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5 Examples of Self-Dealing Transactions that are Prohibited as a Result of Fiduciary Duty

5 Examples of Self-Dealing Transactions that are Prohibited as a Result of Fiduciary Duty
July 31
00:03 2018

They can take away the DOL’s Fiduciary Rule, but they can’t remove the after effects. Remember, the official name wasn’t “The Fiduciary Rule.” When the DOL unveiled the final version, it was rechristened “The Conflict-of-Interest Rule.” The focus wasn’t on some legal definition of “Fiduciary” (although such a legal definition was imbedded within the final rule). Instead, the emphasis was on the dangers inherent in advice containing conflicts-of-interest.

The operational definition of “Fiduciary” has long been built around the avoidance of conflicts-of-interest. Primary among these include the infamous self-dealing transaction. Addressing the negative consequences (to the beneficiary) of self-dealing stand as one of the key elements of the Magna Carta.

With all this history behind it, you might think we’d want to avoid conflicts-of-interest like the plague. While it’s true we no longer sell beneficiaries off into bondage (that’s what the Magna Carta address), it remains common practice to reap a personal benefit through a transaction. In fact, if salesmen didn’t get some form of personal compensation, our entire capitalist economy would collapse.

Notice the language of that last sentence. No conflict-of-interest exists when a salesman sells his wares. It’s understood the buyer has the responsibility to beware (hence, the phrase caveat emptor). In fact, if the buyer fails to fairly compensate the seller, we don’t call the buyer a “buyer,” we call that person a thief.

A fiduciary relationship, however, is not a buyer-seller relationship. It is like a trustee-beneficiary relationship. In this case, the trustee (the “agent,” a.k.a., the “fiduciary”), has been given some legal authority over the assets of the beneficiary (the “principal,” also called the “client”). Within the realm of that authority, while the fiduciary should be fairly compensated, the fiduciary is prohibited from engaging in activities that might increase that compensation to the detriment of the interests of the beneficiary. Such activities represent the definition of a self-dealing transactions.

Here are some examples of self-dealing transactions that, if executed, will likely result in a fiduciary breach.

Worst Case: Theft
Let’s face it, you can get much worse than outright robbery. That’s the ultimate self-dealing transaction. Marc Fitapelli, a partner at Fitapelli Kurta in New York City, says, “The agent always has to act in the best interests of the principal. The most obvious example of self-dealing arises when an agent steals from a principal.”

There’s outright robbery, then there’s a subtler form which sometimes appears legitimate. It usually occurs in the form of an elaborate shell game when assets are moved from one holding account to another. “If the attorney in fact were to transfer real property into their personal name, instead of transferring the property as directed by the principal, this would certainly be a self-dealing transaction that would be prohibited,” says Gerard F. Miles, Jr. a partner at Huesman, Jones and Miles, LLC in Hunt Valley, Maryland.

You don’t need to actually take the assets for yourself to steal them. “The typical example will involve some attempt by the agent (the grantee of the power of attorney) to transfer the principal’s (the grantor of the power of attorney) assets to himself or herself,” says Adam D. Citron, Senior Counsel at Davidoff Hutcher & Citron LLP in New York City. “This can be accomplished either directly (such as a real estate agent who simply keeps the proceeds of a client’s property sale) or indirect (such as a stock broker who uses a client’s money to build a market for stocks the broker already owns). Another example could be releasing monies from a brokerage account to a third party.”

Lesser Form of Stealing – Selling/Gifting to One’s Self
Another form of “stealing” (face it, all self-dealing transactions are a form of stealing), involves seemingly allowed activities that aren’t quite done in a way that dots all the i’s and crosses all the t’s. Fitapelli says these can include “less obvious examples include transactions between the agent and principal that are not for fair market value.” This can occur because the agent is both the buyer (on his own behalf) and the seller (on behalf of the principal) of the same property.

