Ordinary care

What Is Ordinary Care?

Ordinary care, in the context of investment law and standards, refers to the degree of diligence, prudence, and watchful attention that a reasonably prudent person would exercise in similar circumstances. It serves as a fundamental standard of conduct expected of individuals and entities entrusted with managing financial affairs or providing financial advice. This concept is crucial within the broader field of Investment Law and Standards, dictating the level of responsibility professionals like investment advisers and broker-dealers owe to their clients. The principle of ordinary care underpins many aspects of fiduciary responsibility and professional accountability in finance.

History and Origin

The concept of ordinary care has deep roots in common law, where it emerged from the legal principle of negligence. Early legal interpretations established that individuals have a duty to act with a certain level of carefulness to avoid causing harm to others. This general principle was gradually applied to specialized fields, including the management of financial assets. In the realm of finance, the evolution of ordinary care is often intertwined with the development of the "prudent man rule," a legal standard that historically guided the investment decisions of trustees. This rule, established in the 1830 Massachusetts case of Harvard College v. Amory, stipulated that trustees should invest as "men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital."⁹, ¹⁰

Over time, particularly with the advent of modern portfolio theory, the "prudent man rule" evolved into the more comprehensive "prudent investor rule." This modern iteration emphasizes the management of an entire portfolio management in the context of overall risk management and the specific objectives of the trust or client, rather than scrutinizing individual investments in isolation. The shift reflects a more sophisticated understanding of investment practices and the complexities of financial markets, while still maintaining the core requirement for fiduciaries to exercise a reasonable degree of care. The Cornell Law School's Legal Information Institute (LII) provides further insight into the definition of "care" in a legal context, describing it as "watchful attention, prudence, diligence," and distinguishing it from negligence.⁸

Key Takeaways

• Ordinary care represents the level of diligence a reasonably prudent person would exercise in similar financial circumstances.
• It is a foundational element of fiduciary duty and professional standard of conduct in the financial industry.
• The concept has evolved from historical "prudent man" principles to more modern "prudent investor" standards.
• Compliance with ordinary care obligations requires financial professionals to act in their clients' best interest.
• Failure to exercise ordinary care can lead to legal liability for financial professionals and firms.

Interpreting Ordinary Care

Interpreting ordinary care in a financial context involves assessing whether a professional's actions align with what a competent and prudent peer would do when faced with similar information, resources, and client circumstances. It is not about guaranteeing specific investment outcomes, which are inherently subject to market fluctuations. Instead, the focus is on the process and the decision-making framework employed.

For an investment adviser, exercising ordinary care means conducting a reasonable inquiry into a client's client objectives, financial situation, and risk tolerance before making any recommendations. This includes understanding the client's investment experience, liquidity needs, and time horizon. The adviser must then ensure that any recommended investment strategy, including asset allocation and specific securities, is appropriate and suitable for that client's profile.

Hypothetical Example

Consider Maria, a relatively new retail investor who approaches a financial advisor to help her invest a lump sum for her retirement. Maria explicitly states her goal is long-term growth with a moderate risk tolerance, as she is still several decades away from retirement.

To demonstrate ordinary care, the advisor first conducts a thorough assessment of Maria's financial profile, including her income, expenses, existing assets, and specific retirement savings goals. The advisor then explains various investment options, outlining their potential risks and expected returns, and discusses how different investments might fit into a diversified portfolio management strategy.

Based on Maria's stated client objectives and risk tolerance, the advisor recommends a diversified portfolio heavily weighted towards equity funds, with a smaller allocation to fixed-income securities. The advisor explains the rationale behind this asset allocation, emphasizing the long-term growth potential of equities and the role of fixed income in mitigating volatility. The advisor also provides Maria with clear documentation outlining the investment strategy, associated fees, and potential risks, ensuring Maria understands the recommendations before proceeding. This step-by-step approach, aligning recommendations with the client's stated profile and providing comprehensive information, demonstrates the advisor's commitment to ordinary care.

