ADV Part 1 Changes

As many of you are aware, the U.S. Securities and Exchange Commission (“SEC”) issued a final rule in August 2016, which significantly expands the information required in Form ADV Part 1. The compliance date for the rule is October 1, 2017, and all investment advisers making Form ADV filings on and after that date will need to include the additional information, as applicable. Below is a summary of the areas in the document that are materially affected.

I want to be sure that you are aware of these changes as this will require some work on your part to be ready to provide the information for Item 5 as part of your annual updating amendment in the first quarter. Please read the information below and work with your portfolio management application provider to determine how you can provide this information.  You may want to run the numbers as of 9/30/17 to be sure that you are prepared.

Item 1 – Identifying Information

Item 1F(5) – List the total number of offices, other than principal office (which is referenced Item 1F).  In Schedule D for Item 1F, you will be required to include the (i) address, phone and fax number for each location; (ii) number of employees at that location, (iii) other type of business activities performed at this location; and (iv) description of any investment-related business activities conducted from this location.

Item 1I – Check this box if the firm utilizes social media sites (e.g., LinkedIn, Facebook, etc.). In Schedule D for Item 1I, you will be required to list the address of all social media sites utilized by the firm.

Item 5 – Information about Your Advisory Business

Item 5C(1) – Provide the number of clients for whom you do NOT have regulatory assets under management, but provided investment advisory services during the most recent fiscal year.

Item 5D – Provide the number of clients AND the corresponding regulatory assets under management (“RAUM”) (no longer range of clients) for each client type listed below.  The type of clients listed are:

(a)     Individuals

(b)     High net worth individuals

(c)     Banking or thrift institutions

(d)     Investment companies

(e)     Business development companies

(f)      Pooled investment vehicles (other than investment companies and business development companies)

(g)     Pension and profit sharing plans (but not the plan participants or government pension plans

(h)     Charitable organizations

(i)       State or municipal government entities (including government pension plans)

(j)       Other investment advisers

(k)     Insurance companies

(l)       Sovereign wealth funds and foreign official institutions

(m)   Corporations or other businesses not listed above

(n)     Other

The total RAUM from Item 5D must be consistent with Item 5F where your RAUM are listed as either discretionary or non-discretionary.

Item 5F(3) – Provide the RAUM (reported in 5F(2)) attributable to client who are non-United States persons.

Item 5I(1) – If you participate in a wrap fee program, what is the amount of RAUM attributable to acting as:

(a)     sponsor to a wrap fee program

(b)     portfolio manager for a wrap fee program

(c)     sponsor to and portfolio manager for the same wrap fee program

In Schedule D for Item 5I(1) provide name of sponsor for each wrap program participated in by the firm, including the sponsor’s SEC and CRD numbers.

You are not required to enter anything in Item 5I if your involvement in a wrap fee program is limited to recommending wrap fee programs to your clients.

Item 5J(2) – Indicate whether the AUM reflected in Form ADV Part 2A is calculated differently than the RAUM reported in Form ADV Part 1.

Item 5K(1) – Indicate whether you have RAUM attributable to clients other than those listed in Item 5D(3)(d)-(f). (This should be a “yes” response.)

In Schedule D for Item 5K(1) complete the chart reflecting the percent of RAUM by asset type for separately managed accounts (SMA) (see definition of SMA below)*. Use the date used to calculate your RAUM for purposes of your annual updating amendment. Below is a list of Asset Types:

(i)                   Exchange-Traded Equity Securities

(ii)                 Non Exchange-Traded Equity Securities

(iii)                U.S. Government/Agency Bonds

(iv)                U.S. State and Local Bonds

(v)                 Sovereign Bonds

(vi)                Investment Grade Corporate Bonds

(vii)              Non-Investment Grade Corporate Bonds

(viii)             Derivatives

(ix)                Securities Issued by Registered Investment companies or Business Development Companies

(x)                 Securities Issued by Pooled Investment Vehicles (other than Registered Investment Companies or Business Development Companies)

(xi)                Cash and Cash Equivalents

(xii)              Other

Item 5K(2) – Indicate whether you engage in borrowing transactions on behalf of any separately managed account clients that you advise.  If so, please let me know as there is other information that will need to be provided.

