Two Duties, One Fiduciary Standard

An investment adviser’s duty of care requires it to give advice in the client’s best interest, seek best execution of client trades and monitor the account at a frequency that matches the relationship. The duty of loyalty requires it to put the client’s interests first, make full and fair disclosure of all material facts and eliminate or disclose conflicts of interest so the client can give informed consent.

Together, the two duties make up the fiduciary duty advisers owe under the Investment Advisers Act of 1940. The SEC set out what each duty requires in a 2019 interpretation, which remains the main reference for how the duties apply in practice.

These duties shape everyday decisions, from choosing a fund to placing a trade, and the Series 65 tests them closely. For the full route from the exam to a career as an adviser, our complete guide to how to become an investment adviser representative covers every step.

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The Duty of Care in Three Parts

The duty of care has three components. The first is the duty to provide advice in the client’s best interest, which requires the adviser to have a reasonable understanding of the client’s objectives through a reasonable inquiry into their financial situation, investment experience and goals.

The second is the duty to seek best execution when the adviser is responsible for selecting the broker that executes client trades. The third is the duty to provide advice and monitoring at a frequency consistent with the agreed scope of the relationship.

Each part can be breached on its own. An adviser who picks good investments but routes trades to a costly broker without good reason, or who agrees to monitor an account and then ignores it, falls short of the duty of care.

The Duty of Loyalty in Practice

The duty of loyalty means the adviser must not place its own interests ahead of the client’s. In practice, it requires full and fair disclosure of all material facts relating to the advisory relationship, including the adviser’s capacity, fees and conflicts of interest.

Where a conflict exists, the adviser must either eliminate it or disclose it clearly enough that the client can understand it and give informed consent. Some conflicts are serious enough that disclosure is not enough and they must be removed.

Loyalty also means treating clients fairly against each other and against the adviser itself. Allocating investment opportunities, splitting trades and handling personal trading by staff all fall under this duty. The Series 65 Exam Preparation course at FRC covers each of these obligations as part of the laws and ethics section.

Care and Loyalty Compared

Understanding the Client

The duty of care starts with knowing the client. The adviser must make a reasonable inquiry into the client’s financial situation, level of financial sophistication, investment experience, objectives and risk tolerance, building what the SEC calls the client’s investment profile.

The profile must be kept current. Advisers update it at intervals that make sense for the relationship and whenever they learn of a significant change, such as retirement, a job loss or an inheritance.

For institutional clients, the inquiry focuses on the mandate the client has given, such as an investment policy or benchmark. Our guide to what does fiduciary mean explains how this inquiry fits into the wider fiduciary standard.

Worked Example: Weighing Cost Within the Duty of Care

An adviser is choosing between two broadly similar bond funds for a client’s $400,000 allocation. One charges 1.2 percent a year and the other 0.05 percent.

Step one: the first fund costs 1.2 percent of $400,000, or $4,800 a year. Step two: the second costs 0.05 percent, or $200 a year. Step three: the difference is $4,600 a year, so the adviser needs a clear reason, such as a genuinely different strategy or risk profile, to choose the more expensive fund.

The SEC has said cost is an important factor but not the only one, and an adviser is not required to always choose the cheapest option. What matters is that the choice is in the client’s best interest and the reasoning can be shown.

Study Fiduciary Duties With FRC

Questions on these duties usually test what each duty requires, how principal trades must be handled, what trade allocation rules apply and how personal trading is controlled. Our Series 65 course works through each with exam-style scenarios.

Consider studying with FRC for every exam on your route. Explore our USA exam courses, from the SIE through the Series 7, Series 63 and Series 65.

To take advantage of the membership, explore FRC Professional Membership, which gives you a verified Digital Profile that shows employers your real-time course progress, together with the Video Resume. Current offers are on our membership deals page.

Best Execution and Soft Dollars

Best execution means seeking the most favorable terms reasonably available for a client’s trade, considering the full range of a broker’s services, not just the lowest commission. Price, speed, reliability, the ability to handle difficult trades and the quality of research can all be part of the assessment.

