DEFINITION: A fiduciary is an individual or entity charged with the responsibility for representing and working on behalf of another person (the “client”).
Fiduciaries prioritize the interests of their clients above their own. Being a fiduciary involves both the moral and the legal obligation to act in the client’s best interests.
The standard which the proper discharge of this legal obligation must meet—dating back to 1830—is often referred to as the “prudent person standard of care.”
The failure of an individual or entity to live up to its fiduciary obligations is a form of professional malpractice called “fiduciary negligence.”
In some cases, a fiduciary may be called upon to assume responsibility for the overall welfare of another individual. An example of a fiduciary with such a broad responsibility would be the legal guardian of an underaged individual.
However, in most cases, being a fiduciary involves the responsibility for handling a client’s financial affairs.
ETYMOLOGY: Both the adjectival and the nominal uses of the English word “fiduciary” are attested from the seventeenth century.
The English word derives from the Latin adjective fīdūciārius, meaning “committed” or “given in trust,” which in turn derives from the noun fīdūcia (“confidence,” “reliance,” “trust”) and the verb fīdo, fīdere (“to trust,” “to confide in”).
USAGE: The prudent-person rule mandates that a fiduciary entity must prioritize the interests of its clients above all else. This means that extreme vigilance must be exercised against the creation of any possible conflicts of interest between the fiduciary and the client.
In many instances, the fiduciary entity is only allowed to profit from the relationship with its client to the extent that was explicitly agreed upon at the commencement of the relationship.
Many different kinds of financial and business professionals bear fiduciary responsibility towards their clients in the ordinary exercise of their duties. Among these relationships, we may mention the following:
- Lawyers and clients
- Executors and legatees
- Guardians and wards
- Trustees and beneficiaries
- Insurance companies/agents and policyholders
- Financial advisors (money managers, accountants) and their clients
- Investment corporations and investors
- Corporate board members and shareholders
- Stock promoters and subscribers
Special Fiduciary Responsibilities of Corporate Board Members
Duty of Care: The duty of care involves the way in which corporate board members reach decisions that influence the future of the business. The duty basically prescribes an obligation to thoroughly investigate all potential options and assess their potential impact on the company. As such, it is similar to the concept of due diligence.
Duty to Act in Good Faith: Even after conducting a thorough investigation of available options, the board bears the responsibility of selecting the option that it genuinely believes will most effectively serve the interests of the business and its shareholders. This is the duty to act in good faith, which is conceptually a step beyond “due diligence.” One might call it “due action.”
Duty of Loyalty: The duty of loyalty prescribes that the board must prioritize the company and its investors above all its other financial and other interests. Board members are obliged to avoid any personal or professional engagements that could compromise their allegiance to their company’s best interests.
If a board member violates his fiduciary duties of care, good faith action, and loyalty, he may be held legally accountable by the company or its shareholders in a court of law.