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TAMP Users: Watch Out for This Fiduciary Landmine

Scott's Column

TAMP users beware!  There is a disturbing trend in our industry that may get you in trouble with the regulators if you’re not careful.

Everything Was Fine Until…

It all started innocently enough.  In the “early days” (early 1990s) there weren’t many TAMPs, and their investment offerings were quite different.  Advisors chose which TAMP they worked with based primarily on their assessment of the different investment offerings.

Over the years, many new TAMPs popped up.  Most were copy-cat offerings.  These new-comers often had a hard time differentiating themselves from the more established players.

For the established players, competition was heating up too.  Of course, the new-comers created competitive pressure.  But the larger, more established firms also started looking for additional ways to differentiate themselves from each other and win the hearts and loyalty of financial advisors. Their investment offerings, alone, weren’t doing the trick.

Their solution was often a healthy dose of “practice management.”  TAMPs developed “universities,” “academies,” and every other kind of institute of higher education to help advisors better run their practices.  Today, there are TAMPs with education departments that are seemingly more prominent within their organizations than their investment departments.

Recently, some TAMPs have taken this trend to its logical extreme.  They are offering advisors a range of “free” services, including sales and marketing support, website development, technology, and compliance assistance.  But there’s a catch.  Advisors must bring their clients’ assets to the TAMP to gain access to those services.

When I was a boy, our local bank offered a free toaster to anyone who opened a checking account.  I guess great ideas never die.  But you earned your free toaster by bringing your own money to the bank, not someone else’s.  And, importantly, no one involved was a fiduciary.

Something for Nothing

The modern-day version of the free toaster creates a big, fat fiduciary problem for advisors. Advisors are, in effect, using their clients’ assets to buy services for themselves. If, in the process, their clients are paying more for their TAMP services than they might pay elsewhere for similar services, the advisor may have breached his or her fiduciary duty to their clients.

This is analogous to the “soft dollar” problem that the SEC has dealt with for years in the brokerage industry. Financial advisors have a fiduciary duty to seek “best execution” when they initiate brokerage transactions for their clients. Low price is an important component of getting “best execution.” But in a soft-dollar arrangement, an advisor pays a higher commission to a broker who, in return, sets aside a pool of “soft dollars” for later use by the advisor.

The SEC has said that an advisor does not breach his or her fiduciary duty by paying more for brokerage and generating soft-dollars in the process as long as three conditions are met.

  1. The brokerage commission must be reasonable.
  2. The soft-dollars must be used to purchase “brokerage and research services.”
  3. The services must provide assistance in the performance of his or her investment decision-making responsibilities.

“Brokerage and research services” are narrowly confined to services that directly benefit the advisor’s clients in the management of their accounts. For example, advisors are permitted to purchase advice, analysis, and reports that contain knowledge and reasoning about the value of specific securities or the outlook for different industries or market sectors. These are tools that might reasonably be expected to help an advisor provide better advice to their clients.

On the other hand, products and services that are considered part of an advisor’s operational or overhead expenses are not protected under the SEC’s soft-dollar interpretations. These include computer hardware, web design, back-office software, marketing support, and meals and travel expenses associated with attending seminars. Advisors who “pay-up” for these things using client assets risk being held in violation of their fiduciary duties.

In July 2018 the SEC’s Office of Compliance Inspections and Examinations issued a compliance alert related to best execution by investment advisors. The alert reminded advisors of their fiduciary obligation to make sure clients are not overpaying for the services they receive, especially if the advisor is receiving a benefit in the process. Here’s a link to the alert if you’re interested.

Still in the Dark

The SEC has not yet applied similar standards in the TAMP context. However, as TAMPs offer advisors an increasingly long list of “free” services in return for their clients’ asset flow, the parallels with the soft-dollar issue become more and more obvious. The conflicts of interest inherent in these relationships are too blatant to ignore and will attract attention soon enough.

Since the SEC hasn’t turned this stone over yet, we don’t know exactly how it will deal with it once it does. But if it views this issue using the same frame of reference it has used for years in the soft-dollar area, it represents a fiduciary landmine for unwary TAMP users.

