This chapter describes how validation can be carried out for models used in investment management. This chapter also describes what differentiates investment management models from other models and ends with conceptual framework for validating a few investment management risk models.

The policy preference for funds and asset managers to engage in corporate governance roles is owing to policymakers’ need to galvanize ‘self-regulatory’ credibility in the corporate sector after corporate scandals. UK policymakers have since the 1990s looked to the private sector to develop self-healing techniques to address one corporate scandal or collapse after another. This is to minimize the need for regulatory intrusion and to galvanise proximate and resourceful actors such as shareholders. Relying on shareholders to ‘do the right thing’ in monitoring the corporate economy for the common good is, however, a lofty ambition and one that institutional investors have not quite lived up to and may not be well placed to fulfil. The authors argue that challenges to shareholder engagement lie in the limitations of investment management roles and their legal and regulatory frameworks, and that the investment chain, value concerns in investment management and the governance of funds pose challenges for engaged corporate governance roles for institutional investors. These concerns need to be addressed as new expectations are placed on institutional shareholders regarding ESG engagement.

Debates over fiduciary status gained national prominence with the Department of Labor’s 2016 attempt to define an investment adviser fiduciary under the Employee Retirement Income Security Act in 2016. The DOL’s fiduciary rule, however, was vacated by the courts, leaving doubt as to whether and when an investment advisor is considered a fiduciary under ERISA. Moreover, many believe that earlier guidance from the DOL on who is an investment advisor fiduciary is too narrow to protect retirement investors. What is less well known is that many of the debates in ERISA over investment advisor fiduciaries track larger debates in the common law regarding fiduciary status. This chapter explores three parallels between the common law and ERISA in determining fiduciary status. The first is the structure of fiduciary categories and the division between categorical and ad hoc fiduciaries. The second is the tendency to look to whether one person has discretionary authority to determine whether the first person is a fiduciary. The third is the challenge raised by advice giving. Both common law courts and ERISA jurisprudence struggle to determine whether and when advisors, who lack discretionary authority, should be considered fiduciaries. The chapter concludes that trust can serve as a foundation for an advisor’s fiduciary status both in the common law and under ERISA.

The regulation of mutual funds in the United States arguably contains the world’s most extensive system of fiduciary protection, buttressed by elaborate liability rules and a host of procedural protections and mandatory disclosure requirements designed to facilitate investor protection and choice. The intensity of this regulatory structure is a subject of perennial debate, as officials and analysts attempt to balance the cost of compliance and oversight against benefits to investors. Government officials have made numerous accommodations to ameliorate the system’s costs and facilitate industry innovations. But, the burdens of this enhanced system of fiduciary protections for mutual funds remain significant and have encouraged industry participants to evade these legal requirements in a number of ways, such as the creation of alternative vehicles for collective investments and the imbedding of regulated mutual funds into other legal structures that escape the full application of the enhanced system of fiduciary protections for mutual funds. This chapter suggests areas where aspects of mutual fund regulation might appropriately be extended to functionally similar investment vehicles.

Financial firms that offer investment advice to retail clients are beset by conflicts of interest: they may receive compensation tied to particular products, operate the financial products themselves, or be subject to other distortions. Regulators and lawmakers have looked to fiduciary and quasi-fiduciary duties to mitigate these conflicts. The paradigmatic example is the rigorous fiduciary standard imposed on registered investment advisers, but the Department of Labor’s now-defunct fiduciary rule, and the Securities and Exchange Commission’s recently adopted Regulation Best Interest similarly aim to mitigate problematic conflicts by imposing duties on those giving investment advice. These interventions largely focus on conflicts affecting which investment products investors are advised to hold, but other types of distortions, less discussed, may be just as important. This chapter offers an expanded account of conflicts of interest, how conflicts might interact, and how the fiduciary rule and Regulation Best Interest should be evaluated in light of this expanded menu of problematic incentives.