Fiduciary Duty

Updated on May 15, 2024
Article byPrakhar Gajendrakar
Edited byAaron Crowe
Reviewed byDheeraj Vaidya, CFA, FRM

Fiduciary Duty Meaning

Fiduciary duty is a legal obligation between two parties. Fiduciaries have an obligation to uphold the best interest of their clients. This responsibility applies to every plan, decision, and execution. It is a crucial component of client-servicing relationships.

Fiduciary Duty

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The client here could be an individual, company, or entity. For example, a client could hire an investment banker and entrust them with authority to make decisions on their behalf. In this scenario, the investment banker is the fiduciary and is under obligation to invest the funds in the right way. These obligations are legally binding.

Key Takeaways

  • A fiduciary duty is a responsibility undertaken by fiduciaries (responsible personnel) to uphold the best interests of their clients.
  • Common examples of fiduciaries are trustees, attorneys, legal guardians, brokers, and agents.
  • Mistrust, frauds, scams, and betrayals are considered a breach of fiduciary duty. Since the obligations are legally binding, clients can take legal action against fiduciaries.
  • Also, a fiduciary cannot legally enter into a relationship , leadingto a conflict of interest with the client.

Fiduciary Duty Explained

The fiduciary duty is a legal obligation between two parties—a client and a fiduciary. Here, the fiduciary is responsible for servicing clients with their knowledge, experience, and expertise. In addition, the fiduciary owes a sense of loyalty to perform at the highest level and in the client’s best interest For example, lawyers have a fiduciary responsibility to act in the best interest of their clients. The same goes for a physician—it is their duty to act in the best interests of their patients.

The fiduciary is entrusted with good care of the client’s money, property, assets, and investments. The client or the entity to whom the fiduciary is entrusted to work is referred to as the beneficiary or principal.

Fiduciary duty in real estate involves taking stakes care of a client’s property. Also, the fiduciary is supposed to keep their eyes open for any lucrative deals or opportunities (if the principal is willing to rent or sell the property).  

In most such legal obligations, there is an exchange of financial resources. Therefore, disobedience, mistrust, fraud, and malice are considered a breach of fiduciary duty. At the same time, fiduciary roles do not involve financial commitments.

Also, a fiduciary cannot legally enter into a relationship, leading to a conflict of interest with the client. Thus, the term ‘fiduciary’ signifies trust and confidentiality.

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Example

Let us take an example of the fiduciary duty of board of directors and to shareholders:

Elon Musk offered to buy Twitter at a premium price of $43 billion. But the acquisition attempt failed—Twitter’s board of directors adopted a poison-pill strategy to reject the bid. A poison pill is a defensive technique where minority shareholders thwart a takeover by increasing the acquisition cost.

But Elon did not initiate a hostile takeover. Elon’s bid potentially served the company’s best interests. Many experts believed that Twitter was going against its fiduciary duties. Elon highlighted how the board’s actions breached their fiduciary duty towards Twitter. Elon threatened them with legal action entailing hefty penalties.

In February 2022, Goldman Sachs valued Twitter at $37.83 billion—nearly 30% lower than Musk’s initial bid.

A firm’s board of directors does not have enough authority to go against the institution’s best interests. If they do so, they risk legal action. Finally, Twitter’s board caved in. On April 14, 2022, Elon Musk bought Twitter for $44 billion.

Breach Of Fiduciary Duty

If a fiduciary party violates default obligations (that goes against the client’s best interests), it is considered a breach of fiduciary duty. In addition, since fiduciary duty binds both parties in a legal arrangement, clients can take legal actions (or civil suits) against the fiduciary manager or entity.

To take legal action, clients follow the following steps.

  • Before reporting a breach, the client has to check whether the fiduciary relationship existed at the time of the violation.  
  • Then, the client inspects the duties and responsibilities shared between the client and the fiduciary. Finally, whether terms were violated is ascertained.
  • Finally, the client determines the motive behind the misconduct. The severity of penalties depends on motives, whether the fiduciary acted out of self-interest or not. Legal actions are also undertaken when there is a conflict of interest.

The fiduciary breach process involves the following components—the particular fiduciary duty, the plaintiff (client), the defendant (fiduciary), and the damages incurred by the plaintiff. Here, the plaintiff must prove that the damage was directly caused by the fiduciary’s action (or inaction). This part is important; without that, injuries are not actionable.

Such lawsuits allow clients (plaintiffs) to recover compensation for incurred damages (caused by a breach of fiduciary responsibility). But, again, to avail of the compensation, the plaintiff must prove motive as well—that the misconduct was committed out of self-interest, fraud, or malice.

Frequently Asked Questions (FAQs)

1. What is an example of a fiduciary?

A fiduciary trustee is a legal representative appointed for a client’s money or asset. The client could be a person, company, or entity. The fiduciary duty binds the representative to take care of their funds, assets, and real estate property. For example, lawyers have a fiduciary responsibility to act in the best interest of their clients. The same goes for a physician—it is their duty to act in the best interests of their patients.

2. What is a fiduciary duty in the UK?

It refers to a relationship built on confidence. A fiduciary takes responsibility for acting on behalf of a client. Here the fiduciary is liable to perform duties in the client’s best interests. For example, if an owner appoints a property broker to work on their behalf, the property broker is referred to as a fiduciary.

3. What are the five fiduciary duties?

The five duties are as follows:
1. Confidentiality
2. Loyalty
3. Obedience
4. Accounting
5. Care

4. What is a breach of fiduciary duty?

When a fiduciary does not act in their client’s best interests, they violate statutory fiduciary responsibilities. For example, fiduciaries cannot use office supplies, the firm’s assets, or sensitive information for personal gain; doing so would breach fiduciary responsibility.

This article is a guide to Fiduciary Duty & its meaning. We explain its breach, the duty of the trustee, board of directors, & shareholders, & an example. You can learn more about corporate finance from the following articles –

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