This year will go down in history as the year of the great fiduciary wars: advisors v. brokers, DOL v. SEC, Senator Elizabeth Warren v. the entire financial services industry…the list could go on. Tensions have flared and much ink has been shed.
When the dust and rhetoric settles, the highest casualties will likely be suffered by the investing public and their confidence in our industry and government representatives.
But alas, I digress. I’m here today not to wax poetic about the fiduciary duty owed by advisors to their clients, but instead to offer some insight into a less controversial fiduciary duty: one owed by a board of directors to its corporation and shareholders. If you’re on the board of a corporate RIA, BD, or other firm, this article’s for you.
At the most fundamental level, a director owes a fiduciary duty of both care and loyalty. These duties are owed to the shareholders of the corporation and the corporate enterprise as a whole. Care and loyalty are distinct concepts with several sub-components that are primarily understood through the laws of the state in which the corporation is incorporated, but common law principles and the corporation’s specific articles of incorporation and bylaws also play a part.
The duties of care and loyalty apply whenever a director carries out the normal functions of a director of a corporation: making decisions or otherwise causing the corporation to act in some way (e.g., approving a transaction, entering into a capital-intensive project, appointing officers, etc.). Though day-to-day functions are almost always carried out by an appointed group of officers, directors are still ultimately responsible for the corporation’s management and direction. The shareholders are not.
The duty of care stands for the proposition that a director must only make informed decisions and not act like an idiot. Rather, a director must be reasonably apprised of material information that could inform a decision, act in good faith when deciding how the corporation should act and carry out decision-making authority as an ordinarily prudent person in a like position would. The exact language will differ by state and each state will be informed by its own case law, but the basic tenets of the duty of care are the same. A director essentially can’t be asleep at the wheel.