For many advisors, the Series 65 is a ticking time bomb. Or, so says Donald B. Trone, founder of the Foundation for Fiduciary Studies in Pittsburgh.
Trone, a long-time investment consultant, contends that no one is paying attention to a tricky, sticky matter: The fiduciary responsibility advisors holding a Series 65 have for managing other people's money and making what's called prudent decisions. It's a responsibility that goes well beyond that of Series 7 brokers. And, according to Trone, if you don't follow the right fiduciary practices, you just might wind up in a heap of legal trouble.
To prevent that from happening, Trone developed a five-step process, with more than two dozen specific practices, that advisors can follow to make sure they fulfill their fiduciary responsibilities. Four years ago, he started training advisors in how to use them; about 1,000 people have gone through the program. And, a year ago, he introduced a professional designation for those who have completed the training. Courses now are offered over the Web or at the University of Pittsburgh or Stetson University in Orlando.
We talked to Trone about his views on the problem and what he's doing to address them.
Can you discuss in more detail what the advisor's responsibilities are?
The SEC has taken the position that a registered investment advisor has a fiduciary relationship with their clients. That, of course, implies a much higher standard of care than what's required of people holding a Series 7 license. This responsibility isn't determined by investment performance, but by whether sound investment practices were followed. The point is, it doesn't really pertain to how well the investments you choose perform. It has to do with how prudent your management of them was. Most investments are rarely not prudent. It's how they're used and how the decisions were made regarding their use that determines whether the standard for prudence was met. If you lose money, but followed the correct practices, you will have fulfilled your responsibilities.
But the implications for advisors registered with the SEC at either the state or federal level is that, if the advice does not meet a fiduciary standard of care, they're vulnerable to litigation.
Do you think many people with a Series 65 have a clue there's a potential problem brewing?
Even though the stakes are pretty high, I think it's very safe to say that most advisors don't understand these implications.
What about the rest of the financial advisory community?
The question of fiduciary responsibility is highly contentious. I find that no one wants to touch the issue. The broker/dealer community, for example, is trying to avoid any connectivity between a broker's activity and a fiduciary standard of care. The standard of care for people with a fiduciary relationship to a client, as I said, is much higher than that of a brokerage relationship with the same client. But any professional organization ideally would like to be held accountable to the lowest standard it can get away with.
The standard preparation for the Series 65 doesn't go into any of these issues?
One of my staff members just took the Series 65, and I asked him whether the exam in any way addressed practices the advisor should follow as a fiduciary. I was told that the test, or preparation for it, does not even remotely address fiduciary issues. The point is this: The Series 65 does not properly prepare advisors for their role as a fiduciary.
Can you tell us about how you're trying to better prepare advisors?
The additional things an advisor should learn are steps I've developed and laid out in a handbook called Prudent Investment Practices. We have 27 practices, arranged so they sequentially fall according to the appropriate stage in the investment management process. The stages, by the way, include analyzing your client's current position, diversifying and allocating the portfolio, formalizing an investment policy, implementing the policy and monitoring and supervising that policy.
What's the most important step?
The most critical practices would be the ones that pertain to the preparation and maintenance of the investment policy statement. That means an outline of how the fiduciary responsibilities will be met. It's the business plan that the advisor follows in managing a client's assets. You lay out the goals and objectives of the client, the parameters of the asset allocation, like risk tolerance, what type of return they need to meet their goals and objectives, and the time horizon of their investment strategy. It becomes a written document prepared by the advisor and signed by the client that says this is how we're going to manage your assets. And, as a result, you significantly reduce the probability of miscommunication and reduce the probability of litigation.
Are there are other benefits?
These practices also make the best investment sense. First, when they follow these steps, advisors often wind up fine-tuning their asset allocation, and that translates to better long-term investment performance. Because we provide a more detailed due diligence process for the selection of investment options, the client typically ends up with a better array of options. Also, our detailed monitoring criteria translate into insights about when and how to terminate a manager of a fund that's dead wood. Plus, since advisors going through this process have to thoroughly understand all their fees and expenses, they may be able to devise new fee saving arrangements with clients.
Any other related issues?
One significant issue in the future for advisors is going to be the ability to get professional insurance to cover their work. Just as we've seen medical insurance dramatically changed because of medical malpractice, we'll see a similar phenomenon with investment advisors over the next ten years. We're beginning to see it now. Liability insurance already has risen at least 25 percent to 30 percent over the last three years, and there's no end in sight. If liability insurance continues to rise at that rate, it will only take a couple more years before the cost will weigh very heavily on an advisor's practice. When you talk to property and casualty companies that underwrite advisors' insurance, however, you discover they have virtually no standards that address fiduciary responsibility. As a result, good advisors end up carrying the cost of the advisors who are doing a poor job. We're trying to convince these companies to reduce the premiums of advisors who affirm they're following our practices. So, poor advisors would end up paying more.
