fi360 Blog

Do you always read what you sign?

Each year, our AIF and AIFA designees are required to renew their designation by completing continuing education requirements, attesting to the Code of Ethics, and paying their designation dues.  Often times, they have questions about the process that are addressed via email or over the phone by our staff.  One such exchange turned into a prolonged dialogue via email and eventually a conference call to discuss our differences of opinion.  Ultimately, the designee renewed his designation, although it was not a given that would be the end result.

The primary point of contention was the first bullet in our designee Code of Ethics, which reads:

"I will employ and provide the client information on the Prudent Practices when serving as an investment fiduciary and/or advising other investment fiduciaries."

The designee did not feel comfortable attesting to this statement because he did not provide information on the Practices to all of his clients and, for various reasons, did not intend to do so; at least not in the short term. 

We often refer to our Prudent Practices (Practices) as a checklist that defines a fiduciary standard of care.  With the exception of CEFEX-certified firms, we are not aware of any firm that is aligned with all of them.  We explained to this designee that although we deemed the Code of Ethics very important and expected that it would be followed, we did not expect perfection.  We described how the Practices are based on ISO 9000, which defines a quality management system that is based on continuous improvement.  We explained how we routinely tell departing students that their new found fiduciary knowledge should be disseminated in bite size pieces so as not to overwhelm their co-workers, peers, or clients.  Improvements or changes to the investment management process should be made systematically over time so as not to be too disruptive to the ongoing operations.

If this designee was ignoring the Practices, that was a problem.  But if it was simply that it would take some time before he could be completely aligned with the Practices for all of his clients, we did not see why he could not attest to the Code at stated above.  He eventually agreed, attested to the Code of Ethics, and renewed his designation.

Admittedly, at times we felt that this designee was being a real pain; splitting hairs.  We joked with him that as an attorney, isn't being a pain a large part of what he is trained to do.  But upon reflection, we couldn't help but be impressed and will consider some of suggestions upon our next review of our Code.  Most all professional designations have a Code of Ethics and all of them have a percentage of designees that do not take the Code seriously or, worse, intentionally violate it.  Many could not tell you what it says.  It's those type of designees that keep us awake at night.  If only all were this deliberate before they attested to the fact that they would comply.

Do you read and fully intend to abide by what you sign?

Answering your questions on a fiduciary approach to alternative investments

A few weeks ago, fi360 hosted a webinar on a fiduciary approach to alternative investments. Our guest presenters, Tom Orecchio and Mark Willoughby of Modera Wealth Management and Guy Barudin of Terrapin Partners covered the ins and outs of alternatives, their place in diversified portfolio and appropriate due diligence. A recording of the webinar and the slides are now available for download on our website (AIF and AIFA Designees should access the recording via the Designee Portal in order to receive continuing education credit).

The session led to many questions from the audience looking for further insights and clarification that we were unable to address in the time allotted. Fortunately, Tom, Mark and Guy were kind enough to answer the remaining questions, which we are happy to present in the following Q&A:

Q: Why are equity asset classes becoming more closely corellated?

A: We will not attempt to answer this question: quite simply, we do not know. There are innumerable factors that potentially feed into correlations among equity asset classes. Rather than attempting to explain those factors, we focus on what the data is telling us, and then form judgments about what it means to our clients as we attempt to engineer and design effectively diversified investment portfolios. The recent correlation data point to a reduced diversification benefit from investing across equity classes. We would like to stress, however, that this does not mean we would discontinue the use of these equity asset classes in an investment portfolio. It means we seek sources of diversification elsewhere to create a smoother investment experience for the client. Finally, these recent correlation trends could well reverse in the future. Historically, correlations between different asset classes have ebbed and flowed, so it would be dangerous to conclude that these elevated correlations are here to stay.

NASAA Sweep is Wake Up Call for IA Fiduciaries

The results of the state securities regulators’ sweep of registered investment advisers are in, and they aren’t pretty, particularly for sole proprietors.  

