Big Step Forward: Moving Toward A Universal Fiduciary Standard

 

ENVESTNET PRACTICE MANAGEMENT SERIES

»

With the January 22 release of its 200-plus-page Study on Investment Advisers and Broker-Dealers, the SEC has recommended a common fiduciary standard for both registered investment advisers (RIAs) and brokers.

While this step means the long-debated question has been clarified, a full spectrum of issues remain to be decided – notably a clear definition of the standard, implementation, and financing of compliance audits. Industry groups and other advocates will continue to weigh in with their points of view. In the meantime, this white paper will examine three topics associated with the current fiduciary discussion:

(1) key points and next steps relating to the SEC report,
(2) advisor-client attitudes and relationships, and
(3) strategies that advisors can use now to grow their client base.

[T]he standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers ... shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice. 1

 

 

 

 

 

 

 

 

 

 

 

 

 

To support your record-keeping, Envestnet has added Fiduciary Oversight Notes (FONs) to its platform. FONs make it easy for advisors to make a note of any discussions that might lead to a change in a client’s account, enhancing transparency. In addition, with FONs, you can also see fiduciary commentaries to help guide you in your process in critical decision-making areas.

Defining the fiduciary standard
The SEC staff suggests that standards be built upon the elements of fiduciary responsibility described in the Advisers Act of 1940, which include loyalty, disclosure, duty of care to seek best execution of transactions, and personalized investment advice. The SEC report also recommends “harmonization” of current regulations so that they apply equally to RIAs, broker-dealer representatives and other financial professionals who provide personalized advice. If, for example, both RIAs and brokers are performing the same functions, the study recommends that regulatory requirements should be the same for both. Education at the federal level (www.investor.gov) should be enhanced to provide unbiased fiduciary and financial information to consumers.

Cost of compliance audits
With its tight budget, the SEC has made it clear that its ability to finance additional
compliance audits is limited. The report recommends three possible steps to ameliorate
the funding shortfall: to bill advisors for the cost of audits via “user fees;” to delegate audit responsibility to FINRA, the self-regulatory organization that governs broker-dealers; or to delegate audit responsibility to another, unnamed self-regulatory organization. FINRA appears to be prepared to take on additional responsibility; if that happens, the broker-dealers’ self-regulatory organization could also audit RIAs. It also appears likely that those firms that are being regulated will finance the process through additional fees.

Investor choice and competition
Throughout its report, the SEC staff refers to the importance of maintaining competition and choice for investors. “The Staff developed its recommendations with a view toward... assuring that retail investors continue to have access to various investment products and choice among compensation
schemes to pay for advice.”2

Clients and Advisors Convey Their Fiduciary Beliefs and Attitudes

While “big picture” issues are being decided at the national level, as an advisor, you might be wondering how your business will be affected. To help make your own decisions regarding the fiduciary path, take a look at how retail investor and advisor groups perceive issues of service and care,
according to a study Envestnet commissioned last year.”3

How well do investors trust the advisors? How does the profession rank when compared to physicians, accountants and lawyers? Do investors think that advisors are highly regulated? And – here is a critical question – how do investors feel about a universal fiduciary standard? Some answers might surprise you.

Consider the first question, how well do investors trust advisors? Investors were asked “whom do you trust the most to act in your best interest?” by ranking a series of professions beginning with the most trusted. Financial advisors rated in the top three at an average of 53%, following doctors and accountants. The fourth-rated group, psychologists/therapists, trailed by a wide margin, being listed only 34% of the time.

Getting closer to the fiduciary debate, do retail clients perceive advisors as highly regulated as compared with other professions? The answer is generally no. Only 19% of the respondents see advisors as highly regulated, well behind airline pilots, physicians, casino employees and bankers. In all, 64% of respondents believe that advisors are somewhat or highly regulated.

Critical question: Consumers on a universal fiduciary standard
Investors do not understand the distinction between RIAs and broker-dealers. In its just-published study, the SEC refers to the 2008 RAND report, commissioned by the SEC, which said that “participants ... believed that investment advisers and broker-dealers offered the same services and were subject to the same duties, although generally investors were satisfied with their financial professional.”4 The SEC also
cites an August, 2010 study which sampled more than 2,000 adults and concluded that “a majority of investors surveyed incorrectly believed that stockbrokers and “financial advisors”
are held to a fiduciary duty ...”5

Envestnet’s 2010 study took these findings one step further. “When informed about the fiduciary discussion, two-thirds of investors say they would strongly support a regulation
that held all financial advisors to the same standard of client service.”6 Advisors shared that opinion. A total of 90% either agreed or strongly agreed that “following a fiduciary standard is actually good for business.”

Based on what we know now about the development of a fiduciary standard – both at the regulatory level and how individuals and advisors feel about it– how can you use this information to improve client relationships and grow your practice?

Fiduciary Strategies that Serve Clients Better and Grow Your Practice

If only “in the best interest of my client” were all you needed to know. This powerful concept – established in case law but not yet explicitly defined by today’s regulators and industry representatives – brings with it a host of questions. That does not mean, however, that a diligent advisor should wait for the fiduciary standard to present itself in full and final definition.

While core values for financial advisors are unlikely to change in the current discussions, there is a good chance that the cosmic regulatory shift currently underway will impact your practice. Consider this: an RIA could find that his firm is no longer audited by the SEC but by FINRA or some other self-regulatory organization. In addition, there is a good chance that fees will be imposed to cover the cost of more stringent oversight.

