making suitable investment recommendations based on each client’s needs and objectives. This requires knowing the client’s complete financial picture and risk tolerance.

Ongoing monitoring of client accounts is essential as well. RIAs must periodically review their investment recommendations to ensure they remain appropriate as circumstances change.

Get in Compliance & Stay in Compliance With My RIA Lawyer

As experienced RIA lawyers, the professionals at My RIA Lawyer advise financial professionals on meeting their fiduciary obligations while succeeding in today’s complex regulatory environment. They help RIAs understand their duties so they can serve clients ethically and effectively. 

Reach out to the team at My RIA Lawyer for trusted guidance on RIA compliance. You can visit their website at https://www.myrialawyer.com/contact-us/ to learn more today.