Item 5K(3) – Indicate whether you engage in derivative transactions on behalf of any of the separately managed account clients that you advise. If so, please let me know as there is other information that will need to be provided.

Item 5K(4) – Indicate whether any custodian holds 10% or more of SMA RAUM.

Report RAUM attributable to clients other than those listed in Item 5D(3)(d)-(f) (see list above) (separately managed accounts).

* A separately managed account (SAM) is defined as advisory accounts other than pooled investment vehicles (e.g., registered investment companies, business development companies and private funds). Based on this definition it is my understanding that an SAM is a mutual fund, ETF, and individual stocks.

In Schedule D for Item 5K(4) provide the following information for any custodian that holds 10% or more of your aggregate SMA RAUM.

(a)     Legal name of custodian

(b)     Primary business name of custodian

(c)     Location of custodian’s office(s) responsible for custody of the assets (city, state, country)

(d)     Is custodian a related person of the firm?

(e)     If the custodian is a broker-dealer, provide its SEC registration number

(f)      If the custodian is not a broker-dealer, or does not have an SEC registration number, provide its legal entity identifier

(g)     Provide the RAUM attributable to separately managed accounts held at the custodian

 

 

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Morningstar Introduces Best Interest Scorecard

The consolidated proposal system, available in Morningstar® Advisor Workstation(SM), represents company’s ongoing efforts to help advisors serve clients’ best interests

CHICAGO, Oct. 26, 2017 /PRNewswire/ — Morningstar, Inc. (NASDAQ: MORN), a leading provider of independent investment research, today announced the launch of the Morningstar Best Interest Scorecard, designed for financial advisors to help clients make an informed decision on possible rollover options designed with their best interests in mind. This new tool demonstrates Morningstar’s ongoing efforts to prioritize investors’ best interests in light of changing regulatory requirements for retirement accounts, as well as evolving investor preferences and global trends around investment advice. The Best Interest Scorecard is available as an add-on feature in Morningstar® Advisor WorkstationSM.

Morningstar, Inc. Best Interest Scorecard

“Investors today are demanding a more collaborative and transparent approach to investment advice, which is driving advisors to better demonstrate and document the value of their advice,” said Tricia Rothschild, chief product officer at Morningstar. “With the Best Interest Scorecard, advisors now have a rigorous, convenient way to assemble the data they need to consider investment options, investors’ preferences and financial situations, and other factors to ensure their advice is in the best interests of prospective or actual clients.”

The Best Interest Scorecard is a comprehensive tool that enables advisors to assess the client’s current investment plan; changes the client could make within their current plan; and the new portfolio and service offering that the advisor is proposing for the client through a rollover or other process.

Advisors can then determine, demonstrate, and document whether their proposal is in the investor’s best interest through three different lenses:

  • Investment Value: The expected returns and costs of 97.5 percent of US mutual fund and ETF assets, powered by our research team’s ratings and methodology.
  • Client Fit: Overall efficiency of the asset allocation relative to Morningstar® Target Risk Indexes1 and the ability of the plans to deliver a portfolio that matches the client’s risk profile. In a sample of retirement portfolios, Morningstar found that 90 percent were aligned with the asset allocation and diversification embedded in the Target Risk Indexes and 10 percent were not2.
  • Service Value: The net benefit of financial planning services provided, dynamically mapped to the investor’s needs. Morningstarresearch has revealed that these services can add more than 20 percent to an investor’s income in retirement before fees.3 Examples include life insurance advice, estate planning, behavioral coaching, rebalancing and annuity purchase decisions.

The Best Interest Scorecard also allows advisors to capture other client factors, such as appreciated employer securities, financial health of the investor and employer, or desire to work with an advisor, without weighing these factors explicitly in scores.

“For the first time, advisors can provide investors with a clear, concise synopsis of how their proposal could benefit them,” said David Blanchett, head of retirement research at Morningstar Investment Management LLC. “Our methodology is unique as it combines ratings and analytics from Morningstar’s comprehensive investment database with retirement plan data and aggregation capabilities to give advisors the most up-to-date and rigorous information we can get on retirement plan fees, lineups, and participant portfolios.”

