What Is a Fiduciary Risk?

A fiduciary is an individual or entity that manages assets on behalf of another person or organization. The owners of such accounts have to contend with fiduciary risk which describes the danger that the fiduciary will not act in the best interests of the client. There are laws in many countries that are designed to reduce the level of fiduciary risk that account owners must face.

In many instances, fiduciaries are appointed to manage the assets held within a trust. Typically, trust documents include explicit instructions for the fiduciary agent or trustee about how the assets should be managed. The trust document includes details such as the kinds of assets the trustee can buy and sell, and how the trust's assets are to be disbursed to the designated beneficiaries. Trust owners are exposed to consequences of fiduciary risk when the trustee decides to violate the terms of the trust agreement and conduct unauthorized transactions. In many regions, trustees who violate fiduciary responsibilities can face fines or even jail time.

Pension plans and retirement accounts are usually operated by fiduciaries that are responsible for making investment decisions on behalf of the plan participants. People who deposit money into these accounts have to contend with fiduciary risk because a fiduciary agent may decide to misappropriate the funds or commit fraud by providing plan participants with false information about the performance of the accounts. In some nations, regional or national regulatory authorities are responsible for conducting regular audits on retirement accounts so that fraud situations can be uncovered and dealt with before investors lose their money. As with trustees, pension plan fiduciaries can face criminal prosecution for misusing funds.

Aside from situations involving fraud, fiduciary risk also describes the danger that a trustee may cause an investor to lose money due to mismanagement that may take the form of poor record keeping, neglect or simple accounting errors. In some instances, account owners have the right to replace fiduciaries that make poor investment decisions but in other instances, account owners can only remove a fiduciary by taking that individual or entity to court. Laws vary from nation to nation but in some areas, a judge may fine a trustee who causes an account owner to lose money even if the trustee did not willfully or knowingly take actions with the intention of harming the client. In other instances, investors have no legal recourse in the event that funds are lost or assets lose value as a result of the fiduciary's mismanagement.