Officially called the 2011 Coordinated Investment Adviser Exams, the North American Securities Administrators Association has conducted the biennial sweep in alternate years since 2007.  The current sweep covered 825 state-registered investment advisers – including some in Canadian provinces – between Jan. 1^st and June 30^th of this year. 

The U.S. advisers were state-registered and managed less than $30 million in assets.  The typical U.S. advisory firm examined this year, not including financial planning practitioners and solicitors, averaged $14 million in assets under management, had 57 clients, and two investment adviser representatives.  About one in five (18.8%) were affiliated with a broker-dealer.

The dominant group of advisers examined by the state regulators was the single-advisor firm.  Seventy-two percent, or 594 of the 825 advisers, were sole proprietors.

Keeping in mind that, for the most part, RIAs are usually cited for ‘broken tail light’ violations involving inconsistencies in their Form ADVs and books and records omissions, not fraud, the 2011 results were no different.  Sloppy compliance is no excuse, of course.  Although NASAA did not have available the number of advisors who passed with flying colors, reports by the SEC tend to show about 9 out of 10 RIAs are cited for deficiencies, but only a small percentage referred for enforcement. 

In this instance, there were apparently not many Bernie Madoffs caught up in the state reviews – less than 5 percent of the advisors who were cited for ethical deficiencies were found to be engaged in Ponzi schemes, altering documents and the like.  Nonetheless there were some interesting and even startling findings when viewed from a fiduciary perspective. 

Fiduciary consulting--embrace it

We received a call from an AIF designee earlier this week asking for help.  He was updating his personal information in the CFP database and having trouble finding a category in the database drop down list that fit the fiduciary service he was providing to clients.  My impression was that there must have been an "Other" category that he could select, but he needed to provide a short description of what "Other" was.  His voice mail indicated that he was thinking of using "Fiduciary Adviser," but when we talked, we agreed that "Fiduciary Adviser" was too narrow as it typically refers to providing specific investment advice to qualified plan participants per the Pension Protection Act.  After listening to what services he was providing, my suggested description was "fiduciary consulting."  He liked the description and intended to contact the CFP Board and suggest it be added to the drop down list in their database.

Our sense is that the demand for fiduciary consulting is increasing.  We just completed AIF and AIFA programs at the University of Pittsburgh that had to be added to the initial schedule released at the beginning of the year.  CEFEX has seen a steady increase in phone calls asking about fiduciary assessments and certification programs.  Large insurance providers are partnering with registered investment advisory firms that provide ERISA 3(21) and 3(38) services to qualified plans.

Court decision a reminder that plan document procedures are to be followed

As most fiduciaries know, investments should be managed in accordance with governing documents, including the investment policy statement, and, in the case of a retirement plan, plan documents.  In addition, fi360 often promotes the concept of ensuring a fiduciary engages in procedural prudence when managing investments in order to reduce their exposure to fiduciary liability.  "Procedure," in this case typically applies to how investments and services providers are chosen and monitored.  However, a recent case serves as an important reminder to plan sponsors and other investment stewards serving as fiduciaries that they need to ensure the procedures set forth in governing documents for all issues affecting plan and investment management are properly followed.   

In the case of Tatum v. R.J. Reynolds Tobacco Co., the plaintiff representing a class of RJR employees and retirees brought a claim in 2002 of a breach of the duty of prudence related to the removal of Nabisco Stock Funds from RJR Tobacco’s retirement plan.  The breach of duty of prudence is still being decided by the trial court, but the court recently issued an order ruling on an amended complaint by the plaintiff that is equally important to fiduciaries. 

Due diligence processes are evolving

Anyone who is in an advisory role competing for assets under management or advisement knows that it is not easy to win prospective clients.  The most cynical argue that it's not what you know, but who you know that most often wins the day.  Although I would readily acknowledge that this happens, I am convinced that people are becoming more selective and more objective in choosing financial service professionals.

