a) Explain how the concept of fiduciary duty, as reflected in relevant regulation, affects
the roles of asset managers and company directors in the investment chain (1500
words)
b) Briefly explain the types of harm caused by breaches of fiduciary duty in the above
mentioned context (1000 words).
2457 words
Typically, people do not associate the financial system, both in the UK and globally, as ethical,
due to the number of high-profile cases in which finance professionals have acted in ways that
seem dishonourable and sometimes criminal. However, there is a place for ethics within
finance, as acting ‘ethically’ gives the public confidence in financial industries, which is crucial
to its sustainability. Ethics may be defined, in a financial context, as acting with transparency
and integrity, providing honest information and promoting this behaviour with others in the
field. Fiduciary duty asks for all of this. Fiduciary duty can be defined as “the duty of an
individual or an organization in a position of trust to act in the interest of another party with
the skill and competence of a reasonable, prudent person.” (Boatright, 2015, Abstract). This
essay will explain the idea of fiduciary duty and how it affects the responsibilities, including
the consequences of not abiding by these, asset managers and company directors have in the
investment chain, taking reference from regulations such as CFA Standard III (A) and (C), and
The UK Stewardship Code FRC (2020).
To explain the concept of fiduciary duty and how it affects the roles of asset managers and
company directors in the investment chain we must first look into their job descriptions and
relationships without the additional fiduciary obligations. The role of an asset manager is to
supervise the assets owned (for example property and funds) by a company or beneficiary and
produce documents and accounts of how these assets have been maintained, looked after and,
hopefully, improved (Davis, 2016). Whereas the role of a company director is based around
making strategic decisions about the future direction of the company ensuring it meets its key
objectives, adjusting them if necessary, in line with its visions and values (Keay, 2007). The
relationship between asset management and company directors is important, not only as a
standard employee to employer relationship but there has to be an extra level of trust and mutual
understanding between the two. As the leader of the organisation is accountable a for the
performance of all employees and should actively manage that performance to ensure the
success of the company. This is only possible if managers are honest in the way they report
what they are doing to their directors. This relationship is crucial for the progress and success
of the company as a whole, if this relationship is not healthy or is fuelled with dishonesty it can
negatively impact the potential of a company. Fiduciary duty allows for a universal
understanding and obligation of how one party should act with regards to the other, along with
reinforcing this professional relationship fiduciary duty encourages asset managers and
company directors to make better decisions as they must now consider how it will affect and
fulfil the stakeholders’ and beneficiaries’ goals. The Companies Act of 2006 lays down the
fiduciary duties of company directors including the “Duty to exercise independent
judgement… Duty to exercise reasonable care, skill and diligence… [𝑎𝑛𝑑] Duty to avoid
conflicts of interest” (Companies Act, 2006, Chapter 2, provisions 172-174). Although there
are fiduciary duties due to a company director from an asset manager, mainly concerning the
delivery of frank and up to date reports of their progress, an asset manager has more duties
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, towards a beneficiary as it is their relationship that creates a link of interaction and
communication from company to beneficiary in the investment chain.
The fiduciary relationship between asset holders also referred to as beneficiaries and asset
managers can be created through a contract or law. This relationship is characterised by
candour, care and loyalty (Mohite, 2021, Lecture 5). These characteristics ensure that asset or
fund managers are transparent with the information they give their clients making sure the
reports that filter down in the investment chain are realistic, and that the clients are not being
misled or misinformed. These criteria also make sure asset managers act in ways that are in
their client’s best interests, loyalty takes this one step further and implies that the manager
should put the beneficiary’s needs above all else, including their own. These features are clearly
specified in regulations, most notably; CFA Standard III (A) Loyalty, Prudence, and Care
where it states “Members and Candidates had a duty of loyalty to their clients and must act
with reasonable care and exercise prudent judgement… for the benefit of their client and place
their clients’ interests before their employer’s or their own.” (CFA Code of Ethics and
Standards of Professional Conduct p.85) It should be noted that this single piece of regulation
does not override other legal and regulatory obligations, asset managers (and company
directors) must not go outside of the law to produce the best results for the beneficiaries who
hire them, for example insider trading could create gains for the beneficiaries, but is a criminal
offence as described in the Criminal Justice Act of 1998.
Many asset management agencies provide two or three types of manager. Socofigest Asset
Management, for example, offers three types of mandates; the discretionary mandate, the
advisory mandate and the ‘tailor-made’ mandate (as described on the Socofigest Asset
Management website). However, they can be simplified to active and passive forms of
management. Active management involves asset managers taking care of assets or funds and
making sure that they are performing as well as other similar or equal assets in the market.
Whereas passive management gives the trustees the power to choose how the funds are
distributed and then the manager will choose what securities are invested, usually looking at
an index using a comparative method. It should be recognised that both types of management
styles or mandates create problems and things to avoid, but in order to keep this essay concise
they will not be explored. CFA Standard III (C) Suitability is a piece of regulation relevant to
the process of choosing the type of management style a client desires and gives clear guidance
that the “needs, circumstances, and objectives of the clients” must be considered “when
determining the appropriateness and suitability of a given investment or course of investment
action.” (CFA Code of Ethics and Standards of Professional Conduct p.103) Although the
regulations, rules and mandates of fiduciary duty may suggest that an asset manager is only
expected to trade securities (with the intent of positively benefitting the beneficiaries) Professor
Kay argues that there is an obligation for an asset manager to do more. In The Kay Review
(2012), Kay explains that active asset managers should “have more concentrated portfolios
which are more differentiated from each other and from benchmark indices” (Kay, 2012, p.50)
suggesting it is not only important for managers to advance the beneficiaries position as much
as possible, they should have the motivation to do it in a sophisticated way. Kay goes on to
state that passive managers “should recognise a special responsibility to improve the
performance of the index they track.” (Kay, 2012, p.50), this is an even more involved task, as
to do this the performance of other companies in the index must too be improved. The idea of
having to do more than just simply trade securities is furthered and explained when you
consider The Stewardship Code.
The Stewardship Code (2020) works towards the long term prosperity of companies, which in
turn leads to the success of those who provide capital. The ultimate responsibility is held by
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