Basic TAMP services such as portfolio management, account onboarding and administration, billing, and performance reporting, do not raise a fiduciary issue. Marketing materials that explain the TAMP’s services or help advisors generate proposals don’t raise an issue either. As long as their cost is reasonable, these services all directly benefit the client. They help the client understand the TAMP’s services or specifically relate to managing the client’s account.

It’s when TAMP offerings include broader services not directly related to the management of client accounts that fiduciary issues start to arise. Practice management is a particularly difficult area. Much of what is taught under the banner of practice management clearly benefits clients in the management of their assets. “New ideas in portfolio construction,” or “better due diligence techniques” are examples. But “better use of social media” or “tips on how to build a better website” have little relevance to the management of client accounts.

The problem gets worse as the array of “free” products and services broadens. Many of the services that TAMPs now offer advisors—website design, marketing support, and compliance assistance, for example—are specifically mentioned in the SEC’s interpretive positions as services that raise fiduciary issues in the soft-dollar context. Would it be different for TAMPs?

Advisors may argue that these broader services make their firm better and more efficient, which benefits their clients. But such generalized arguments carry no weight in the soft-dollar context. The SEC has specifically stated it is a conflict of interest for an advisor to pay-up using client assets for services related to the advisor’s internal management, operations, or overhead expenses. Again, one could expect the SEC to take the same position in the TAMP world.

Side-Stepping the Landmine

There is nothing wrong with any of these products or services per se. In fact, most advisors could benefit from all of them. But it’s not OK to use client assets to acquire them. If you’re looking the other way while your clients are paying high TAMP fees and getting mediocre performance, just so you can get access to a cornucopia of “free” services, you have a problem.

Here’s how advisors can avoid stepping on the landmine. First of all, the problem only arises if clients are paying more for TAMP services than they might otherwise pay for substantially similar services. If you can document that your clients are not “paying-up” for their TAMP services, you can avoid the conflict of interest issue raised by the receipt of free TAMP services.

This requires that you have a due diligence process in place that would allow you to establish that your clients are not paying more than necessary to get the quality of investment offering, the performance, and the level of service they are receiving. The key here is having a disciplined process in place and systematically revisiting this issue on a periodic basis. The 2018 SEC compliance alert addressing soft-dollar practices made clear that having a process and sticking to it is important in showing an advisor has discharged his or her fiduciary duties.

In any case, an advisor should disclose in their ADV and client agreement the nature of all services received from a TAMP. If the only services received are those directly related to the management of client accounts, then there is no issue about the existence of a possible conflict of interest arising from the advisor’s receipt of free services. The only issue is whether the cost of the services is reasonable given the nature of the services received.

If an advisor is paying up for TAMP services and receiving free products or services, disclosure of that fact may serve to ameliorate the problem. But disclosure, alone, is not a guaranteed cure for this problem. Some conflicts of interest are too egregious to fix with disclosure.

As an additional step, advisors might seek their client’s written consent or obtain a specific waiver of the conflict. Of course, the ramifications of asking a clients to approve a practice whereby they pay higher fees so you can receive free services are not likely to be positive.

As a practical matter, it may be best to simply avoid such situations entirely. Pay TAMPs to provide traditional TAMP services and hire them based on the quality of their investment management offering, the level of service they provide, and the reasonableness of their fees. Don’t mix the TAMP hiring decision with decisions about how to get other services you need.

Pay vendors and consultants directly for the services you need rather than using your clients’ assets as currency. There are plenty of great practice management consultants and vendors that will help with web design, compliance support, and the other services now being offered by TAMPs in return for client asset flow. Write them a check based on the value of their products and services and pay only for the products and services you need.

Everybody likes “free,” but in this case it comes at a high cost.

Tick, Tock

The lesson is clear. In selecting a TAMP, your clients’ best interests, not your own, must drive the decision. If you have a problem in this area, there’s time to fix it. The SEC has not yet woken up to this problem. Don’t wait until they come knocking on your door.

For those of you who work with First Ascent and no other TAMPs, you need not worry about the problems identified above. We have structured our business to avoid these issues.

You may be wondering about whether our practice management-oriented Master Classes cause an issue. They don’t because any advisor can attend those sessions whether they work with us or not. No one is required to bring us assets in return for access to those classes.

As always, we have your best interests and those of your clients at heart.