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E-MailDeborah A. DeMott is David F. Cavers Professor of Law at Duke University School of Law. This post is based on her recent paper, forthcoming in the William & Mary Law Review.
By imposing obligations of loyalty, does fiduciary law “crowd out” the force of intrinsic motivations to act loyally? Or does fiduciary law reinforce (and thereby “crowd in”) intrinsic motivations to trust and to act in a trustworthy fashion? This paper examines relationships between the formal domain of fiduciary law and other factors that shape conduct, including intrinsic motivation and markets for professional services, as well as the force of reputation in a market or an industry. The paper demonstrates that looking across domains—from the legal to the extra-legal and back to the legal—places the distinctiveness of fiduciary law into sharp relief. The relationships to which this body of law applies are ones that necessarily make one party vulnerable to the other to some degree; the prospectively vulnerable party “has to trust” that the other will prove trustworthy. Fiduciary law undergirds intrinsic motivations to repose trust by addressing the risk of betrayal intrinsic to relationships in which one party must to some degree trust the other; the law also addresses the risk of aversion to the prospect of being duped or made a chump by reposing trust in another. Surveying relevant behavioral research, the paper examines its significance for fiduciary law, which the paper argues is invulnerable to critique on crowding-out grounds.
Deepening the analysis, the paper identifies dimensions on which fiduciary relationships differ. These include the presence or absence of prior ties linking the parties that are consistent with intrinsic motivation toward loyal conduct, the role assumed by an actor in whom the vulnerable party necessarily reposes trust, and the economic stakes for the vulnerable party. Each dimension of difference is relevant to assessing the power of crowding-out critiques of the law and illustrates variations in how intrinsic motivation and other extra-legal factors may operate. For example, what the parties already know about each other may enable better-informed choices by the prospectively vulnerable party or, alternatively, may facilitate better-calibrated choices of victims by parties who may prove untrustworthy. And the stakes matter; higher stakes are consistent with the exercise of greater care by prospectively vulnerable parties but can lead to greater loss when trust is betrayed.
To elaborate further, the paper uses three concrete examples that differ along these dimensions. These include broker-dealers who furnish investment advice to customers, given that brokers may or may not be deemed fiduciaries by state law and if so, either categorically or through fact-intensive inquiry by the court; organizers of philanthropic fund-raising campaigns, especially when facilitated by platforms or other Internet-based resources; and trustees of family trusts who operate subject to a conflict created by the trust’s settlor. In relatively high-stakes investment settings, a recent quantitative study finds that brokers’ advice conforms to a fiduciary standard—as measured by the behavior of registered investment advisers, categorically treated as fiduciaries by federal securities law—in states in which the law treats brokers as fiduciaries. The study also finds that better outcomes for investors stem from the entry into geographically-defined markets of brokers who offer better-quality advice, coupled with the exit of those offering lower-quality advice. These findings demonstrate the baseline impact of fiduciary law relative to other factors that may shape conduct, including reputation in a market.
In contrast, the economic stakes are not necessarily high for donors to crowd-funded philanthropic campaigns. Donors as well as campaign organizers more likely fit within paradigms dominated by intrinsic motivation, but—unlike a securities broker-dealer—an organizer’s conduct is not structured by a defined professional role within a complexly regulated and multicomponent industry. The introduction of platform-based fundraising (as well as other philanthropic channels facilitated by the Internet) reduced the likelihood of prior ties between campaign organizers and prospective donors by decoupling philanthropic fundraising from geographic localities that linked older-style organizers to donors. If an organizer misuses funds donated via a platform, donors suffer direct harm and, more indirectly, may look askance at other philanthropic appeals in the future. To be sure, a crowd-funding platform itself can mitigate the risk that funds may be misused, while the legal status of campaign organizers remains unresolved in the United States. In contrast, Canadian law since 2011 characterizes organizers of informal philanthropic appeals as trustees, which clarifies organizers’ duties and backstops donors’ willingness to trust them.
In contrast to these two examples, the situation of a trustee of a family trust who acts subject to a conflict created by the trust’s settlor is not novel. Trust law respects a settlor’s freedom of disposition, which encompasses the appointment as trustee of a family member who is also a life or remainder beneficiary of the trust. Likewise, trust law respects a settlor’s consent to conflict on the part of a commercial trust company, as when the settlor consents to the trust company’s investment of trust assets in affiliated entries. A family-member trustee and the settlor typically share a history, which is consistent with the presence of intrinsic motivations toward loyal behavior. A trust officer and an associated commercial trust company, in contrast, provide professional services in defined roles that conventionally trigger fiduciary duties. For both categories of conflicted trustees, the stringent fiduciary duty of loyalty imposed by trust law furnishes a backdrop normative standard that abides notwithstanding the settlor’s creation of structural conflict through the choice of trustee or provisions in trust instruments that consent to conflicts. By guiding trustees’ decisions, this backdrop should be no less likely to shape conduct than state fiduciary law as understood by broker-dealers who provide investment advice.
Behavioral research that finds crowding-out effects does not support critiques of fiduciary law given its distinctive functions, which are grounded in the distinctive qualities of relationships governed by this body of law. Examining why this is so identifies characteristics within fiduciary law’s domain of application that lend overall coherence to a subject characterized by many differences across types of fiduciaries and fiduciary relationships. All are “have to trust” relationships in which disloyal conduct is always a possibility.
The complete paper is available for download here.
