Journal of Financial Planning: February 2019
Todd Sakoda is a compliance consultant with The Consortium (liftburden.com), which was founded on the philosophy that marketing and compliance can work in harmony. He is also a compliance coach for the FPA Coaches Corner.
Financial planners can serve the best interests of their clients in many ways. Some planning and advisory firms—with the appropriate background and expertise on staff—choose to directly manage their clients’ portfolios. Others may choose to focus their time on financial planning needs and outsource the investment management.
Regardless of how a planner decides to operate, it’s important that a firm’s disclosure documents are in line with what they are doing, and that the firm is properly registered.
Regulators will scrutinize a firm’s disclosure documents for accuracy. The focus of this column is to help planners who outsource (or plan to outsource) the investment management to third-party money managers understand their situation so they can properly answer the disclosure questions in the SEC’s forms ADV 1, ADV 2A, and ADV 2B, and determine whether the structure of the third-party money manager relationship makes sense for their situation.
Issues and Considerations
Consider the following potential issues and considerations when working with third-party money managers.
1. What is the true nature of your firm’s relationship with the third-party money manager(s)?
- Are you acting as a solicitor?
- Is the third-party money manager acting as a sub-adviser?
2. Under this relationship, what services are you providing clients versus the services that the third-party money manager is providing?
3. How are you compensated? How is the third-party money manager compensated?
4. How do you disclose the true nature of the relationship on your ADV disclosures?
5. When the third-party money manager is engaged, is the client still considered a client of yours?
6. If they are deducting fees, but it is “your client”:
- Are they doing it properly under the custody rule?
- Are they billing in advance for a period of more than six months (triggering audited financials for you if it is “your client”)?
7. Is it your policy not to have dis-cretion?
- If so, does the third-party money manager trade with discretionary authority?
- Are you responsible for approving their trades? (If you approve recommended changes without prior client approval, you are likely violating your policy and taking discretion.)
8. How does the outsourcing of the investment management impact your firm’s value proposition?
9. What is the reputational risk of working with third-party money manager(s)?
10. If things go wrong with a specific client account, can they disclaim liability because it is your advisory account?
Due Diligence
During your due diligence process, discussions with sales representatives or relationship managers of the third-party money manager will often provide you with the general information you need to answer the questions here. That said, it may serve you well to read through the third-party money manager’s actual documents (Form ADV, agreement between your firms, and the advisory agreement your clients will sign), even though it will require additional time and analysis.
The devil is in the details. When push comes to shove, these documents will likely be at the center of determining whether your firm’s disclosures are accurate, as well as the ultimate responsibility on any issues that arise.
This article was originally posted on the FPA Coaches Corner. FPA members can access more resources from Todd Sakoda to help strengthen compliance policies and procedures at OneFPA.org/CoachesCorner.