The Best Interest Scorecard is fueled by Morningstar’s proprietary research including the Morningstar Quantitative RatingTM, asset allocation models and portfolio analytics to assess portfolio risk and returns-based style, and proprietary measures of the utility of advisory and financial planning services to investors at different stages of their investing career. All these have been assembled into a concise decision architecture that enables advisors to assess the net benefit for their client of changing to their proposed plan and portfolio from an existing one.

Please visit http://www.morningstar.com/company/dol-fiduciary-rule for more information about the Morningstar Best Interest Scorecard and Morningstar’s Best Interest Solutions. Learn more details about the research behind the Best Interest Scorecard at http://www.morningstar.com/blog/2017/09/28/rolling-over-401k.html.

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Disaster Recovery Plans

With all of the disasters in the past couple of months (hurricane, fires, floods) now is a great time to determine the adequacy of  your Disaster Recovery Plan (“Plan”).  You are required to “test” your  Plan each year.  Riding out a disaster is an opportunity to “test” the Plan.  Create an after-action report if you will and document this “test”.  Your “test” didn’t occur if it isn’t documented, so be sure to document what you did and what you learned.

I have been reviewing several Plans in the past  weeks as part of the Annual Document Review for clients.  After discussions with those clients that have been through a disaster recently and reviewing these Plans, I feel it is important to have a hard copy of your plan handy AND that the Plan include the information that you need to know in the event that you don’t have access to anything at your office or in the cloud. Access to the cloud is not a guarantee during a disaster – as many people can attest to during the past couple of months.

When reviewing your Plan, take a look at the details – do you need to add account numbers or policy numbers in the event of a disaster?  Is the person that is responsible for completing something as part of a disaster preparedness the only person that is trained to do this process?  If so, what happens if they aren’t in the office when this process needs to be performed?  One of my clients discovered during their disaster preparation that the only person in the office that knew how to forward the phones was on vacation.  So their preparations were slowed while they discovered how to forward the phones.

You’ll want to really look at the Plan and determine if you will be able to recover from a disaster with the information in the plan alone.

 

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Cybersecurity Checklist

At the NASAA (North American Securities Administrators Association) annual meeting last month, the group was presented with a tool for state-registered advisers to help them assess their cybersecurity preparedness.

The NASAA Cybersecurity Checklist for Investment Advisers includes 89 assessment areas to help identity, protect and detect cybersecurity vulnerabilities, and respond to and recover from cyber events.

Take a look at the checklist.

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The Fiduciary Rule, Distributions and Rollovers

information provided by Fred Reisch blog at FredReisch.com

Now that it seems likely that the fiduciary rule and the transition exemptions will continue “as is” until at least July 1, 2019, it’s time to re-visit the fiduciary rule and the requirements of the transition exemptions. This article focuses on the requirements for recommending that a participant take a distribution and roll it over to an IRA with a financial institution and its advisor. (Practically speaking, the financial institutions will likely be broker-dealers, RIA firms, and banks and trust departments). For ease of reading, this article uses “advisor” to refer to both the entity and the individual.

In order to recommend that a participant take a distribution, the financial institution and advisor must satisfy ERISA’s prudent man rule and duty of loyalty. That is because a recommendation to a participant is considered to be advice to a plan. Among other things, that means that, if the advisor violates the rules, there is a cause of action under ERISA for breach of fiduciary duty (as opposed to the Best Interest Contract Exemption, where a private right of action is less certain).

If the advisor will earn more money if a participant’s benefits are moved to an IRA, that will be a prohibited transaction. As a result, the advisor will also need to comply with the condition of an exemption, most likely the Best Interest Contract Exemption (BICE). The transition version of BICE requires that an advisor adhere to the Impartial Conduct Standards. Of those standards, the most significant for this purpose is the best interest standard of care. Since the best interest standard of care and ERISA’s duties of prudence and loyalty are substantially similar, this article just refers to the best interest standard (even though both apply). The best interest standard requires that an advisor obtain the information that is relevant to making a prudent and loyal recommendation about a distribution. The Department of Labor has said that, at the least, that includes the services, investments, and fees and expenses in both the plan and the IRA. In addition, the best interest standard requires that the plan and IRA information be evaluated in light of the needs and circumstances of the participant.

