■ Define the term “fiduciary” and describe the fiduciary responsibility of CIMA® designees.
■ Describe the principal-agent relationship between investment professionals and individuals, trusts, foundations, endowments, and ERISA plan clients.
■ Identify circumstances that may cause a person to be identified as a fiduciary.
■ Describe laws that apply to investment advisors and consultants, including:
ERISA (Employee Retirement Income Security Act)
UPIA (Uniform Prudent Investor Act)
UMIFA (Uniform Management of Institutional Funds Act)
UPMIFA (Uniform Prudent Management of Institutional Funds Act)
Other international, federal, and state laws
■ Identify prohibited transactions.
In the client relationship, a consultant often is identified as a fiduciary or is said to have a fiduciary duty owed to the client. The term fiduciary can have a variety of meanings to clients and consultants. In general, a fiduciary duty, or capacity, can be defined as an ethical relationship between a consultant and a client in which the consultant is to act on behalf of and always in the best interest of the client. In turn, the client places trust and good faith in the consultant. The sole purpose of this relationship must be to safeguard the interests of the client at all times. Additionally, a fiduciary must adhere to a process that is deemed to be prudent.
The fiduciary relationship for a consultant and client can be established with individuals, trusts, foundations, endowments, ERISA plans, and many other circumstances. In each case, certain duties are expected to be performed at a minimum on behalf of the client or clients.
For individuals and trusts, the fiduciary has a responsibility to manage investments prudently. The Prudent Man Rule or the Prudent Investor Rule may apply in such cases. Although the rule is almost 200 years old and based on the Harvard College v. Amory case of 1830, it still is considered the foundation for most fiduciary relationships.
The rule states that trustees are directed 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 the capital to be invested.” Trustees are to exercise care and skill in the selection of investments.
The initial Prudent Man Rule focused primarily on the merits of the individual investments, did not allow for risky investments, and focused on investments in government securities. Over time, interpretation of the rule evolved, with large steps taking place after the Great Depression and after World War II.
The more modern Prudent Investment Rule incorporates the theory of diversification and allows for overall portfolio management as the guiding principle for astute investment management.
Trustees are considered to be fiduciaries to the beneficiaries. Legally, an account or property is committed to the trustee. A beneficiary has no legal title to the trust, but has a beneficial use or interest. In this relationship, the trustee must only act in the interest of the beneficiary, and can in no way act in his or her own best interest.
With foundations, endowments, and ERISA plans, a board of directors may be held to the same fiduciary standards as a trustee. A major difference is the board's capacity to act in the interest of an entity, or in some cases, a large group of individuals. In many cases, the entities or individuals have legal title or claim to assets that the board is managing on their behalf. The decisions may be on a different scale, but the core principal of the fiduciary relationship remains intact.
Another term for the relationship is the principal-agent relationship. In a trustee relationship, the principal is the beneficiary, the person who is owed the duty, while the agent would be the trustee, the person who is the fiduciary. Other examples of the principal-agent relationship include company-board of directors, client-consultant, and heirs-executors.
A consultant may be considered a fiduciary under a number of different circumstances. In most cases, as a fiduciary, the consultant must apply fiduciary standards and exercise those standards with care. Some cases are obvious and others are by default.
Direct Relationships
In many cases, the consultant should be aware of the direct fiduciary relationship. These cases include becoming a trustee and sitting on the board of directors of a foundation.
If a consultant is named as a trustee, the consultant must be prepared to act in a fiduciary capacity on behalf of the client. The foundational case for trustee fiduciary standards was Keech v. Sandford in 1726. The law ultimately states that the trustee has a strict duty and that there never should be a conflict of interest in the relationship. Consultants agreeing to become trustees must realize that they are expected to be fiduciaries.
A consultant who holds himself or herself out as a fiduciary for ERISA plans and pensions may be held to fiduciary standards. In these cases, consultants must be prepared to define the scope and nature of their relationship with the entity for which they are consulting.
Sitting on the board of directors for a company, foundation, or endowment also may make the consultant a fiduciary. The duties owed to the individuals or entities should be examined by the consultant prior to making the commitment to sit on a board.
Indirect Relationships
In some cases, the consultant may be held out as a fiduciary without realizing that he or she is being held to a fiduciary standard. Sitting on the board of directors, as described above, may be one of those cases. Another situation is in the case of discretionary accounts. If a consultant manages a discretionary account on behalf of a client, he or she may be considered a fiduciary. In most cases, if there is a question of the nature of the relationship, the consultant may be held to the high standards of fiduciary care.
Under current legislation, prohibited transactions for ERISA plans are specific. According to IRS Publication 560 and www.irs.gov, ERISA prohibited transactions including the following six:
1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person
2. Any act of a fiduciary by which plan income or assets are used for his or her own interest
3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets
4. The sale, exchange, or lease of property between a plan and a disqualified person
5. Lending money or extending credit between a plan and a disqualified person
6. Furnishing goods, services, or facilities between a plan and a disqualified person
According to Publication 560, disqualified individuals include the following 10 types:
1. A fiduciary of the plan
2. A person providing services to the plan
3. An employer, any of whose employees are covered by the plan
4. An employee organization, any of whose members are covered by the plan
5. Any direct or indirect owner of 50 percent or more of any of the following:
a. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation
b. that is an employer or employee organization described in (3) or (4)
c. the capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4)
d. the beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4)
6. A member of the family of any individual described in (1), (2), (3), or (4) (i.e., the