Spotting Issues Common to Institutional & Quasi-Institutional Fiduciaries

August 2018

August 2018
Steven G. Wood

Below is the fourth article in our “Fiduciary Duties” newsletter series discussing “Institutional and Quasi-Institutional Fiduciary Relationships.” If you missed our last newsletter, “Corporate and Partnership Fiduciary Duties,”  click here to read.

Please contact Steve Wood at 650.517.5509 or with any questions.
Institutional and Quasi-Institutional Fiduciary Relationships

While the proliferation and complexity of investment fiduciary relationships is a relatively recent phenomenon from the 20th century, the basic concepts of fiduciary duty are ancient. In fact, the English word “fiduciary” has its roots in the Latin word “fiducia,” which means both “trust” and “confidence.” (“Fiducia.” 
Def. Latin Word List. 
Today’s investment fiduciary relationships likewise involve delegation to an agent of discretionary management responsibility for particular assets in order to provide future benefits to one or more third-party beneficiaries or specified purposes. Such relationships are based on a high level of trust and confidence in the agent. Fiduciary duties supply rules that guide the agent’s implementation of those delegated responsibilities, with the goal of ensuring that the fiduciary faithfully fulfills its obligations. Yet, there is no universal definition of fiduciary duty. Concepts of fiduciary duty cross the boundaries of different fact situations, legal systems and cultures, making a single global definition impossible.
Fiduciary or “Special Relationships” Between Lender and Borrower

Even if a lender is not a fiduciary of the borrower at the inception of the loan, the lender may become a fiduciary after the loan closes. Commercial loans require frequent interaction between the lender’s loan officers and the borrower. This crucial interaction presents the risk of fiduciary, quasi-fiduciary, and other “special” relationships being formed on the basis of the loan officer’s conduct. Because it takes more than a mere lender-borrower relationship to create a fiduciary relationship during loan administration, that simple relationship has to change for a fiduciary or “special” relationship to exist.
Under general principles of agency and statutory duties created by California real estate law, a fiduciary relationship may exist between a real estate loan broker and the borrower if the broker participates in loan collection or administration. See Wyatt v Union Mortgage Co. (1979) 24 Cal.3d 773, 782 (broker charged borrower with multiple late payment fees and was unable to justify them at trial; court held jury could reasonably infer that fees were imposed as part of scheme to defraud borrower). As illustrated by Wyatt, a fiduciary relationship may determine the issue of equitable tolling and the continuing tort doctrine.
A private lender acting in a fiduciary capacity toward the borrower may be liable for constructive fraud. In Warren v Merrill (2006) 143 Cal.App.4th 96, the court ruled that a real estate broker was liable for both actual and constructive fraud because she lent money to her client for part of the down payment, which she combined with her client’s funds to purchase a home. She instructed the escrow company to put the title in her daughter’s name and refused to convey title to the client as promised after the closing. The defrauded client was permitted to quiet title against the offending parties and recover damages, and the court also ruled that the absence of a written contract was not a defense for a fiduciary’s commits.

Duties of Trustees

The term “fiduciary” was originally used in the common law to describe the nature of the duties imposed on a trustee, such as at the legendary Fidelity Fiduciary Bank! Fiduciary principles are still deeply embedded in the law of trusts. Among the duties typically owed by a trustee are the duty to administer the trust solely in the interest of the beneficiary; the duty of full disclosure of material facts by the trustee when dealing on his or her own account; the duty to keep and render clear and accurate accounts of the administration of the trust; and the duty to take reasonable steps to take, keep control of, and preserve the trust’s property. One who purports to be a trustee may be burdened with fiduciary obligations even when no trust has been created.

Agency Duties

Agency may be the most basic fiduciary relationship arising under law. It serves as the basis for other, more specialized fiduciary relationships such as broker/customer and attorney/client. Agency results from “the manifestation of consent by one person to another that the other shall act on his behalf and be subject to his control, and by the consent of the other so to act.” Among the fiduciary duties imposed on agents as fiduciaries are the duty of full disclosure, loyalty, and faithfulness to the principals. Sierra Pacific Indus. v. Carter, 163 Cal. Rptr. 764, 766 (Cal. App. 1980) (once agency relationship is established, fiduciary duties of loyalty and full disclosure flow as a result).

Fiduciary Duties of Estate Representatives

Fiduciary duties govern estate representatives upon appointment by the probate court. The estate representative has a fiduciary relationship with heirs of the estate pursuant to which the representative must act fairly and make full disclosure. The estate representative also owes a duty to the estate itself, for the benefit of both heirs and creditors of the estate. In re Mudge, 654 P.2d 1307, 1310 (Cal. 1982) (Richardson, J., dissenting) (holding attorney, as executor of estate, owed “independent fiduciary obligation to the decedents’ estate and to those beneficially interested therein, whether as heirs or creditors”).

Spotting Issues Common to Institutional Fiduciaries 

Common dynamics in investment fiduciary relationships, regardless of culture or jurisdiction, can leave beneficiaries and the market vulnerable to fiduciary abuse, and include:
  • Breaches of the duties of care, loyalty, disclosure and accounting, which may not immediately be apparent, and can prevent effective evaluation of the fiduciary.
  • Fiduciaries managing assets for fees for others, creating potential conflicts of interest.
  • Fiduciaries often possessing special expertise that beneficiaries lack, making the standard of care difficult to evaluate.
  • A situation which, unlike with tradable securities, beneficiaries often cannot avoid harm by removing a broker or the timely trading of securities.
Employees and heirs rely heavily upon pension funds and other fiduciary-managed assets for future security, creating both personal and market economic risk. Institutional investor fiduciaries control vast economic power with potentially adverse social impacts, since fiduciary asset management paradigms often employ cost externalization by off-loading indirect costs and forcing negative effects on third parties, especially when such damage is not immediately apparent to the real parties in interest.

Given the foregoing factors, it is evident that fiduciary relationships require trust and confidence. Fiduciary duties require criteria to protect beneficiaries and society from facing undue disadvantages in fiduciary relationships. Even though fiduciary standards may vary in how they are applied between jurisdictions, there are consistent themes. Fiduciary duties focus on intent and process, rather than investment outcomes. Despite variations in wording, fiduciary principles in most jurisdictions, and particularly in California, address:
  • Maintaining loyalty, including faithfulness to beneficiary interests and a fund’s purpose, and impartiality among differing classes of beneficiaries;
  • Prudent care in managing investments, diversification and risks;
  • Controlling costs and management fees;
  • Avoiding conflicts of interest;
  • Maintaining transparency and accountability; and
  • Complying with terms of governing documents and applicable laws.
In the next newsletter, we will examine 
“Homeowners Association, Real Estate Agent and Broker Fiduciary Relationships.”
Gray·Duffy has more than three decades of experience parsing, preventing and prosecuting fiduciary claims in all aspects of real estate and other matters. Please contact us to discuss any fiduciary issues you’re facing.
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Please Note: This article is necessarily general in nature and is not a substitute for legal advice with respect to any particular case. Readers should consult with an attorney before taking any action affecting their interests.