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The Whole Truth: What the Fiduciary Duty of Good Faith Means to Investors

September 18
00:26 2012

As part of Fiduciary September, we’re proud to present the second of a six part series exploring the six duties of all fiduciaries and what they mean for investors. “Essential to fiduciary conduct,” these core duties are defined by the Institute for the Fiduciary Standard and have been provided to by its President, Knut Rostad.

The typhoon spawned giant mid-ocean waves that dwarfed the small vessel. As the seas raged around him, the defiant Captain vowed to maintain the course. His junior officers, by now firmly convinced their commander has lost his mental capacity, openly disagreed. The intensity of the storm paled in comparison to the drama on the tossing ship’s bridge. As the tension reached its climax, the executive officer relieved the Captain under Article 184 of Navy Regulations. When they returned to port, the Navy court-martialed the junior officers.

We’re all familiar with the scene where the judge calls the witness to the stand. The usually rattled testifier tentatively makes his way to the dock, leaving the audience on the edge of their seats: will he or won’t he crack under cross-examination.

But, before this drama can even begin, viewers must endure the usual “Oath” scene. You know the one. It’s where the bailiff asks the witness to place his hand on the Bible and swear to “tell the truth, the whole truth and nothing but the truth.” Then the fireworks of interrogation begin.

Let’s rewind the clip a bit and go back to that oath. What does it mean to “tell the truth, the whole truth and nothing but the truth”? Well, for one thing, it represents not only the solemn promise of every testifier, but also the “Duty of Good Faith” under which every fiduciary operates. What does this all mean to the jury? What does this all mean to the investor? And how does a fiduciary’s actions under this duty compare to that of a non-fiduciary? We’ll examine these answers for each of the three parts of the oath.

Tell the Truth: This one’s straight forward. It means “don’t lie.” Now, you would think that would be enough, but as a former president has shown us, we’re often not sure what “is” a lie. In the case of said president, his “truthful” answer all depended on what the prosecutor meant by the word “is.” This former president got into trouble for his “answer,” but the degree of trouble depended on whether you believed he was acting in a fiduciary capacity (i.e., the issue was relevant to his oath of office) or a non-fiduciary capacity (i.e., the issue was not relevant to his oath of office). A non-fiduciary has the opportunity to parse. A fiduciary doesn’t, which leads us into our next part of the oath.

The Whole Truth: It’s not enough just to tell the truth, you must also not leave out anything important. In a court case, it means answering the full intent of the question. You cannot limit yourself to just one (usually favorable) interpretation of the question. For example, let’s say the judge asks you if you knew how fast you were going when the officer pulled you over. The truth may be you failed to read your speedometer the moment the police officer clocked you on his radar. The whole truth, however, might be you knew you didn’t slow down after earlier noting your excessive speed. Operating under the lesser standard of “suitability,” a non-fiduciary is not required to tell the whole truth. A fiduciary, under the “fiduciary standard,” must. Here’s how this works in real life: A non-fiduciary may suggest you buy a “hot” commodity stock because of its “upside potential” and the fact others your same age have purchased it. This is perfectly legal. For a fiduciary, on the other hand, buying that same stock, given its downside potential and its highly speculative nature, may not be in your best interest (see our previous installment). Indeed, those your “same age” who purchased it also had a net worth ten times more than you. Therefore, the fiduciary, who is obligated to tell you the whole truth, may reveal this information, causing you to make a decision to avoid the stock.

Nothing But the Truth: We know lying is wrong, but so is bringing up misleading data. In the case of our traffic court, you might tell the judge “the cars around me were darting all over the place and I had to pay more attention to avoiding an accident than to my speed.” Well, though that could be a truthful statement, it could also be a misleading statement, especially of the actions of the other drivers were only in response to your own erratic driving. For an investor, it means the difference between a fiduciary adviser who avoids the hoi polloi argument that says “this investment is what everyone else is doing” and the non-fiduciary who regularly uses that very same statement as a basis for getting you to buy a particular investment product.

But, and here’s where “the whole truth” comes into play. It’s not just a fiduciary’s responsibility to tell the whole truth when investment decisions are made, but it’s also his duty to tell the whole truth at all points in the relationship. Nowhere is this more evident than in the discussion of investment performance. While mutual funds are required to report investment performance in a standardized calendar year manner, the same is not true of investment advisers. They may choose any arbitrary reporting period and, as those inside the industry are well aware, there’s always a reporting period available to cover up even the worst performance. A non-fiduciary can search for that misleading reporting period. A fiduciary cannot.

In the movie The Caine Mutiny, whose plot summary opens this piece, the Navy court-martialed the two junior officers because their “log” of the Captain’s mental illness could have also been interpreted merely as the Captain being a strict disciplinarian, something he was well known for. When all seemed lost for the defendants, the defense attorney brought Humphrey Bogart’s Captain Queeg to the stand. There, despite the lawyer’s own beliefs, he placed the best interest of the Navy – and his clients – first and, by bringing up an event involving missing strawberries, managed to get the befuddled Captain to display those same signs of psychological incapacity he exhibited on the ship.

Ironically, at the end of the movie, the now drunken attorney interrupts the celebrating junior officers to relieve his “guilty conscience.” He reprimanded them for their actions aboard the Caine. Queeg, he said, managed a successful career despite being in a constant state of danger and peril. Had they supported him, Queeg might not have broken down. Now, Queeg’s reputation is shattered, all thanks to their dereliction of duty. One might say, their dereliction of their Fiduciary Duty to their captain, their ship and the Navy.

In the end, as an investor, you must decide this: Do you want to do business with someone who is prepared to use a technicality to get himself out of hot water or do you want to do business with someone who is prepared to dive into hot water to get you out of it?

Or, as Little Feat might have said, a good fiduciary would never bogart that, er, anything.

Previous: How Walt Disney Showed Us What the Fiduciary Duty of Loyalty Means to Investors  |
Next: Why Nobody Likes Stinky Pete: What Conflict-of-Interest Means to Investors  |

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s new book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA


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