What Does Fiduciary Duty Mean?
Fiduciary duty is a mandate for one party to act purely in the interest of another party so that this party can achieve its financial and non-financial goals. Persons or entities that act in the interest of another party are called fiduciaries while the entities to whom a duty is owed are called principals. Along with working in the interest of principals, fiduciaries also have to ensure that conflict does not arise between themselves and their principals in any circumstance.
Divestopedia Explains Fiduciary Duty
Fiduciary duties are mandated by law and upheld by courts, especially in matters relating to private equity. In fact, this is one of the strictest duties of the legal system in the U.S. and other countries who have a reasonable financial market. These regulations ensure that private equity companies put the interest of their clients ahead of their own. Doing this protects investors from conflicts of interest between themselves and fund managers. It also provides a sense of accountability for managers and prevents them from making arbitrary or reckless investments in risky portfolios. This is why regulations mandate mutual funds to disclose their holdings to the public with details of their investments.
On the surface, a fiduciary duty may sound like an unreasonable obligation by one party to another. However, a deeper analysis shows that fiduciaries have to act in the best interest of principals for a transaction to be beneficial to everyone.
Using private equity as an example, fund managers are the fiduciaries while investors are the principals. The fund managers work diligently to ensure that they meet the obligations and interests of the investors while also helping themselves because they get a higher share in the profits only when they make more money for their investors.