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It surely makes sense to require the RIA to disclose whether his services are tailored to the client’s individual needs, or whether restrictions may be imposed on individual investments. But let’s return to risk disclosures. Should specialized advisors have to make additional risk disclosures? The SEC suggests that these advisors should. The clear implication is that a specialized advisor–an RIA who holds himself out to the public as a financial planner, for instance, even if he is not a CFP–poses a greater risk to the client than an advisor who isn’t specialized. But is this necessarily true? If not, then it is misleading. Once again, neither client nor advisor benefits. The SEC could lend guidance here by refining which kinds of specialized services warrant additional risk disclosures.

The Cost of Doing Business

“Specialized service” invariably gives rise to another related issue: commissions and fees. Fee schedules are anything but uniform on a national or regional basis. There can be as many different fee schedules as there are different kinds or categories of clients. Clearly, it is a matter of justice to require fair disclosure of your fee schedule to your clients. But it is doubtful that justice requires you to effectively disclose your fee schedule to your competitors. Yet if the SEC implements these proposed rule changes, the electronic IARD could become a medium for broadcasting your fee schedule to the world on a daily basis. A fee that is negotiated, in contrast to a “shelf” fee schedule, is usually considered to be proprietary information; thus, all the more reason not to put it in the public domain. If the SEC decides to finalize its proposed rules changes to Form ADV, shouldn’t the SEC decline to require “negotiated” (and other) fee schedules to be electronically entered into the IARD?

And then there is the question of how fees should be disclosed. There is the advisory fee and then there are costs–the custodian fees, brokerage commissions, mutual fund expenses, and related additional costs. Should an RIA’s “fees” be stated in a single specified amount that encompasses both advisory fees as well as costs in excess of advisory fees? What about allowing the RIA to provide ranges, as opposed to specified amounts? And what if the RIA doesn’t know exactly what these fees are or will be at the point of establishing a relationship with a client or at another future date?

Consider the analogy of an attorney trucking down to the courthouse to file a deed only to find that the tax assessment ratios changed since he filed a deed last month, increasing the amount of real estate transfer taxes he should have quoted to the client. While the attorney may cover the difference at the time of filing, surely every reasonable person expects the client to reimburse the attorney. The lawyer’s client is not entitled to a windfall over an expense that the lawyer has no control over. Why should an advisory client enjoy a greater advantage just because a cost or expense changed since the RIA filed his ADV? The real issue here is how to effectively manage fair disclosure with things that can change at a moment’s notice, keeping in mind that the ultimate purpose of the IARD should be to establish and maintain trust between the advisor and his client.

Sometimes it simply benefits everyone, professional and client alike, to provide nothing more than a general statement describing these non-advisory costs and expenses without getting into express dollar amounts or even ranges that the clients will have to incur when receiving advisory services. Once more, clarity rather than ambiguity in guidance from the SEC greatly serves the client and his advisor.

A Matter of Discipline

The SEC has sought comment from RIAs about how to report disciplinary history, asking whether this information should appear in a separate written document apart from the brochure. Obviously, this serves the regulator’s cause of making this information appear significant when the client sees it. It therefore comes as no surprise that most commentators urge the SEC to make disciplinary hearing reporting part of the Part II brochure.

But maybe the more significant issue is what kinds of arbitration liability should be included. The SEC proposes that the RIA disclose “all material facts about any legal or disciplinary event” about the firm or its “management person.” Advisors know this, and in theory, it seems simple. In practice, however, it is more complicated. For instance, would the RIA be in compliance if the disciplinary information he provides is a summary, rather than a play-by-play of the details? That is, can the advisor leave out of the brochure any information that must be included in a Disciplinary Reporting Page (DRP)?

In addition, what is “material”? The clear area is SRO [self-regulatory organization] disciplinary events that touch on market conduct violations and other violations of the securities laws. Clearly, felony convictions are material. The more difficult question is: What about investment-related criminal proceedings that are only pending? Should presumption of innocence be given its full due here? And should the appeal process following conviction be considered “pending”? Acquittals are great for feelings of personal vindication, but how does the RIA undo the long-term harm done to his practice during the period of time that the pending proceedings appeared on his ADV? The adage about being unable to unring a bell once it’s rung applies here.

Should an advisory firm be allowed to remove disciplinary information for advisory associates who are no longer associated with the firm? If the disciplinary information relates to “suitability” issues (where advisor supervision and oversight policies and procedures contributed to the infraction), the answer seems obvious. But if, for example, the associate’s disciplinary information relates to a “selling away” issue (where associate was acting as a maverick and successfully concealed his activity from the firm), should the RIA be required to report disciplinary action that comes to light after the associate has left the firm? Conventional consensus seems to favor inclusion. But doesn’t this force the advisor to take on liability for information that his employee has done everything in his power to withhold?

Should awards of arbitrators be included? Clearly, SRO decisions dealing with market conduct issues present an obvious need to disclose. But, then again, not all arbitration awards are evidence of wrongdoing. If wrongdoing on the part of the RIA was never an issue in this particular arbitration, then does the arbitration award speak to the advisor’s integrity? There is another important fact to consider: The securities industry does not require arbitrators to publish their findings. Only the award (the equivalent of a verdict or a judgment) is generally published. Without the rationale behind the decision, it is not so easy and indeed may not be possible at all to glean from the arbitrator’s award whether the decision reflects adversely on the integrity of the advisor.

Consider this claim brought by a customer. The client instructs his advisor that he wants to “chase” a particular stock in a buy limit order trade. After “chasing” this stock for a while as the stock continued to move upwards, the frustrated client calls his advisor and says, “I no longer want to chase this stock.” Later, the stock drops through the last limit order price that the client instructed. The stock is bought in–except now, the stock continues to dive instead of rebounding as the client expected. The client now looks for an avenue to recapture from the professional what he lost in the market. The client now says, “When I said I no longer wanted to chase the stock, I meant for you, my advisor, to cancel the buy limit order.” Whatever outcome arbitrators might reach in this kind of dispute, there is surely no wrongdoing that implicates the integrity of the RIA.

But should the RIA be required to report this kind of incident? Is it the customer’s complaint alone that should trigger the requirement to disclose? Is only the outcome of the decision (the award) of the arbitrators what should dictate the need to disclose–”yes” if favorable to the customer, “no” if favorable to the RIA? If the RIA is required to disclose an arbitration award even when it favors him, should the RIA then be allowed to fully explain the case in his IARD brochure in order to “defend his integrity”? If the RIA does so, will he then tread into “no man’s land” where there is too much detail that overwhelms the already overwhelmed client?

Of course, there are many other issues and questions, such as disclosing conflicts of interest, that remain to be resolved; certainly it is hoped that Chairman Pitt will address these as soon as possible. Until then, investment advisors join their colleagues in the securities industry in welcoming Mr. Pitt back to the SEC.