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New SEC rules that require federally-registered advisors to disclose their disciplinary histories in brochures and provide them to clients will get under way in earnest by the end of the summer. The initiative, aimed at improving transparency for investors, is likely to result in some difficult conversations for advisors with material marks on their records. And those conversations will occur not only between advisors and their clients but also among advisors at the same firm, two experts predicted.
“You can have relationship problems with your clients if they don’t like the disclosures… (Advisors) have got to worry about explaining something to clients that may not have been part of the previous conversations they had,” said attorney Patrick J. Burns Jr. of Beverly Hills, Calif. He added, “People that have some disclosures, if they’re at a small firm and now they have to hand out these brochure supplements, how does that affect the rest of the firm? It’s going to make for some very hard conversations if that’s the reason you’re not winning any new business.”
The SEC last year decided to recast its Form ADV by adding a Part 2B, a disclosure supplement to the document that advisors currently provide to clients which includes information on services and fees. Among other things, Part 2B must explain, in plain English, the advisor’s educational background and business history, other business activities, supervision, and any material disciplinary history (certain state-registered advisors also must disclose awards in certain arbitration or civil cases, and bankruptcy filings.)
The rule only applies to closed cases that resulted in findings against advisors, and it allows the advisor to decide what constitutes a “material” result. That isn’t a loophole for avoiding a disclosure, however, Burns said; it’s what a “reasonable person” would decide is material. “If there’s something that’s material and you make the wrong call, I don’t think you’d get in trouble if you had a reasonable basis for disagreeing with them,” he said. The SEC offers examples of what they’re looking for: felony convictions, misdemeanor convictions involving investment-related business fraud, regulatory administrative hearings that find that the advisor broke investment rules, among things.
The SEC pushed back the deadline for implementing Part 2B to accommodate wirehouses that had thousands of advisors for whom brochures were required. Newly registered advisors (those who registered between Jan. 1 and April 30 of this year) were required to deliver Part 2B brochures to new and prospective clients by May 1, and to existing clients by July 1. Advisors who were registered before the start of this year have until July 31 to provide the brochures to new and prospective clients, and until Sept. 30 to existing clients.
Part 2B is not sitting well with some advisors. A Morgan Stanley Smith Barney advisor told Registered Rep. this week that the company let him know on Tuesday it was including advisor disciplinary history in “welcome packets” to clients with managed accounts. “All of us have written complaints that never go anywhere,” he said. He called it an “invasion of privacy” and predicted it would erode client confidence in an advisor. He didn’t understand why the firm didn’t just refer clients to their CRD filings, which can be found at the SEC’s website.
Burns said the written complaints that the MSSB advisor protested aren’t required to be included in the brochure; only material findings against the advisor must be disclosed. The new rules are designed to make it easier for consumers to evaluate a prospective advisor’s credentials; “I’m not sure how your average client that doesn’t have a financial services background is ever going to be able to look up these disclosures without having a brochure handed to them,” he said.
A Morgan Stanley Smith Barney spokesperson said the firm was taking “appropriate steps to comply with this new requirement,” and declined further comment. In an email, Merrill Lynch spokeswoman Selena Morris wrote, “We support the SEC's regulatory initiatives promoting transparency and plain language disclosures to clients. We are working with our advisors to make sure that our clients have all of the information called for by the regulations. In fact, we are looking to deliver this information in the manner in which our clients want to receive it, either electronically or in paper.” Spokespersons at Wells Fargo Advisors, and UBS Wealth Management Americas could not be reached for comment.
Dan Inveen, principal of the advisor consultancy FA Insight in Tacoma, Wash., said Part 2B is a cause of concern to some advisors. “I’ve heard instances of things that got into an advisor’s record that may not have been entirely fair and they’ve got a great explanation, but they can’t cleanse those records,” he said. “But from the standpoint of the overall good of the industry, I think the regulators’ intentions are good. Certainly more disclosure will keep everybody more honest and help better identify the rogue advisors out there.”
“If you do have disciplinary issues and you know you’ve got to disclose them, be upfront about that and control the message before your client hears it through another source,” Inveen said. “I would just tell them the truth. If at one time in the past you made a mistake, I would fess up and just let them know that you might have made a mistake and here were the circumstances and you learned lessons from it, and you’re a better advisor from the experience.
“Trust is huge. That’s how people make their decisions about who to affiliate with when they’re thinking about advisors. If you can’t establish and win that trust, an advisor is going to have a difficult time making a go of it.”
