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Capitol Punishment?

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Advisors have their eyes on Washington these days–and well they should, as the nation’s capital is rife with regulations from Congress and the Securities and Exchange Commission that may make advisors’ lives easier, or not.

The SEC has added some new items to its examination checklist of late, and is scrutinizing the information advisors are disclosing on Form ADV, the accuracy of their performance numbers, their best execution and soft-dollar arrangements, and the suitability of their recommendations to clients, as well as their use of hedge funds. While the SEC claims that keeping a watchful eye on these areas is tantamount to protecting investors’ interests, some advisors are taking issue with the usefulness of the Form ADV and the lack of clear guidance on how to comply with best execution standards.

Also on advisors’ regulatory radar screens is the pension reform bill, which passed the House on April 11 by a 255-to-163 vote and includes the controversial investment advice legislation sponsored by Representative John Boehner (R-OH). Independent advisors have been up in arms over the idea that a 401(k) administrator would be allowed to dole out potentially biased advice to plan participants.

The advice bill has many hills to climb before it becomes law; the bill was pushed through the House by Republicans with a healthy majority, but has many detractors in the Senate. Should it become law, it would heat up the competition for retirement dollars among independent planners, investment companies, and life insurance companies. Lawmakers are attempting to avert another Enron disaster by including the advice provision, as well as other post-Enron provisions modeled after President Bush’s pension overhaul. The provisions allow workers to sell employer-matched stock in their 401(k) after three years and stipulate that employees must be informed before any account changes occur.

Donna Skeels Cygan, a planner with Essential Financial Planning, Inc., in Albuquerque, New Mexico, says she’s become particularly concerned about how Fidelity handles its 401(k) relationship with Sandia National Laboratories, one of the largest employers in Albuquerque. “Fidelity sends the employees enormous amounts of information about how they should have all of their personal assets at Fidelity, how they can roll their 401(k) into an IRA at Fidelity when they retire, and how wonderful their 529 plan is, et cetera,” Cygan says. “Fidelity provides seminars at Sandia for Lab employees during lunch hour about lots of different topics, not only 401(k)s, and definitely has a captive audience. I am unclear on just where Fidelity is supposed to draw the line between administering the 401(k) plan and taking advantage of having their foot in the door to provide seminars that are anything but objective.”

Senator Jeff Bingaman (D-NM), is sponsoring a bill in the Senate that champions independent advisors’ call to limit 401(k) advice to only “independent parties.” But that doesn’t sit well with Jack Dolan, spokesman for the American Council of Life Insurers. “The idea of ‘independent’ is suspect. [Life insurance and investment companies] are providing investment options and educational materials, so we are the ones best equipped to provide advice,” he argues. “The Bingaman bill would stifle competition.”

The Nifty Thrifty

Another bill that’s causing a stir in the planning industry is H.R. 3951, the Financial Services Regulatory Relief Act of 2002, which includes a provision exempting thrifts from the Investment Advisers Act of 1940. “Under the exemption, thrift employees could be bank tellers one day and investment advisors the next day without disclosure of qualifications, disciplinary histories, or conflicts of interests,” says C. Bradley Bond, a planner with C.B. Bond Financial Planning, Inc., in Murrysville, Pennsylvania.

In a recent letter to Congresswoman Melissa Hart (R-PA), Bond says that it’s unfair to exempt thrifts from the Investment Advisers Act when, unlike banks and broker/dealers, heavily regulated investment advisors are still prohibited from advertising client testimonials. It’s also unfair, he says, that SEC-registered advisors have to undergo SEC exams every five years, and “that advisors have recently been required to pay from $100 to $800 annually to be registered on a new Internet database, the Investment Adviser Registration Depository (IARD), with the SEC or state securities commissioners” when the Office of Thrift Supervision (OTS) “doesn’t have any experience or resources to audit a thrift’s retail advisory activities.”

Much Ado over ADVs

Lou Stanasolovich, a planner with Legend Financial Advisors in Pittsburgh, says the information advisors must provide on Form ADV is “useless” to clients. “It talks about how much money we manage, but it doesn’t tell a client how we charge, and how we treat clients in certain situations or how we bill. That might be in [ADV] Part 2 that’s coming.”