Some advisers receive research or other services from brokers in return for directing client trades to them, an arrangement known as soft dollars. Section 28(e) of the Securities Exchange Act of 1934 provides a safe harbor for research and brokerage services that genuinely help the adviser manage client accounts, provided the commissions paid are reasonable in relation to the value received.

Soft dollar arrangements are a loyalty issue as well as a care issue. Advisers must disclose them, because clients may pay higher commissions for services that benefit the adviser, and the benefit must flow back to client accounts rather than to the adviser’s general business.

Monitoring at the Right Frequency

The duty to monitor depends on what the adviser agreed to provide. An adviser managing a discretionary portfolio for an ongoing fee must monitor it continuously, rebalance when appropriate and respond to market and client changes.

Worked example: step one, one client pays an annual fee for ongoing discretionary management, while another pays a one-time fee for a financial plan. Step two, the first adviser must keep reviewing the portfolio throughout the year. Step three, the planner’s monitoring duty generally ends when the plan is delivered, unless the agreement says otherwise.

The key is matching the monitoring to the fee and the service, and writing that scope clearly into the advisory agreement. Charging an ongoing fee for an account that is never reviewed is a classic breach of the duty of care that regulators look for.

What Informed Consent Means

The duty of loyalty often turns on informed consent. A client can consent to a conflict only if the adviser’s disclosure is specific enough for the client to understand the conflict and how it could affect the advice.

Consent can be explicit, such as a signed acknowledgment, or implied, when a client continues the relationship after receiving clear disclosure. For retail clients, regulators expect disclosure to be plain and specific rather than buried in general language.

Phrases such as “may have conflicts” are generally not enough when the adviser actually has a conflict. The disclosure should say what the conflict is, how it arises and how the adviser manages it.

Account Type and Rollover Recommendations

The duty of care also covers recommendations about what kind of account a client should use. Recommending that a client roll a workplace retirement plan into an individual retirement account managed by the adviser is advice that must be in the client’s best interest.

The adviser should compare the costs, investment options, services and protections of staying in the plan with those of the new account. A rollover that increases the client’s costs mainly to bring assets under the adviser’s management raises both care and loyalty concerns. This is one of the clearest places where the adviser’s duty goes beyond the broker’s, as our comparison of fiduciary standard vs suitability standard explains.

Our comparison of IRA rollover vs IRA transfer explains how these moves work and the rules that apply to each.

Fair Trade Allocation

When an adviser buys the same security for several clients, it often combines the orders into a single block trade. The duty of loyalty requires the adviser to allocate the shares and the price fairly, typically by giving every participating client the same average price.

Worked example: an adviser buys 10,000 shares for three clients at an average price of $45.20, for a total cost of $452,000. Step one: Client A receives 5,000 shares, Client B 3,000 and Client C 2,000. Step two: each client pays the same $45.20 per share, so Client A’s cost is $226,000, and the others pay proportionally.

The practice known as cherry-picking, where an adviser waits to see how a trade performs and then allocates the profitable shares to favored accounts or its own account, is a serious breach of loyalty. Advisers prevent it by deciding allocations before trades are placed and recording them, so every client can see they were treated alike.

Principal and Agency Cross Transactions

A principal transaction occurs when an adviser, acting for its own account, buys a security from or sells a security to a client. Because the adviser is on the other side of the trade, the conflict is obvious, so the Advisers Act requires special handling.

Under Section 206(3) of the Act, the adviser must disclose in writing that it is acting as principal and obtain the client’s consent before the transaction is completed, on a trade-by-trade basis. A general consent given in the advisory contract is not enough for principal trades.

Agency cross transactions, where the adviser or an affiliate acts as broker for both the advisory client and another party, carry similar conflicts. Advisers must disclose their capacity and follow the requirements that apply before completing these trades.

Personal Trading and Codes of Ethics

SEC-registered advisers must adopt a code of ethics under Rule 204A-1 that sets standards of conduct and addresses personal trading by employees with access to client information, known as access persons. The code helps prevent staff from trading ahead of clients or using client information for their own benefit.

