What Happens When an Advisor Violates the Fiduciary Duty?

The fiduciary duty is a central ethical standard in the financial advisor industry. It legally requires professionals and organizations to put clients’ interests first, act with integrity, and disclose or avoid conflicts of interest. This duty protects clients and gives them confidence in their advisor.

But what happens when that promise is broken? To understand the repercussions, it’s necessary to consider how accountability comes into play and the steps clients can take to protect themselves when fiduciary standards are not met.

To anchor our discussion, we’ll first clarify the meaning of fiduciary duty and define what actions constitute a breach. From there, we’ll examine the possible impacts on clients, outline the legal and regulatory consequences for professionals, and explain what steps to take if you suspect a fiduciary breakdown.

What Fiduciary Duty Means in Practice

The fiduciary duty requires financial advisors to practice with a high standard of ethics. It’s a crucial part of the advisor-client relationship and, if it’s upheld, signals that a professional is acting in your best interest and is of strong quality.

“There are multiple components of an advisor’s fiduciary duty to clients,” says Jason Steeno, president of CoreCap Investments and CoreCap Advisors. “Among these are the duty of loyalty, duty of care and duty of obedience.”

Steeno notes that it’s most common, both inside and outside of the industry, to focus on the duty of loyalty when discussing the fiduciary standard. This refers to “the duty to put the client’s interests ahead of personal interests and avoiding conflicts of interest,” he explains.

Avoiding conflicts of interest means that advisors must recommend investments and strategies that they genuinely believe will help you reach your goals. Conversely, if their objective is to solely earn compensation by referring products to you, such as insurance or specific securities, that would present a conflict and could break their fiduciary duty.

The fiduciary duty also includes that an advisor must conduct themself with professionalism and diligence. They must keep accurate records, respect client confidentiality, and observe the law. These comprise the duties of care and obedience, per Steeno.

What Constitutes a Fiduciary Violation

Even though the fiduciary duty exists to protect clients and hold advisors accountable, violations can still occur. Breaches can be subtle and hard to spot or more extreme and costly. They can range from failing to disclose conflicts of interest, misrepresentations, making unsuitable investments, or even misconduct.

In any form, fiduciary violations are breaches of trust between clients, advisors, and financial institutions. Here are some examples of what constitutes a violation:

Failure to Disclose Conflicts of Interest

Fiduciary advisors must disclose any conflicts of interest that arise in client relationships. This includes situations where they could benefit from the advice they provide, whether by recommending products (e.g., life insurance, annuities, etc.), in-house products or investments, tools, or investing strategies.

According to Steeno, the most typical and visible “example of violating fiduciary duty is choosing a product that pays the advisor a higher fee than a similarly suitable product that could accomplish the same objective.”

Conflicts of interest can also surface in less obvious ways. Steeno notes that it could involve “choosing a custodian that offers a lower custodial fee that the advisor pays from their own pocket when that custodian’s offering is not as comprehensive,” or selecting “a share class of mutual funds that results in lower fees for the advisor, but potentially higher fees for the client.”

Unsuitable Investment Recommendations

As noted, it’s crucial that fiduciary professionals recommend investments that are in the best interest of their clients. If they knowingly don’t, whether it’s to earn a commission, maintain an outside relationship, or for any other reason unrelated to the client’s goals, that would violate their status as a fiduciary.

“An advisor may also violate fiduciary duty by choosing an investment because they have a good relationship with the salesperson from that investment company,” Steeno relates. “The advisor may receive benefits from that relationship (sports tickets, dinners, etc.) in exchange for the business.”

Negligence or Poor Documentation

A financial advisor could also fracture their fiduciary status by being negligent with a client’s account or drafting poor records, violating the duty of care. This occurs when a professional fails to act with competence, diligence, or thoroughness, or without a client’s needs or goals at the forefront.

Examples may include:

• Excessive trading, leading to losses or inflated fees.
• Failing to do proper research on investments to vet suitability, performance, or risk profile.
• Failing to take a client’s risk tolerance, goals, and time horizon into account when delivering a plan or investing strategy.
• Mismanaging confidential information or key documents.

Misrepresentation or Deliberate Misconduct

Intentional misrepresentation, misconduct, or fraudulent behavior is a severe violation of the fiduciary duty. This can take many forms, such as:

• Intentionally hiding or underexplaining fees.
• Downplaying investing risks.
• Overpromising on returns.
• Falsifying documents and records.
• Using client funds inappropriately.
• Investing in a client’s account without authorization.

How Violations Impact Clients

Fiduciary breaches carry significant financial and emotional impacts on clients. They break the critical trust that needs to exist in an advisor-client relationship and, in serious cases, could lead to unnecessary costs or losses.

The financial repercussions can be sweeping. Clients may experience poor investments or underperformance, especially if the strategy was chosen for the professional’s personal gain. Unnecessary tax burden and fees are also possible if the portfolio is structured negligently or intentionally recklessly. Finally, clients may miss out on opportunities to grow their portfolios and reach their goals that might have existed with a better financial advisor.

Breaches can also lead to legal headaches for clients. If clients suspect their advisor isn’t upholding the fiduciary agreement, they’ll need to spend time filing complaints with regulatory agencies or hiring an attorney to begin a lawsuit or dispute. This can be an arduous, stressful, and complicated process that incurs legal fees and, unfortunately, isn’t always successful.

Perhaps the most lasting damage, however, is that clients could lose faith in financial advice. The fiduciary duty represents the highest standard of integrity and trust in the industry. But once this is broken, even if it’s just one bad advisor, its meaning could crumble for a client. After a single bad experience, some clients may be discouraged and never pursue financial advice again.

