Ethical and Fiduciary Duties Flashcards

A CRPC® is meeting with a new retirement planning client. The advisor recommends a specific managed mutual fund that aligns with the client's risk tolerance. However, a nearly identical, lower-cost index fund (ETF) exists that would also meet the client's objectives. The managed fund pays the advisor's firm a 12b-1 fee, while the ETF does not. Under the fiduciary duty of loyalty, what is the primary ethical issue in this situation?

Answer: A conflict of interest exists where the advisor's compensation may have improperly influenced the investment recommendation.

The duty of loyalty requires an advisor to place the client's interests above their own. Recommending a higher-cost product that provides the advisor with extra compensation (the 12b-1 fee) when a comparable, cheaper alternative exists represents a material conflict of interest. A fiduciary must act to avoid or, at a minimum, disclose such conflicts and ensure the recommendation is still in the client's best interest, which is difficult to justify when a less expensive and equally suitable option is available.

Which of the following is a core component of the fiduciary 'duty of prudence'?

Answer: Acting with the care, skill, and diligence that a knowledgeable professional would use in similar circumstances.

The duty of prudence specifically requires an advisor to act with a high level of competence. This means applying the care, skill, prudence, and diligence expected of a professional in that field. Disclosing conflicts and placing the client's interest first are components of the duty of loyalty. Following client instructions is a separate duty.

A CRPC®, who is also a registered representative of a broker-dealer, recommends a client purchase a variable annuity. Under the SEC's Regulation Best Interest (Reg BI), which of the following actions is required to satisfy the 'Care Obligation'?

Answer: Having a reasonable basis to believe the annuity is in the client's best interest and considering reasonably available alternatives.

Regulation Best Interest (Reg BI) requires broker-dealers to adhere to four component obligations: Disclosure, Care, Conflict of Interest, and Compliance. The Care Obligation specifically requires the representative to exercise reasonable diligence, care, and skill to understand the risks, rewards, and costs of the recommendation. They must have a reasonable basis to believe the recommendation is in the customer's best interest and that it doesn't place the broker's interest ahead of the customer's. A key part of this is considering reasonably available alternatives.

A client is considering rolling over their 401(k) from a previous employer into an IRA managed by their CRPC®. This transaction would move the client from a low-cost plan protected by ERISA to an IRA where the advisor will earn an asset-based fee. Under current Department of Labor (DOL) guidance, what is the advisor's MOST critical responsibility?

Answer: To document the specific reasons why the rollover is in the client's best interest, considering factors like costs, services, and investment options.

The Department of Labor (DOL) considers a recommendation to roll over assets from an ERISA-governed plan (like a 401(k)) to be fiduciary advice. The advisor must perform a diligent analysis and document why the move is in the client's best interest. This involves a careful comparison of the fees, services, investment options, and fiduciary protections in the 401(k) versus the proposed IRA. Simply having more investment choices is not sufficient justification on its own.

A client gives their CRPC® a direct and lawful instruction to sell a specific stock from their advisory account, even though the advisor believes it is a poor long-term decision. The advisor has clearly communicated their opposing view and the potential negative consequences. Under the advisor's fiduciary duties, what is the most appropriate next step?

Answer: Execute the client's instruction as requested.

A core fiduciary duty is the duty to follow a client's lawful and reasonable instructions. While the advisor must act in the client's best interest, this does not give them the right to override a client's direct order regarding their own assets, provided the advisor has fulfilled their duty to inform the client of the risks. Refusing the order would violate this duty.

All of the following are potential breaches of an advisor's fiduciary duty EXCEPT:

Answer: Conducting a quarterly portfolio rebalance to bring asset allocations back in line with the client's documented investment policy statement.

Conducting a systematic rebalance according to a pre-established and agreed-upon investment policy is a standard and essential part of prudent portfolio management; it is an action that fulfills a fiduciary duty. The other options are breaches: failing to disclose a conflict of interest violates the duty of loyalty, unfairly allocating trades violates the duty to act in good faith, and reverse churning is a form of overcharging that violates the duty to ensure fees are reasonable.