Practice 3.4 includes a Criteria that states: A documented due diligence process is applied to select the custodian and all other service providers.

This criteria requires a documented due diligence process, but what does this process look like?  Essentially, it has to be reasonable, which means an external party (think judge or arbitration panel) would conclude that it addressess criteria that are well aligned with industry norms, although not necessarily best practice.  A formal process where requests for proposals are requested, received and evaluated is certainly the best way to demonstrate due diligence in making a service provider selection.  However, less formal approaches are also permissible.  The key is to gather sufficient information from a number of service providers, such as their capabilities, costs, and ability to address security requirements.  That information can then be evaluated before making an initial selection, or when deciding whether or not the relationship with a service provider should continue.  At all times documentation, the evidence, is essential. Education, experience, and professional credentials are also certainly important when one contemplates engaging a service provider.  

In addition to these quantitative factors, qualitative factors such as who you know do continue to play a part in the due diligence process, but a recommendation should not be given lightly. We are often asked for such recommendations and are reluctant to provide one unless we have first-hand knowledge of the person or organization we are recommending.  Since it is impractical to personally know everyone that comes though our training, we typically recommend only those organizations (most often the request is for an advisor or record keeper) that have be awarded a CEFEX (Level III) certification.  In those cases, their process has been formally vetted and we know confidently that they are adhering to all the applicable fiduciary practices; in short, they have their fiduciary act together.  Level I (self-assessments) and Level II (consultant's or external assessments) are both less formal and although helpful, do not provide us sufficient information to make a recommendation; in most cases we don't have access to this data.  So if you want to put yourself in a better position to obtain personal recommendations, work towards an objective, external review of your process.  And if you have been asked for a recommendation, making them can be fine, but make sure you have done adequate due diligence before doing so.  "They are a good friend" really no longer cuts it.

Have you looked at your investment committee lately?

We received a question last week related to investment committees that was straight forward enough,  is there a requirement for investment committees to rotate their members?  This particular advisor typically recommends doing so to his clients and just recently was getting some resistance.  The client's concern was captured by the old adage "if it ain't broke, don't fix it."

We are not aware of any requirement to rotate investment committee members, although we do think it is a good idea.  Getting a new committee member periodiocally with a fresh perspective, who may be more likely to question the existing process, is healthy and helps combat problematic behavior like group think.  You can rotate non-permanent members and still have permanent members that fill key roles. 

Our fiduciary practices address investment committees in Practice 1.2 under two criteria:

• Criterion S-1.2.3:  All parties have acknowledged their status in writing.
• Criterion S-1.2.4:  Investment committees have and follow a defined set of by-laws.

All committee members should acknowledge their fiduciary status in writing, although many (probably most) do not.  It's not unusual to get reactions of concern and even outright refusal when you approach committee members with this letter requiring their signature.  It will lead to a discussion of what fiduciary responsibility really entails; possibly for the first time.  This is a good thing, even if it turns out you need to look for others that are willing to replace the member(s) who is not up for the task.  In the end, you'll most likely have a competent and engaged committee.

The committee by-laws are essential for establishing the process by which the committee operates.  Other industry best practices with respect to investment committees include:

• Recruit individuals that are interested in participating.
• Choose members comprised of senior personnel from HR, finance, and operations, as well as other staff as deemed appropriate. (Note: Taft-Hartley (Union) plans require equal representation from management and labor.)
• Keep the number of members between 3 and 10; this is largely driven by the plan or portfolio size.
• Select a committee chair who has strong investment skills; typically a senior executive like the CEO, COO or CFO.
• Include permanent (CFO, VP of HR, etc.) and non-permanent members who rotate regularly (every three years is about right).
• For larger committees, stagger the rotation of non-permanent members.
• Avoid becoming too dependent on a single member (Vanguard recently published the results of a survey on committee leadership styles.
• Require regular attendance and that members take their duties seriously; signing a fiduciary acknowledgement letter helps to get this point across.