And “it’s a big mistake” that advisors must file their ADVs with the National Association of Securities Dealers Regulation (NASDR), Stanasolovich says, because it provides renewed impetus to the NASD’s long-held desire to regulate advisors. This issue tends to rear its ugly head every couple of years, he says, and would be detrimental to advisors if adopted because it would basically put advisors under the purview of broker/dealers. “The NASD is focused on those people that sell things for commissions and work for the broker/dealer, not for the client,” Stanasolovich says. “I think there’s a distinctive difference there.”

Planner Curt Weil, of Weil Capital Management in Palo Alto, California, says planners are still in the dark about when the SEC is going to unveil an electronic version of ADV Part 2, though it’s going to be “narrative” in form, he says.

Nancy Lininger, a consultant with The Consortium in Camarillo, California, which provides compliance and marketing services to investment advisors and broker/dealers, says while federal advisors have already had to file their Form ADV electronically on IARD, state-registered advisors can file voluntarily until their state sets a deadline. The next filing deadline for the IARD, she says, is transferring broker/dealer reps onto the system. “The states are just now setting deadlines to transfer the [B/D] reps onto the system, and many states are setting June to August deadlines, so that’s coming up,” she says. “That means you have to start getting this info onto the system.”

Weil, who was recently examined by the SEC, conducts a study group of 40 advisors in the South Bay area, and at the last meeting a compliance expert was on hand to prep advisors for their exam. Advisors were told to fix any problems cited in the last SEC exam, to perform a “best execution” survey–including small advisors who sometimes ignore this area–and to disclose soft-dollar arrangements in their Form ADV. “We also hear that a proper written disaster plan is being required, and that our ADV and/or contract should mention that, if we use mutual funds, the client is subject to an added layer of fees–ours and the fund manager’s,” Weil says.

Planner Stanasolovich says he’s having a hard time figuring out how to comply with the “best execution” standard. “The SEC is not providing any feedback,” he says. “Because we don’t run multiple custodians, it’s tough to say our order was filled in so many seconds. We say we choose a custodian because we get relatively quick execution and the prices are cheaper. But now [the SEC] expects us to compare some alternatives, which certainly from a price standpoint we can do, but how fast it actually goes through, that’s another story. I’m just concerned that [the SEC] isn’t providing any hardcore guidelines, and, to a large degree, what they expect is unrealistic.”

Hedge Funds, Web Services, and Identity Fraud

The SEC is also stepping up its oversight of advisors’ “preferential treatment” of hedge funds. The regulator says that “an increasing number of advisors are allowing one or more of their portfolio managers to create and manage a hedge fund or other private equity fund side by side with the portfolio manager’s management of a registered investment company or traditional separate accounts.” During exams, the SEC says it will question how the advisor allocates securities and determine whether the advisor is appropriately managing all of the accounts.

And last month, the SEC adopted new rules: Investment advisors conducting most of their business through an interactive Web site could register with the SEC, instead of with various states; a new Form N-6 was instituted for the registration of variable life insurance, which sports a shortened and simplified prospectus; and the definitions of “equity security” in rules under the 1933 and 1934 acts now include security futures.

Advisors should also be alerting clients to a new identity fraud scam that has cropped up, says Lininger. Consumers are receiving an “official-looking” letter that’s supposed to be from their bank, she says. The letter requests that clients fill out an IRS form W-9095 in order to update resident and non-resident alien and citizen records “to enable us to detect persons exempted from the U.S. reporting and withholding tax on interest paid to you on your bank account and other financial dealings.” Consumers are to then fax it to a number designated in the letter. “It’s a fictitious IRS form and the fax number goes to these people who are stealing identities,” she says. The Office of the Comptroller of the Currency is asking consumers to report receipts of the letter. For more information, log on to and click on the April 5 alert.

This tally of compliance issues is surely just the tip of the iceberg, and for the sake of their practices and their clients, advisors will do well to stay abreast of relevant compliance issues. And since I recently moved from New York to Washington, I’ll do my best to help keep you up to speed.