• / Free eNewsletters & Magazine
  • / My Account

Related Content

  1. Videos
  2. Articles
  1. Despite Recent Compromise, No Long-Term Tax Certainty

    Investors still need to plan for long-term tax hikes and keep AMT exposure, itemized deduction limitations, charitable distribution opportunities, and trust taxation on their radars, says Investor Solutions' John Pitlosh.

  2. 5 Medalist Funds Shining in a Stormy Year

    Some defensive-minded funds have thrived, while others have outperformed by playing offense or pulling back on some hard-hit areas of the market, says Morningstar's Russ Kinnel.

  3. Tap Into Unloved MLPs Using Exchange-Traded Notes

    Because of their tax structure and low fees, exchange-traded notes are among the best ways to gain exposure to master limited partnerships, says Morningstar's Bob Goldsborough.

  4. Don't Make These Tax Mistakes

    Inefficient contributions and withdrawals and poorly timed asset purchases are among the many common tax-related blunders, but Morningstar's Christine Benz offers solutions to avoid such pitfalls.

A Higher Standard

When acting in clients’ best interest, RIAs may need to ramp up fiduciary compliance activities. 

Sheryl Rowling, 10/14/2016

The new U.S. Department of Labor (DOL) rules imposing fiduciary requirements on professionals who advise on retirement accounts can have far-reaching effects. (To learn how broker/dealers can prepare for the April deadline, check out Morningstar’s Best Interest site.) Even though registered investment advisors (RIAs) who have always held themselves out as fiduciaries might believe that they are immune to these new rules, they actually now need to consider and document how they put clients' interests first.

Let's take this particular sentence in the DOL's preamble:

“Specifically, the final rule includes text that describes management of securities or other investment property, as including, among other things, recommendations on investment policies or strategies, portfolio composition, or recommendations on distributions, including rollovers, from a plan or IRA.”

This one single sentence encompasses every aspect of investment advice from investment policies, risk tolerance assessment, choice of investments, and asset allocation to distribution strategies and rollover recommendations. So, what does this mean? In my opinion, avoiding conflicts of interest means more than simply not selling commission-generating products. Advisors must proactively ensure that every aspect of service related to retirement accounts is in the best interest of clients and, thus, ramp up their fiduciary compliance activities.

As an advisor, I am looking at how these rules might affect my own practice. Based on what I know at this point, I believe we will need to invest time and money into more robust processes and documentation in our advisory tasks, as broken into three categories: Pre-Investing, Investing and Advice, described as follows:

Pre-Investing functions can include risk tolerance assessment, designing and recommending an asset allocation, coordinating investment goals with financial planning and creating an investment policy statement.

Our fiduciary strategies: In the “Pre-Investing” category, it’s all about getting to know the clients, including their goals, risk tolerance, current assets and liabilities, tax situation, etc. Some of this knowledge is factual, such as investment statements, tax returns and mortgage balances. Other pieces are “soft,” which require meetings, evaluation, and analysis. In all aspects of pre-investing services, the advisor is faced with integrating the factual with the non-factual. We will focus on risk tolerance, asset allocation, financial planning and proposal generation.

For risk tolerance, we will be relying on quantitative risk tolerance assessment tools as well as integrating qualitative information from client meeting to truly assess clients’ ability to tolerate risk. For asset allocation models, as opposed to arbitrarily selecting asset classes and percentages for asset allocation models, due professional care requires analysis and documentation.

Although we use software tools to design our own allocation models, outsourcing to a qualified provider can also be a good solution. Since each client has individual needs and goals, I firmly believe that investment managers who don’t integrate financial planning risk noncompliance with fiduciary requirements.

Depending on the advisor’s/clients’ needs, software choices can be basic or complex, goals-based or cash flow-based, modular or comprehensive, interactive or report output and integrated with other advisory software or stand-alone. Finally, demonstrating and documenting a fiduciary engagement relationship requires attention to both objective and subjective details with formal proposal documents. Client deliverables include a formal proposal summarizing services and value-added benefits, summation of fees and expenses, engagement letter, and Investment Policy Statement (IPS).

Investing responsibilities are comprised of selecting funds, ETFs, stocks, bonds, and/or other investment vehicles for the clients' portfolio; determining an appropriate management strategy considering rebalancing parameters, cash needs and tax implications; selecting a custodian (or custodians) based on clients' needs and preferences as well as "best execution;" implementing an effective and coherent portfolio monitoring and reporting system; and utilizing a timely methodology for monitoring and evaluating funds' (and other holdings) performance and management on an ongoing basis. 

Our fiduciary strategies: The “investing” phase involves all functions related to choosing investments, managing and monitoring the portfolio, reporting and choosing custodians. To thoroughly analyze and document compliance with fiduciary requirements, my firm utilizes several tools for consistency, automation, and quality control, such as portfolio accounting software, rebalancing software, data aggregation and investment analysis tools. For firms that would rather take the headache out of all the new compliance requirements, outsourcing to a turnkey solution could be a good option.

Advice services might encompass recommending an implementation strategy on 401(k) accounts (such as choosing between a target date fund, pre-selected asset allocation, or hands-on management), advising on rolling qualified plan assets into an IRA, suggesting Roth conversion (or reversal) and developing a draw-down plan in retirement. 

Our fiduciary strategies: Although more nebulous that the prior two categories, our “advice” services will be thoroughly documented as meeting industry standards and in the best interests of clients. Thus, advising on 401(k)s, 529 plans, Roth conversions, retirement draw-down strategies, etc. will be verified through outside channels rather than merely our internal evaluation. Many of these tools are relevant in the advice category. Additional resources can include retirement plan and 529 plan analyses tools, tax projection software, and tax research tools. The bottom line is that any advice provided to a client must have some type of written support to document the “best interest” requirement.

Finally, although the new rules apply only to retirement accounts, all of the financial services we provide can impact and overlap between retirement and non-retirement accounts. For example, it might be improper to recommend an asset allocation for a 401(k) account without considering other investments held by the client. Likewise, analyzing a draw-down strategy would be incomplete without coordination with the client's non-retirement holdings and taxable income situation. In other words, the blurred line between retirement advice and non-retirement advice means that advisors must be very careful when providing any financial services post the DOL rules effective date.


Upcoming Events

©2014 Morningstar Advisor. All right reserved.