The information about the services, investments, and fees and expenses in the plan is the most difficult to obtain. Fortunately, that information can be found in the participant’s plan disclosure statements. Additional important information is in the participant’s quarterly statements.

But, what if the participant can’t locate the information? Realistically, that should be a rare case, since plan sponsors are required to distribute the disclosures at the time of initial participation and annually thereafter.

But, what if the participant can’t find those disclosure materials? In a set of Frequently Asked Questions, the DOL responded that an advisor must make “diligent and prudent efforts” to obtain the plan information. If the participant can’t find those materials, then it seems likely that, at the least, a diligent and prudent effort would require that the advisor inform the participant that:

  1. The information is usually available on the plan’s website and they could obtain it from that source.
  2. The information is available from the plan sponsor upon request to the benefits personnel.

If neither of those options is successful, or if the participant is unwilling to take those steps, the advisor can use information from the Form 5500 or from industry averages. (Interestingly, 5500 data is not considered primary data for this purpose. It can only be used after a diligent and prudent effort has been made to obtain current plan data from the participant.)

Even where 5500 data or average plan data is used, there are additional considerations:

  • The advisor must provide “fair disclosure” of the significance of using the primary plan data, that is, current information about the plan from, e.g., the participant disclosure forms.
  • Plan averages must be based on “the type and size of plan at issue.” As a result, the advisor will need to know the type and size of the plan.
  • The advisor must explain the alternative data’s limitations.
  • The advisor must explain “how the financial institution determined that the benchmark or other data were reasonable.”

However, it would likely be a rare case that alternative data could be used. If a financial institution finds that its advisors are consistently using alternative data, that suggests that the advisors are not making “diligent and prudent efforts” to obtain actual plan data. The consequence of non-compliance is that the compensation paid from the rollover IRA is prohibited and cannot be retained by the financial institution or the adviser. There could also be an ERISA claim for breach of fiduciary duty.

An additional issue is that the “alternative data” may only include information about fees and expenses. In order to perform a best interest analysis, the advisor must also have information about a plan’s services and investments. For example, does the plan offer a brokerage account where, if the participant desired, the participant could have access to a wider range of investments? Another example is whether the plan offers discretionary investment management for participants’ accounts. If it does not, that may be a valuable service offered by the IRA; but, if it does, the expenses and the quality of those services in the plan and IRA should be compared.

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Finding Fees to Satisfy DOL Rule – Part 2

FeeX for Advisors helps financial advisors comply with the new Department of Labor fiduciary rule regarding 401k rollovers and IRA transfers. FeeX automatically collects and analyzes the 404a5 participant fee disclosure document as its main data source and runs a detailed analysis on an investor’s existing account, taking into consideration the investor’s specific plan and holdings.  This type of detailed analysis could take a veteran advisor days to complete and is now required under the new DOL rule.

The FeeX for Advisors platform automates and streamlines compliance processes thereby saving financial advisors valuable time which allows them to focus their efforts where they are truly needed – helping customers.

The platform allows for a side-by-side comparison of fees, features, past returns and asset allocation against a model portfolio or personalized portfolio. It can be white labeled and deployed in a matter of minutes. It is currently being used by thousands of advisors as well as Fortune 100 financial services companies.

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Finding Fees to Satisfy DOL Rule

A question I keep hearing is “how do I determine the fees associated with the 401(k) or other retirement plans that a client currently owns?”  Good question and could be a difficult one to answer.  Here are some suggestions:

  1. Ask the client to provide you with the Summary Plan Description for the plan.  This should have the information that you require.
  2. Check out a website http://www.showmethefees.com.  It looks like they will provide the information, but you may receive solicitations after entering information to obtain a response.
  3. RiXtrema’s tool IRAFiduciaryOptimizer is a paid software that could be of assistance.

If any of you try these, I would appreciate any feedback.

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