How advisers can head off litigation

Investment advisers and money managers are the next targets of opportunity for lawyers, according to Donald B. Trone, the president of the Foundation for Fiduciary Studies and a director of the Center for Fiduciary Studies at the University of Pittsburgh’s Katz Graduate School of Business.

Given what has happened to equity investments over the past two years, that’s not surprising. Lawyers always look for aggrieved parties on one side and apparently deep pockets on the other side. Right now, there are lots of people who think they were burned in the stock market.

And money managers, financial planners, investment advisers and brokers, and the companies that insure them, seem to have deep pockets. Merrill Lynch & Co. Inc.’s $100 million settlement last week with New York state’s attorney general, Eliot L. Spitzer, will only confirm that impression.

Rapid growth

The fastest-growing section of the American Bar Association, Mr. Trone said, is fiduciary liability – people suing investment advisers and money managers. He spoke this month at the National Association of Professional Financial Advisors conference in Nashville, Tenn.

The revelations about the conflicts of interest among analysts on Wall Street no doubt have increased suspicions that any losses sustained in the market weren’t simply the result of the bursting of a bubble.

“It’s easy to prove the mismanagement of assets,” said Mr. Trone, who previously was a pension consultant with Callan Associates Inc. in San Francisco.

If you are a fiduciary, you could be a target. Perhaps you don’t think you are a fiduciary, because you don’t exercise investment discretion; you simply make recommendations.

Certainly, anyone who has the responsibility for managing someone else’s money is an investment fiduciary. If you have investment discretion, if you can buy and sell stocks for the client, or if you can move money into and out of particular mutual funds, you definitely are a fiduciary. However, Mr. Trone noted, the definition is wider than that.

A fiduciary, he said, is one who manages property for the benefit of another, exercises discretionary authority or control over assets and/or acts in a professional capacity of trust, and renders comprehensive and continuous investment advice.

Note the last six words: “renders comprehensive and continuous investment advice.” That’s what financial planners and investment advisers are paid for. Even accountants and lawyers, if they advise on investments, could fall under that definition. Therefore, if an unhappy client sues his broker, or the managers of the mutual funds in which he or she is invested, the investment adviser, financial planner, accountant, etc., involved also will be sued.

That’s the bad news. The good news is, there is a way to immunize yourself. That’s by applying seven standards of fiduciary care.

The seven standards are: knowing the appropriate laws and trust provisions; preparing an investment policy statement for each client; diversifying the assets to the specific risk/return profile of each client; using “prudent experts” and documenting due diligence; controlling and accounting for expenses; monitoring money managers and servicing vendors; and avoiding conflicts of interest and prohibited transactions.

Educational project

Mr. Trone said the Foundation for Fiduciary Studies developed the uniform standards of fiduciary care to promulgate practices that define a prudent investment process from end to end. It has been an educational initiative, not a regulatory one, he said.

The implementation of such fiduciary practices will encourage lawyers to look elsewhere for easier targets, he said. “The role of a fiduciary is to manage the investment process, not make investment decisions,” he added. “Advisers get into trouble when they make investment decisions rather than managing the process.”

Clearly, financial planners and investment advisers should look at their practices in light of the standards developed by the foundation. They should change any that fall short.

Should they feel the need for detailed guidance, they may attend courses in proper fiduciary practice at the Center for Fiduciary Studies.

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