So, it is not good enough simply to flow along with the stream. The best way to thrive in your business is to look ahead and prepare for the changes that will come. To that end, we suggest five strategies that we believe align with the fiduciary momentum and support the growth of a solid client base.

1.) Take advantage of leading edge technology
As the fiduciary standard becomes more clearly defined, it is more important than ever to embrace technology that has the fiduciary model at its center. It is way too easy to let operational problems and “do-it-now” tasks pull you away from business development. Why not let technology give you the freedom to increase personal contact with clients and meet your fiduciary commitment? In response to increasing regulatory scrutiny, Envestnet has given compliance a stronger position on its platform, making reporting requirements easier to fulfill.

2.) Weave the fiduciary standard into all processes
A comprehensive process can help you incorporate more fiduciary concepts into your practice. For example, since the 2008 market drop, risk tolerance assessment has become more important. You probably assess risk tolerance with a new client at the first or second meeting, or revisit the issue when meeting with an ongoing client. Envestnet has developed an iterative process that involves a robust set of applications – the Envestnet Advisor Suite™ - which incorporates all of the key steps to an advisor’s fiduciary process. The first step starts with a questionnaire which can be the basis for your assessment and ultimately, the client’s asset allocation.

The next step in the client process is to develop the appropriate asset allocation model. You may ask how the fiduciary component fits in the asset allocation. For one, products and solutions that have passed a stringent due diligence screen are critical to the long-term health and growth of the portfolios you manage. Just about every week, trade publications report on products that have failed the fiduciary test and triggered huge financial issues for the firms that sold them, and which could have been avoided by solid due diligence.

Second, access to a broad array of products and solutions means that you can recommend investments that are genuinely appropriate for clients. A choice of separate accounts, advisor-directed accounts and mutual funds can be allocated based on capital market assumptions. In addition to long-term strategies, a short-term tactical component has become increasingly important for many portfolios.

In addition, with the Envestnet Advisor Suite™, you have access to an ongoing monitoring and reporting process that enhances your value to the client in the years to come.

Meet compliance requirements with documentation and transparency
Beginning with the early decision-making days with clients, you have a fiduciary obligation to maintain notes on how and why decisions were made. Compliance reviews by both the SEC and FINRA stress the importance of documentation for decisions.

To support your record-keeping, Envestnet has added Fiduciary Oversight Notes (FONs) to its platform. FONs make it easy for advisors to make a note of any discussions that might lead to a change in a client’s account, enhancing transparency. In addition, with FONs, you can also see fiduciary commentaries to help guide you in your process in critical decision-making areas.

Strengthen relationships with a holistic approach to wealth
Advisors are continually challenged by the lack of complete information about their clients. Sometimes this happens because the client simply forgets to mention a vacation house or a large CD. Or, the client has a 401(k) held by his company’s custodian and must physically deliver a statement to his advisor so that component of his wealth is included in an asset allocation process. To further aggravate the problem, a stock held in one account might be sold and purchased in another, unknown to the advisor – resulting in a wash sale or triggering unexpected tax consequences.

To resolve this problem, Envestnet has developed the Unified Managed Household (UMH). The UMH allows advisors to see the full range of client assets, including those which are held outside of the primary account. Because these “off-site” assets are included in reporting, advisors can analyze the full range of household assets within a reasonable timeframe.

This fiduciary tool strengthens “know your client” guidelines and it gives advisors more opportunity to provide value to clients. Knowing that a low-risk asset, such as a CD, is held at a bank might mean that a client can take on more risk in an equity portfolio, for example. By increasing transparency and enhancing potential for better recommendations, the UMH leads directly to better client trust.

Communicate your fiduciary commitment
Regardless of how carefully you adhere to a fiduciary process, you will not get credit for your efforts unless you communicate your principles to your clients. With every client contact, there is a new opportunity to make sure they understand that your actions and recommendations are based on a fiduciary standard.

An investment policy statement, or statement of investment selection, signed by both the client and the advisor, is one such chance. As you talk through the plan, point out that documentation and transparency are consistent with fiduciary standards.

Positive Change with the Fiduciary Standard

The SEC Study on Investment Advisers and Broker-Dealers and the earlier RAND study make it clear that investors expect their financial professionals to adhere to a fiduciary standard. This is also echoed in Envestnet’s research.

The potential benefits for individuals and professionals alike are unlimited – more trust, better advice, and a chance for everyone to meet his or her goals in life.

 

---

 

1 Study on Investment Advisers and Broker-Dealers by the Staff of the U.S. Securities and Exchange Commission, January 2011, pages 109-110.
2 Executive Summary, Study on Investment Advisers and Broker-Dealers, page x, (prior to main text).
3 The Fiduciary Opportunity™: Succeeding in a Changing Advisory Landscape, Envestnet Asset Management, 2010.
4 Study on Investment Advisers and Broker-Dealers, page 99.
5 Study on Investment Advisers and Broker-Dealers, page 101.
6 The Fiduciary Opportunity™, page 5.

 

This article is provided for informational and educational purposes only. It is not intended as and should not be used to provide investment advice and is not an offer to sell a security or a solicitation of an offer, or a recommendation, to buy a security. All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Investment decisions should always be made based on the investor's specific financial needs and objectives, goals, time horizon, and risk tolerance. The statements contained herein are based solely upon the opinions of Envestnet. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Neither Envestnet nor its representatives render tax, accounting or legal advice. Past performance is not a guarantee of future results.

FOR FINANCIAL ADVISOR USE ONLY.