More On Legal & Compliancefrom The Advisor's Professional Library
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
With completion of the SEC study mandated under the Dodd-Frank Act, the collapse of distinction in the financial services industry continues down the path set by the repeal of the Glass-Steagall Act in 1999. Competition for wealthy investors’ business began in earnest at that time and appears poised to increase with the adoption of a uniform fiduciary standard. For advisors who want to better distinguish themselves in the marketplace, stepping up due diligence and risk management efforts seems to make a lot of sense.
According to the Center for Fiduciary Studies, there have been four legislative acts that have shaped investment fiduciary standards thus far.
- ERISA - Impacts Qualified Retirement Plans
- MPERS - Impacts State, County and Municipal Retirement Plans
- UPIA - Impacts Private Trusts
- UPMIFA - Impacts Trustees of Foundations, Endowments and other Charitable Assets
Further, the Center for Fiduciary Studies has identified seven standards that are common to these Acts, which are presented below. In this article we will focus on number six: Monitor the activities of “prudent experts.” After all, the ongoing review, analysis, and monitoring of money managers is just as important as the due diligence implemented during the manager selection process.
- Know standards, laws and trust provisions.
- Diversify assets to specific risk/return profile of client.
- Prepare investment policy statement.
- Use “prudent experts” (money managers) and document due diligence.
- Control and account for investment expenses.
- Monitor the activities of “prudent experts.”
- Avoid conflicts of interest and prohibited transactions.
This is not an exhaustive list of monitoring practices; rather
the aim is to highlight three due diligence practices that will help strengthen your fiduciary service to clients.
Expand Monitoring Criteria Beyond Performance
We would argue that it is important for advisors to consider a set of monitoring criteria that extends beyond just returns. Keep track of data points that allow you to monitor risk-adjusted measures, cross correlations, asset allocation exposures, expenses, and portfolio characteristics.
Apply those measures to the roster of managers you use with clients and review regularly to see if all are in line with expectations. Those that fail to meet specific criteria can then be evaluated in greater detail. The monitoring criteria should relate to the due diligence criteria that were defined when originally selecting the investment options.
There are multiple tools available that allow advisors to implement this broader-based approach to quantitative monitoring. This process allows you maintain a well-rounded understanding of each manager, identify trends (positive or negative), and helps facilitate client discussions during
Continually Monitor for Ongoing Changes to People, Firm, Process
Change is constant in the asset management industry. In addition to the quantitative monitoring, periodic reviews of the qualitative aspects of a firm and strategy are equally important. This element of a due diligence process is time consuming but necessary. When is the last time statistics informed you of a portfolio manager change? Qualitative due diligence can help you get out in front of pending trouble.
Create a process by which you either check for changes or have these changes alerted to you. Pay particular attention to issues that can be expected to affect future performance. Here are examples of what to monitor.
- The manager’s adherence to the guidelines established by the IPS
- Material changes in the firm’s organizational structure, investment philosophy, and/or personnel
- Any legal or regulatory agency proceedings that may affect the manager
Document Your Due Diligence Process
The presentation of process is important to regulators so don’t forget to document your due diligence. That means you need to put in writing the details behind your watch, hold and termination criteria and procedures. Capture all the periodic quantitative and qualitative monitoring that you perform and archive it. In addition, keep an inventory of all the decisions (and rationale) you have made on behalf of clients.
Should the uniform fiduciary standard recommendation turn into reality, an opportunity will be presented for advisors to demonstrate how they best serve the interests of clients. In the fiduciary world it is our belief that an investor’s ability to recognize the value of well-researched managers and the advantages of hiring advisors who can assemble them in a globally diversified portfolio will improve. The professionals that can clearly demonstrate and execute on these principles will be appealing to those investors seeking better financial advice.