Practical Applications

Ordinary care is a pervasive concept in the financial industry, particularly for those who serve as fiduciaries. Its practical applications are evident across various regulations and professional standards. For instance, the U.S. Securities and Exchange Commission (SEC) has affirmed that investment advisers have a fiduciary duty to their clients, which encompasses a duty of care. This duty requires advisers to provide advice that is in the client's best interest, conduct a reasonable inquiry into a client's objectives, and have a reasonable basis for their recommendations.⁵, ⁶, ⁷

Similarly, for broker-dealers, the SEC's Regulation Best Interest (Reg BI), implemented in 2020, significantly elevates the standard of conduct beyond the previous suitability rule. Reg BI includes a "Care Obligation," which mandates that broker-dealers exercise reasonable diligence, care, and skill when making recommendations to retail investors. This involves understanding the potential risks, rewards, and costs associated with a recommendation, and having a reasonable basis to believe that the recommendation is in the client's best interest.², ³, ⁴ This standard applies to recommendations for securities transactions and investment strategies, affecting how firms manage potential conflicts of interest and ensure their practices align with client interests. For both retail and institutional clients, the exercise of ordinary care helps to build trust and maintain the integrity of the financial system.

Limitations and Criticisms

While ordinary care sets an important benchmark for professional conduct, its interpretation and enforcement can present certain limitations and challenges. Defining "reasonable" or "prudent" can be subjective and open to interpretation, often relying on the specific facts and circumstances of each case, and potentially leading to disputes. What constitutes ordinary care in one market environment or for one client profile may not be the same for another.

Another criticism arises in situations where financial markets experience unexpected downturns or significant volatility. Even when a financial professional exercises ordinary care and follows established risk management protocols, clients may still incur losses. In such cases, despite the professional adhering to their standard of conduct, the outcome can lead to client dissatisfaction and allegations of negligence, even if the losses were unavoidable market risks. Furthermore, the complexities of investment products and the vast amount of information available can make it challenging for even diligent professionals to conduct exhaustive due diligence on every single offering. Critics also point to the difficulty in fully eliminating or disclosing all potential conflicts of interest, which can implicitly impact the perception of whether ordinary care has been met.

Ordinary Care vs. Due Care

In legal and financial contexts, "ordinary care" and "due care" are often used interchangeably, and indeed, many legal definitions equate the two. Both terms refer to the level of carefulness and prudence that a reasonable person would exercise in similar circumstances. The Cornell Law School's Wex legal dictionary, for instance, explicitly states that "Due care, also referred to as ordinary care and reasonable care, is the standard of care where a reasonable person would exercise in the same situation or under similar circumstances."¹

However, in some specific contexts, "due care" can carry a slightly broader implication, particularly when linked to "due diligence" in corporate or transactional law. While ordinary care is a general standard applied to daily conduct and decision-making, due diligence refers to the comprehensive investigation undertaken before entering into an agreement or making a significant decision, such as an acquisition or a major investment. This process of due diligence is an application of "due care" in a more structured and extensive investigative manner. Therefore, while ordinary care describes the baseline level of attentiveness and caution, "due care" can encompass this general standard while also referring to more specific, proactive investigative measures to ensure all reasonable steps have been taken. Ultimately, both terms reinforce the principle that financial professionals must act in their client's best interest by applying a reasonable degree of skill and knowledge.

FAQs

What does "ordinary care" mean in simple terms for investing?

In simple terms, "ordinary care" in investing means that your financial professional—like an investment adviser or broker-dealer—must act as a sensible and careful person would when managing their own important financial matters. They should understand your needs, explain risks clearly, and recommend investments that are appropriate for you, without putting their own interests first.

How does ordinary care apply to my financial advisor?

For your financial advisor, exercising ordinary care means they are obligated to understand your financial situation, goals, and risk tolerance. They must then provide advice and recommend investments that are suitable for you and are in your best interest, not just appropriate. This involves a thorough and ongoing effort to ensure their recommendations align with your specific circumstances.

Is ordinary care the same as a "fiduciary standard"?

While closely related, ordinary care is a component of a fiduciary duty. A fiduciary standard typically encompasses both a duty of care (which includes ordinary care) and a duty of loyalty. The duty of loyalty requires putting the client's interests ahead of their own, while the duty of care focuses on the diligence and prudence of the advice and actions taken. Many financial professionals, such as investment advisers, are held to a fiduciary standard.

What happens if a financial professional fails to exercise ordinary care?

If a financial professional fails to exercise ordinary care, they may be found to have been negligent or to have breached their standard of conduct. This can lead to regulatory action, such as fines or sanctions from bodies like the SEC or FINRA, or civil lawsuits where clients seek to recover losses incurred due to the professional's lack of diligence.

How does ordinary care relate to the "suitability" standard?

The "suitability" standard, which traditionally applied to broker-dealers, required that recommended investments be "appropriate" for a client based on their profile. However, ordinary care, especially as incorporated into regulations like Reg BI, generally requires a higher standard of conduct than mere suitability. It demands that recommendations truly be in the client's best interest, going beyond simply being appropriate to considering factors like costs and available alternatives.