Legal and Regulatory Consequences

Regulatory agencies, registered investment advisor (RIA) firms, and credential-issuing organizations take the fiduciary duty very seriously. If an advisor is bound by any of these organizations, breaching their fiduciary agreement can lead to severe, career-altering consequences.

Below are some of the consequences that advisors and firms may face by breaking the fiduciary duty:

Regulatory Enforcement and Penalties

Regulatory agencies, such as the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), may impose fines, penalties, or suspensions against advisors who violate their fiduciary duty. In serious cases, such as convictions for fraud or theft, RIA firms or investment advisor representatives (IARs) may lose their licenses altogether.

Loss of Credentials

Advisors who hold reputable credentials (e.g., CFP, CFA, ChFC, etc.) can also lose their credentials either permanently or temporarily if they violate their duty. For instance, the CFP Board suspends individuals for at least one year in cases where they breach their fiduciary standard or are found to have been convicted within the last ten years

Loss of credentials means that the professional can no longer use their marks alongside their name, on their website, or within marketing materials. This remains in effect either permanently or until their suspension ends.

Public Disclosures

Financial advisors may also face disclosures as a punishment. These are public records of a professional or firm’s disciplinary action that they’ve received from regulatory or governmental oversight agencies. Disclosures may note that an advisor had a conflict of interest, committed a crime, or didn’t file records properly, among other details.

You can find an advisor’s disclosures on annual Form ADV documents or FINRA’s BrokerCheck if they’re an RIA firm or IAR. If they hold credentials, you can also check an advisor’s record on the credentialing organization’s website. The CFP Board, for example, has a search tool that displays disciplinary information about professionals holding the CFP marks.

Civil Lawsuits

Besides regulatory consequences, advisors can be liable for civil lawsuits and disputes. Depending on the severity of the violation, clients could seek restitution for damages. In successful cases, courts may order advisors to repay losses, give up earned commissions, or provide compensation to the plaintiffs.

How Clients Can Protect Themselves

Spotting a breach of fiduciary duty can be difficult. Even if you know what a violation looks like, breaches like the ones we discussed earlier happen in the background and are easily concealable. Still, it’s vital for advisor clients to be cognizant of red flags.

“There are warning signs clients should look out for when it comes to an advisor neglecting best interest, says Steeno, who emphasizes that clients “must be on top of their investments” to see them. He recommends clients begin by “reviewing their statements each month, checking for irregularities in the accounts,” such as “missing money or unusual trades.”

If anything stands out as unrecognizable, it’s important to bring it up to your advisor directly. They should be able to address your concerns thoughtfully and completely. If something doesn’t seem right, you’re justified in questioning it.

Another warning sign that Steeno notes could be “an advisor who provides little communication” about what’s going on with your accounts or portfolio. “When you work with a financial advisor, they should be in contact with you to understand your goals and how you want your accounts managed,” he continues. If you don’t feel up-to-speed, it’s reasonable to wonder whether they’re doing their full duty as your advisor.

The final red flag to keep in mind is when fees are unclear or don’t add up to what you agree to. Steeno explains that “you should fully understand fees as the client” and that they “should be disclosed at the beginning of your relationship with the advisor.” Therefore, if things have changed without your knowledge or if things don’t make sense, it’s worth pausing and being suspicious of what’s going on.

What to Do If You Suspect a Breach

If you suspect a breach, even after talking to your advisor, there are a few steps you can take:

• Gather documentation. Keep a record of all details that could demonstrate a violation, including statements, emails, or mismatched information on Form ADV documents or contracts.
• File complaints. Consider reaching out to regulatory agencies, such as the SEC, FINRA, state regulators, or credentialing organizations. If you’re unsure of how to start, it’s a good idea to seek help from a legal professional.
• Seek legal counsel. If you believe that a fiduciary has committed a violation, it may be wise to hire an attorney to begin legal action. “An attorney who specializes in financial industry cases could be of assistance,” says Steeno.
• Switch financial advisors. Even if you don’t have solid proof, it can be a good idea to fire your current professional and switch to a new one if you feel that your advisor isn’t acting in your best interest. You should be able to have confidence in your professional’s ethics and capabilities.

Preventing Future Issues

One of the most effective ways to avoid working with a bad financial advisor is to take steps to vet a professional before hiring them. This includes verifying fiduciary status, asking the right questions, and staying vigilant about your finances.

“One of the biggest misconceptions is that if you’re working with a ‘financial advisor’ they must be a fiduciary,” warns Steeno. “Not all financial advisors are fiduciaries. To ensure you’re working with someone bound by fiduciary duty, they must be an investment advisor representative (IAR) of a registered investment advisor (RIA) and/or they are a certified financial planner (CFP).”

Before working with a professional, you can also ask them upfront questions about fees, services, and business practices. It’s also smart to directly question whether they’re a fiduciary at all. If they’re an honest professional, they should answer one way or the other.

As mentioned, you can also research firms and individuals independently before hiring them. Some of the easiest ways to do this are looking up experts on the SEC’s IAPD database or FINRA’s BrokerCheck, where you can find information on disciplinary actions, affiliations, and business practices. This is a good way to verify if an advisor was truthful when you met them or spoke over the phone.

A final way to locate reputable financial advisors is by using an online matching tool, such as this free one. After answering a few questions about your goals and situation, it will pair you with a vetted fiduciary financial advisor either in your area or online.