In the financial services industry, fiduciaries have a duty to do what is best for their clients. They have to make decisions based on sound reasoning and put their clients’ interests ahead of their own. Fiduciaries also have to disclose any conflicts of interest. For example, a lawyer must disclose his or her own financial interests to their client. This duty is especially important for estate planning documents, such as living revocable trusts.
Many financial professionals use fiduciaries in their work. However, even a diligent plan sponsor can make a mistake. If a plan’s administrator or adviser makes an investment decision based on an incorrect assumption, it may lead to a fiduciary error. It is not as harshly punished as fraudulent activity, however, and is often the result of an unintentional act.
Accounting Mistakes
The law offices of James. C. Shields provided this list of common accounting mistakes fiduciaries make.
- Lack of or Unclear Trust Rules
- Not Keeping the Client Updated and Informed
- Co-commingling Trust with Personal Funds
- Having Many Signatories
- Unreliable Leadership
- Reckless Bank Reconciliations and Transaction Records
- Unnecessary Overdrafts
- Lack of Standardization
- Inadequate Backups
- Listing Funds in the Account as Assets
How to Avoid Mistakes
Fiduciary errors are common. However, they can be avoided. These mistakes are most often due to a lack of awareness or a lack of knowledge about the obligations of a fiduciary. Luckily, there are steps plan sponsors can take to prevent the occurrence of fiduciary errors.
First, the plan administrator should make sure he or she understands what constitutes a fiduciary obligation. Among other things, they must act in the best interest of the plan participants. Secondly, the administrator must be able to assess the risks and controls of the plan. Third, the administrator should ensure that participant deferrals are remitted as soon as administratively feasible. Finally, the plan administrator should review the portfolio’s asset classes to keep risk/reward within targeted limits.
Another way to minimize the chance of making a fiduciary error is to use a plan that automatically rebalances the portfolio’s asset classes. However, not every plan is set up to do this. There are several benefits to rebalancing a portfolio, including value investing, a better long-term result, and reduced volatility.
Lastly, a plan’s investment committee should regularly review its investment decisions. Ideally, it should do so to determine whether the decision was made based on sound reasoning. Furthermore, it should be reviewed to make sure that the decision is consistent with other decisions that have been made by the plan’s administrators.
A recent case in the Southern District of New York emphasized the human element of fiduciary errors. Rather than looking at the return on an investment, the court focused on a person’s reliance on advice. Since the prior administrator’s instructions are not always clear, there is a possibility that the decision was not made based on sound judgment.
What is the penalty for a breach of fiduciary duty?
Frequent penalties for breach of fiduciary duty include suspension or removal as trustee or executor and the payment of money damages, attorney fees, and court costs.
- When it comes to money damages, fiduciaries who violate their duties may be ordered to pay compensatory damages, punitive damages, or double or treble damage. Compensatory damages are intended to make the injured beneficiary “whole” again after the breach. In other words, this type of damage reimburses the trust, estate or beneficiary for the money they lost as a direct consequence of the fiduciary’s breach of duty.
- Punitive damages serve to punish the fiduciary for their wrong actions by requiring them to pay an additional amount of money on top of the compensatory damages.
- Statutory remedies that double or triple the amount of compensatory damages the fiduciary must pay under certain laws is also possible.
In addition to damages, the fiduciary may be required to reimburse the beneficiary for the fees and costs incurred due to the legal action the breach forced them to take. This includes attorney fees, expert witness fees, filing fees, and court costs.
Can a fiduciary go to jail?
Technically, yes, for some breaches of fiduciary duty, such as theft, fraud, and embezzlement. However, more commonly, prosecutors do not have the resources to pursue criminal charges against fiduciaries who breach their duties and allow the civil courts to resolve these issues.
In California, breaching a fiduciary duty through theft or embezzlement is considered a misdemeanor crime when the value of the stolen assets is $950 or less and is punishable by up to 6 months in county jail. If a fiduciary takes property worth more than $950, they can face charges for felony embezzlement, which can lead to a sentence of up to 3 years in jail.
If you have questions about common fiduciary mistakes, give us a call before engaging an advisor.
Additional Resources
