I hate making predictions. It makes me feel like another dart-throwing monkey. But I am confident about this one.
Soon – within the next two years – the SEC will wake up and start holding financial advisors who use TAMPs to the same fiduciary standards they hold them to in selecting mutual funds, ETFs, and other investment products. When it does, many advisors will be in trouble.
The nature of the problem
The problem takes two forms.
Some advisors don’t think of the selection of a TAMP to manage their clients’ assets as an investment decision. Instead, they treat it like any other vendor selection. They put it in the same mental category as choosing financial planning software or a portfolio accounting system.
The other form of the problem stems from inertia. Fully recognizing the selection of a TAMP as an investment decision and treating it that way requires ongoing effort. Most advisors have full plates. They don’t relish taking on more work.
And some advisors have existing relationships with TAMPs that have been in place for years. They are not eager to disrupt those relationships and face the burden of moving business from one TAMP to another based on fiduciary considerations.
Overriding these concerns is the fact that the SEC has been relatively silent on this topic. Why do the work of performing investment-oriented due diligence on TAMPs and looking critically at the costs and quality of their offerings? Why assume the burden of updating that due diligence periodically? Why give up the benefits you might receive and consider only the best interests of clients in TAMP selection? The SEC has never held anyone accountable in those areas. There is little apparent danger to an advisor who adopts a laissez-faire approach to TAMP selection.
Change is in the wind
True enough, but things will change.
The SEC will soon show up on some poor advisor’s doorstep and apply the same standards to TAMP selection that it applies to the selection of any investment manager.
Here’s why I am confident this prediction will come true.
The selection of a TAMP is an investment decision. The fact that the SEC has never directly said so doesn’t change that.
When an advisor outsources a client’s portfolio management to a TAMP, the TAMP takes discretion over the management of the client’s assets. It’s no different than buying a mutual fund or hiring a separate account manager for the client. The advisor is hiring the TAMP to manage the client’s assets.
Therefore, the advisor has the same responsibility to perform due diligence on the TAMP as on a fund or a manager. And under applicable standards the advisor must update that due diligence periodically and document the selection process.
The advisor must also consider the best interests of the client in making the selection decision. An advisor cannot select a mutual fund that pays the advisor a fat trailer if better alternatives are available for the client. In the same way, an advisor cannot disadvantage a client in the selection of a TAMP if better alternatives are available.
Here are the signs that the SEC will soon take a greater interest in this area.
In the past three years the SEC has brought many mutual-fund share-class enforcement actions. The message resonates: You can’t cause clients to pay more if better alternatives are available.
In December 2021 an SEC committee called out advisory firms for the poor quality of their disclosures on form CRS, which is intended to help investors understand possible conflicts of interest and standards of conduct applicable to advisory firms.
In November 2021, the SEC issued a Risk Alert related to practices by advisors who provide their clients with investments through automated digital offerings – roboadvisors. The SEC found widespread deficiencies in advisors’ discharge of their fiduciary duties that harmed clients in terms of the cost and quality of the investment solutions they received.
In November 2021, the SEC issued another Risk Alert in which it noted a large number of fiduciary failures by advisors related to fees and expenses imposed on their clients. Again, the SEC is focused on breaches of fiduciary duty that cost clients money.
In July 2021, the SEC issued a Risk Alert regarding fiduciary failures in advisors’ use of wrap fee programs. The SEC raised issues related to fees and expenses that cost clients money and conflicts of interest that harm clients financially and in terms of investment quality.
In June 2020, the SEC issued a Risk Alert related to compliance failures they found in the examination of private funds and hedge funds run by advisors. Again, they noted a range of fiduciary failures and conflicts of interest that harmed clients financially.
The pattern and the message are clear. Advisors have a fiduciary responsibility in selecting investments for their clients. They must determine that the investments they recommend are reasonably priced and of good quality. They must perform adequate due diligence on an ongoing basis, document their process, and avoid conflicts of interest.
What to do about it
There are many TAMP alternatives. They differ dramatically in cost, performance, experience of investment team, quality of investment process, and the level of support they offer to advisors and their clients.
To avoid trouble with the regulators and to properly discharge their fiduciary duty to clients, advisors must sort through these alternatives with their clients’ best interests in mind. Unfortunately, there are no truly objective, comprehensive data services available to help with this process as there are for mutual funds, ETFs, and separate account managers.
The fact that a TAMP has lots of assets or has been around a long time does not justify selecting it to manage your clients’ assets. You wouldn’t satisfy your fiduciary duty to your clients by selecting a mutual fund because it is big or old; the same is true in the TAMP space.
Watch out for TAMPs that try to buy your business by offering you services at your clients’ expense. A number of high-fee TAMPs have started offering services to advisors that do not directly benefit the advisors’ clients. Watch out. It means you are using client assets to buy services for yourself or your firm. This practice won’t pass fiduciary muster.
The regulatory spotlight will soon shine on the practices around TAMP selection. Get ready before you feel the heat.