Access persons must submit a holdings report within 10 days of becoming an access person and annually after that, and quarterly transaction reports within 30 days after the end of each quarter. They must also get pre-approval before buying securities in an initial public offering or a private placement.

These requirements put loyalty into daily practice. A firm that lets staff trade freely ahead of large client orders would be using client information for personal gain, which the duty of loyalty prohibits.

The Memory Aid

Remember “care is about the advice, loyalty is about the interests”: care asks whether the advice is right, loyalty asks whose interests come first.

For the three parts of care, remember “best interest, best execution, monitoring”.

For principal trades, remember “in writing, before completion, every time”: disclosure and consent must come before each principal transaction is completed.

Exam Traps to Avoid

The first trap is assuming disclosure can cure a breach of the duty of care. Poor or unsuitable advice is not made acceptable by disclosing it.

The second trap is believing an advisory contract can give blanket consent to principal trades. Section 206(3) requires written disclosure and consent before completing each principal transaction.

The third trap is thinking the duty of care requires the cheapest investment. Cost is important but not the only factor. The fourth trap is mixing up the code of ethics timelines: holdings reports within 10 days and annually, transaction reports within 30 days after each quarter.

A Client Scenario

An adviser’s firm holds a municipal bond in its own inventory that fits a client’s tax-exempt income goal. The adviser wants to sell it to the client directly rather than buy a similar bond in the market.

The adviser recognizes this would be a principal transaction. She gives the client written disclosure that the firm is selling from its own account, explains the price and how it compares with similar bonds, and obtains the client’s consent before completing the trade.

She also documents why the bond suits the client and records the disclosure and consent. Both duties are met: the advice fits the client, and the conflict is handled openly.

The Dictionary as a Video Library

The FRC dictionary is a study tool, not just a glossary. Every entry pairs a written explanation with deep-dive video, on-page quizzes and interactive flash cards, so you can read a concept, watch it explained and test yourself in one place.

Rules are covered in the same depth: open a rule and you will find the full explanation alongside video walk-throughs of how it applies in practice. Open the Investment Advisers Act of 1940 entry to see the source of these duties explained on video and test yourself with the quizzes.

Practice Questions to Test Yourself

Question one: What are the three parts of an adviser’s duty of care? Advice in the client’s best interest, seeking best execution, and monitoring at a frequency consistent with the relationship.

Question two: What must an adviser do before completing a principal transaction with a client? Disclose in writing that it is acting as principal and obtain the client’s consent, for each transaction.

Question three: An adviser buys 10,000 shares at an average price of $45.20 and allocates 2,000 to one client. What is that client’s cost? $90,400.

Question four: Within how many days after the end of a quarter must access persons file transaction reports? 30 days.

Question five: Does the duty of care require an adviser to always choose the lowest-cost investment? No; cost is an important factor, but not the only one.

Turn Ethics Knowledge Into Career Evidence

Firms want advisers who can apply fiduciary principles to real decisions, from trade allocation to rollover advice. FRC’s Digital Profile shows employers the courses you are actively studying and the progress you have earned through assessed learning, verified by FRC, and a QR code on your resume takes them straight to it.

The FRC Video Resume lets a hiring manager hear you before the interview. Explaining how you would handle a principal trade shows the compliance awareness advisory firms look for.

Related Questions

The firm and its representatives share these duties, as our comparison of investment advisor representative vs registered investment adviser explains.

Key Points to Retain

The duty of care requires advice in the client’s best interest based on a reasonable understanding of the client, best execution when the adviser selects brokers and monitoring consistent with the relationship. The duty of loyalty requires full and fair disclosure, the elimination or disclosure of conflicts for informed consent and fair treatment of every client.

In practice, loyalty covers fair trade allocation, written disclosure and consent before each principal transaction and codes of ethics that control personal trading. Disclosure can address many conflicts, but it never cures poor advice.

For the role the exam leads to, read our guide to what an investment advisor representative is.