Does succession planning impose fiduciary obligations for investment advisers? This recently has become a hot topic of conversation, due in large part to the high volume of mergers and acquisitions in the adviser space.
A good example of commentary on the subject appeared in Financial Planning on Aug. 14: “Is Your Succession Plan a Fiduciary Breach?” by Matthew Cooper. The article centers on the question of whether an adviser would violate a fiduciary duty of loyalty by deciding to sell his business to the highest bidder even though he believes his clients' interests would be better served by another acquirer.
The article makes the point that when advisers cash out of their business, they should treat formal evaluation of the impact on clients as an obligation. However, ethical principles and fiduciary duties are not the same. While the fiduciary standard certainly involves ethical principles, formal fiduciary status implies potential legal or regulatory culpability for fiduciary breaches.
Whether or not fiduciary accountability exists in a particular situation is a matter of facts and circumstances. A good way to test potential breaches informally is to follow a line of inquiry described by Supreme Court Justice Felix Frankfurter in the case of SEC v. Chenery Corp. The approach involves answering five questions that are paraphrased here:
1. Is the adviser a fiduciary under the law?
2. To whom is the adviser a fiduciary?
3. What obligations does the adviser owe the client?
4. What fiduciary obligations were not fulfilled?
5. What were the consequences of the fiduciary breach?
This process usually brings clarity to the nature of fiduciary obligations that may apply in a specific situation and the extent of exposure associated with a fiduciary breach.
The answers to the first two questions are clear in the scenario described by Mr. Cooper. The situation involves a registered investment adviser serving as a fiduciary to his clients.
The third and fourth questions can also be addressed in tandem. There are inherent duties of loyalty and care that exist in all fiduciary relationships, but there is also a matter of the scope of engagement. The adviser is accountable for fulfillment of fiduciary obligations to the extent he has assumed fiduciary responsibilities under the terms of the client-adviser relationship. I am not aware of any cases in which a court has found that the fiduciary obligations in a typical client-adviser relationship extend to business judgments made in the sale of an adviser's firm. The advisers involved in a transaction must give clients proper disclosures and secure informed consent to any material changes in the post-sale adviser-client relationship. Clients also have the option to exit the relationship. For there to be a fiduciary breach then, the adviser's actions in connection with a sale would have to be sufficiently egregious so as to deceive clients or create circumstances that produce client harm.
Similarly, the final question regarding consequences poses practical challenges for a finding of fiduciary culpability in a sale situation. To be actionable, there needs to be some remedy for a fiduciary breach, typically stated in terms of monetary damages. For example, in excessive fee cases, a fiduciary's gain can be tied directly to fees incurred by the client. In the case of an adviser selling his business, the tasks of identifying and quantifying possible client losses through some form of retrospective “what if” analysis would be daunting.
Even though it may be a stretch to assign technical fiduciary accountability to this scenario, applying fiduciary principles to the succession planning process still makes sense for ethical, regulatory and business reasons.
From the perspectives of clients, advisers and acquirers, business continuity is highly desirable. A firm that strives to achieve fiduciary excellence necessarily applies consistent, compliant and customer-centric policies and procedures and works to attract, develop and retain talented advisers. Moreover, fiduciary-focused organizations that are built with strong operational characteristics, a deep bench and a culture of integrity are positioned to gather, increase and protect client assets and build the assets under management by the advisory firm. Acquirers will not want to change that model and will reward the owner-adviser with a high multiple for the sustainable business he has created.
Blaine F. Aiken is president and chief executive of fi360 Inc.