Advisors eager to adapt to CRM requirements can take some cues from their U.S. counterparts.
They’ve spent more than a decade adapting to rules creating stricter compliance regimens, and greater disclosures to clients.
“The bar keeps getting set higher each year, and the expectations by [SEC] staff and their examinations have changed a lot,” says Michael Koffler, partner and compliance expert at Sutherland Asbill & Brennan LLP in New York City.
Over the last 12 years, he notes, U.S. advisors have dealt with numerous regulatory changes, such as SEC rule 206(4)-7.
This rule calls upon U.S. advisors to address trade timing and clearance, improve portfolio management processes, and to properly disclose how access to new issues and other investments is allocated among clients.
And, it requires advisors to improve disclosures to clients (including their account statements) and develop better procedures for valuing client holdings, as well as to assess the fees that are imposed based on those values.
So, the advisory industry was given what amounted to a brokerage overlay. Sound familiar?
Fortunately, the structure of U.S. securities regulation means a majority of firms have traditionally been licensed as both Investment Advisers (as they spell it) and Broker Dealers. And advisory firms that aren’t dually registered frequently adopt procedures used by the custodial brokers with which they work to place business. Jacqueline Bell, director at Dowling & Yahnke, LLC in San Diego, Calif., says the rules didn’t negatively impact her firm’s bottom line because they were already complying.
“Prior to 2003,” says Bell, “we had already named a chief compliance officer, we were already conducting annual reviews of our policies and procedures, and we had written policies for all supervised persons within the firm. So it was really not a game changer for us.”
A few years later, the SEC began enhancing its Form ADV, which is used to register advisors. Data from those forms is used by the SEC to build an advisory disclosure website to inform clients and prospects about a firm’s structure and to highlight any past wrongdoing.
In particular, Part 2 of the form now requires disclosure of a firm’s fee schedule, any disciplinary information, conflicts of interest and the educational and business backgrounds of managers and other key personnel.
Since early 2011, that disclosure has to come in the form of a brochure written in what the SEC deems plain English, and firms are required to update the brochure when any material changes take place.
“We did overhaul our ADV [to be] in compliance, and that was a significant project, but again not something totally outside what we had been doing. […] It was an expansion of scope as opposed to doing something completely new,” says Bell.
Kenneth Klabunde, founding principal at state-filed Precedent Asset Management in Indianapolis, Ind., sees the enhanced Form ADV as a positive development for both clients and advisors.
“[It’s] a huge improvement in terms of communicating with clients,” he says. “The ADV transitioned from a non-legible document to something you can read [to] get a good sense of how an advisory firm operates.”
Form ADV in practice
Even with the plain language improvements, Klabunde says it’s the rare consumer who reads a regulatory disclosure document—and ADV is several pages long. So, it’s become the advisor’s responsibility to discuss the form’s content, and not simply hand over the brochure and expect clients to read it.
Bell agrees. She says clients don’t seem eager to read the form, and aren’t asking questions about the new disclosures. “All that information in the ADV is [data] that we verbally disclose in our initial meetings with prospects. I’ve never had a call from [a client] needing to follow up on anything.”
In those initial discussions, Bell says she emphasizes key client concerns, such as fees, fee schedules, and investment philosophy and strategy; legal concerns like the firm’s code of ethics are discussed, but to a lesser extent.
Neither Bell nor Klabunde has lost a client because of the disclosures. Nor has cost had a significant impact on their firms’ bottom lines, even with the requirement to include material changes.
“If you understand the regulations and you’re not trying to hide anything from your clients, complying with the ADV regulations is easy to do,” says Klabunde. “You draft it according to the rules; you accurately disclose everything that needs to be disclosed.”
Bell says the disclosure costs are immaterial because SEC filing and material updates to the ADV are electronic, and her firm was already distributing the new disclosures to clients.
Changes in the field
Potentially more worrisome, notes Koffler, are unfolding site examination practices and other factors that work in tandem with the rule changes that are increasing the regulatory burden. Sweep exams during which the SEC visits firms to review compliance with a variety of regulations (anything from books and records, to short selling or disclosure), in particular, have become more aggressive.
Traditionally, sweeps were undertaken to benchmark the performance of firms against one another and, by extension, to determine whether certain firms were compliance outliers. In the case of universal non-compliance, sweeps would find systemic issues with a given rule.
But policy changes, including SEC Chair Mary Jo White’s so-called broken windows strategy, have created an environment in which sweeps result in enforcement actions against firms, whereas in the past they’d normally receive deficiency letters outlining what steps had to be taken to ensure future compliance. A staffing-up of the Commission’s enforcement division, and a feeling among some commissioners that the regulator had been blindsided by the Madoff scandal, also contributed to a change in tone.
“The personnel and the shift in approach of both some of the commissioners and some of the staff is a huge impact,” says Koffler. “You have probably more enforcement actions brought against compliance officers in the last 24 months than the prior few years. That’s not the result of an act; it’s the result of a different emphasis and approach.”
He adds that technological change is also playing a role. The Commission is making use of technology to analyze trading data to look for anomalies that could signal non-compliance or fraud. Based on the severity of what they see, staff can contact a firm immediately and demand an explanation about a trading practice, or address the concern during a site exam.
To the SEC’s credit, Koffler says the annual review required by 206(4)-7 has not resulted in the commission “playing gotcha,” as many in the industry first feared. If firms do a good job, they’re left to respond to their own recommendations.
Bell says her firm hasn’t had increased enforcement because of data mining. “Over the last eight years, we’ve had one review where personnel from the SEC come in to the firm to be on site for a formal review. We haven’t seen any escalation. Once every seven to eight years is what we expect.”
by Michelle Schriver, a Toronto-based editor and writer and Philip Porado, director of content, Financial Services and Advisor Group
Originally published in Advisor's Edge
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