Breach of Fiduciary Duty
Advisors have a fiduciary duty to conduct reasonable due diligence for any investment that the advisor buys, sells, or holds in a client's portfolio. Due diligence is paramount in helping advisors find the appropriate investment opportunity by carefully examining all aspects of an investment before recommending it to a client. An effective due diligence process is not centered around performance; instead, it requires a comprehensive and holistic approach and must (at a minimum) entail consideration of the following: human capital, driving principles, process, conflicts of interest, competitive landscape, and performance. Certain products or opportunities may present additional complexities and require a heavier hand and a more detailed investigation, review, or audit of the investment opportunity.
Additionally, as a fiduciary, advisors must manage clients' portfolios in accordance with their investment strategy/mandate and, as necessary, provide an explanation for material deviations from the agreed-upon directive. So not only does an Advisor need to understand the products it is recommending, but it also needs to understand what products will be most suitable for a specific client.
Recently the SEC announced that it charged an advisory firm and its part-owner and investment advisor representative (IAR) for breach of fiduciary duty in connection with the use of leveraged exchange traded funds (ETFs). The Advisor and IAR invested client assets in leveraged ETFs for extended periods of time, significant concentrations, despite warnings in the funds’ prospectuses that the products carried unique risks, were designed to be held for no more than a single trading day, and required frequent monitoring. Because the Advisor and IAR did not understand the product itself, they did not meet their fiduciary duty in conducting reasonable due diligence on the investment opportunity. According to the SEC’s announcement, the Advisor and IAR additionally did not conduct ongoing due diligence and portfolio monitoring to ensure these products continued to meet the clients’ best interests. The full SEC announcement can be read here.
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