How does your committee measure up?

Fiduciary safe harbor protection and the duty to share

Last month, the Sixth Circuit affirmed the decision of a trial court that a trustee could rely on the ERISA Section 404(c) safe harbor to shield itself from fiduciary liability.  The main issue in the case was whether 401(k) participants seeking to recover damages were prevented from exercising “independent control” over their accounts as a result of a failure of the trustee to disclose material nonpublic information.

Prior to this case, it was clear that the participants’ investment advisor had breached his fiduciary duty.  As the court states in the opening of its opinion, the participants “lost substantial amounts of money from their pension accounts because their investment advisor … was a crook.”  However, because the investment advisor was insolvent, the participants sought to recover their losses from the trustee by claiming that the trustee knew of the investment advisor’s fraudulent conduct and failed to disclose it to the participants. 

The trustee claimed it was shielded from liability by ERISA Section 404(c).  The participants argued, however, that all but one of the prerequisites to the safe harbor were met.  In particular, the participants claimed that the requirement that they exercise independent control with respect to the investment of assets in their individual accounts had not been met due to the trustee’s failure to disclose what it knew about the investment advisor’s misdeeds. 

Philanthropy; an Inspired Process: How values conversations can change your relationships

This week we have a guest post from Mike Skrypnek, AIF, who is Director, Wealth Management at Richardson GMP, ltd., in Calgary, AB. His role as a provider of advisement, both investment and educational, to non-profit organizations has positioned him as an authority on the subject of fiduciary roles and responsibilities as stewards of charitable funds. Mike is also the author of Philanthropy: An Inspired Process, which is currently available in the Fiduciary Store.

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Fiduciary roles extend beyond stewardship for financial advisors; they are the guidelines for action AFTER you have connected with the values of your clients.  While advisory process and the demonstration of a sound methodology are important for your credibility, the question is: how do you gain the position as trusted advisor with the clients you desire to work with? 

We are all in a service industry.  Our clients are the cornerstone of our business.  We provide intangibles for a living and do not make widgets.  We are not craftsmen.  Our actions are intended to secure future hopes and dreams and fund ongoing liabilities using the current and expected financial assets of individuals and institutions who are our clients.  In order to grow our practices in a rapidly commoditized industry, we must differentiate ourselves beyond our credentials.  Our prospective clients may work with multiple advisors because they’re unsure of what distinguishes one advisor from another.  We need to elevate our practice to demonstrate we have more value and are uniquely positioned to help our clients achieve their goals.

For my practice, this effort has come in the form of connecting with the deep personal values of my clients where their life experiences connect with the world around them--their desires to have a greater impact and explore their philanthropy.   But how do you engage in these discussions?  Many advisors see this as an “end-of-life” discussion or an exercise in estate planning.  While this is often the case, it extends deeper than that. 

Answering your questions on risk management & life insurance planning

Last week, we presented a webinar on a fiduciary approach to risk management and life insurance planning with guest presenter Joseph Maczuga, founder and executive director of Fee Advisors Network. During the session, Joe discussed how to identify risk, the shift of life insurance risk and its fiduciary impact, and fiduciary risk management through policy design. A recording of the webinar and the slides are now available for download on our website.

There were several questions during the webinar looking for further insights into fiduciary risk management that we were not able to answer during the allotted time. Joe kindly answered all of those questions, which we are happy to present in the following Q&A:

Q. Does an advisor need to hold licenses for fee advising on insurance products for each state he or she operates in? 
A. Most States have a reciprocal arrangement for Licensed Counselors. 

Q. How many insurance firms offer fee-based insurance products, especially life insurance? 
A. There are four companies that provide advisor-designed life policies, plus a larger number of entities that provide no-load variable annuities. Keep in mind that policy placement is the LAST action in the fiduciary process.