It’s not just selling, it’s gifting, too. “Generally, an agent may not act on behalf of the principal in a transaction in which the agent is an interested party,” says Jill Scherff, a partner at Dinsmore & Shohl LLP in Cincinnati, Ohio. “For example, absent language to the contrary in a power of attorney, if a child is the agent for the parent and the agent is authorized to sell the principal’s property, the agent should not purchase the property using the power of attorney. If the child is the agent and the power of attorney authorizes the agent to make gifts of the principal’s property, the child should not make gifts to him or herself unless it is specifically authorized in the document.”

Excessive/Improper Agent Payments
Here’s the thing that can confuse. There’s no prohibition against a fiduciary getting fair payment for services rendered. In fact, an argument can be made that a fiduciary breach may occur if the fiduciary doesn’t get paid a fair amount. Problems occur not in the act of payment, but when those payments are excessive or improperly procured.

Oleg Cross an attorney at Cross Law APC in San Diego, California, provides two very common examples: “A daughter who has a limited POA over her mother’s finances and instead of using it to pay her mother’s bills pays herself. A broker that has a limited POA for trading purposes engages in churning (which generates commissions for the broker but costs more money to the principal).” In the former case, the daughter is certainly entitled to some compensation, it’s just problematic when she writes checks to herself. In the latter case, there’s nothing wrong with trading so long as it’s in the client’s best interests. Churning – or excessive trading – happens when that trading isn’t in the best interest of the client.

When Sales Reps Cross the Line and Become Advisers
As in the previous case, there’s absolutely nothing wrong with sales reps receiving compensation in exchange for acting as intermediary for transactions. Indeed, we need commissioned brokers to help maintain liquidity in our securities markets. Once these agents cross the line and begin offering advice, those same commissions create a conflict-of-interest.

“In the case of brokers, self-dealing can be in the form of direct or indirect compensation,” says Chris Cooper a California Licensed Professional Fiduciary located in San Diego, California. “Direct compensation would be some form of payment for directing the principal’s money or assets into certain investment products, such as upfront commissions or trailing commissions. Indirect compensation takes the form of receiving a benefit for using a particular broker/dealer, such as specialized websites, software, conferences, and others.”

The State Trap: There’s Always a Loophole
It’s great when we have a single uniform federal rule. This is what we currently have within the retirement plan industry through ERISA. Individual trusts, on the other hand, come under the regulatory umbrella of individual states. This rainbow of rules create circumstances where what’s legal in one state is illegal in another.

“Unlike other fiduciary contexts like the Trustee/Beneficiary relationship, the prohibition against self-dealing in the Limited Power of Attorney realm is less severe,” says Harry W. Drozdowski, Attorney at Anglin Flewelling Rasmussen Campbell & Trytten LLP in Pasadena, California. “In California, for example, the prohibition against self-dealing falls within Probate Code Section 4232, which requires a Principal to act solely in the interest of the Principal and to avoid conflicts of interest. But that same section is careful to clarify that so long as an act or actions were in the best interests of the Principal, any personal benefit received by the Principal is acceptable. In other words, if an Agent receives a financial, personal, or other benefit as a result of acting on behalf of a Principal, there is no breach of duty so long as that action is in the best interest of the Principal. A non-breaching action might be a sale of the Agent’s personal vehicle to the Principal via the authority of a Limited Power of Attorney so long as the Agent needed a vehicle and the sale was for fair market value. But a breaching action would probably occur if the Agent didn’t have a driver’s license or didn’t need or want a car, or if the sale was so far outside of fair market value as to be against the best interests of the Principal.”

The nature of compensation alone does not determine whether a conflict-of-interest exists. This determination must be made within the context of the association between the two parties. Once that association transforms into one of advice, a fiduciary relationship exists. When a fiduciary relationship exists, the rules of engagement change, and self-dealing, even it allowed in certain regulatory environments, can create liabilities that fiduciaries might be wise to avoid.

Christopher Carosa is a keynote speaker, journalist, and the author of  401(k) Fiduciary SolutionsHey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions, practical business tips, and the history of the wonderful Western New York region. Follow him on Twitter, Facebook, and LinkedIn.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


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