The SEC Outsourcing Rule: What Happens When Advisors Fail as Fiduciaries
The SEC recently proposed a new rule designed to ensure that advisors live up to their fiduciary duties when they outsource.
The proposed rule is quite broad in scope. It covers not only outsourcing to TAMPs, but also outsourcing to a range of other service providers.
The proposed rule requires advisors to:
- Have processes and procedures in place to manage due diligence activities
- Perform a thorough due diligence examination before hiring a covered service provider
- Outsource to a service provider only when it is in the best interests of the client
- Monitor the selection on an ongoing basis to ensure it continues to benefit clients
- Keep books and records to document and justify the process
All manner of industry groups and advisory firms have raised objections to the perceived overreach by the SEC. They see it as a rule in search of a problem.
They are correct in saying the rule will adversely impact many advisors who are doing nothing wrong. But they are wrong in saying there is not a problem that needs addressing.
The Nature of the Problem
Thirty years ago, the outsourcing of portfolio management was a straightforward proposition. A handful of firms that saw themselves as investment management organizations offered to use their expertise to manage portfolios for financial advisors who either weren’t skilled at portfolio management or wanted to focus on other activities like client service and acquisition.
As competition in the TAMP space increased, players sought to differentiate themselves. Some developed “supermarkets” that offered the portfolio management services of a variety of managers. These organizations were not so much investment management organizations as they were distribution vehicles for other managers. They catered to the crowd.
Others developed extensive offerings of “value added” services for advisors. These might include practice management training, marketing support, web development services, and a range of other services that were of benefit to advisors who brought their clients to the TAMP, but of questionable benefit to the clients who were paying the TAMP’s fees.
Later came the robo-advisors, who emerged from the technology world, not the investment management world. They brought tremendous efficiency and ease of use to the TAMP world, but their ability to serve as a fiduciary to their clients was questionable. They never met nor spoke to their prospects either before or after they became clients. They just plopped them into a portfolio based solely on the answers to an 8 to 10 question risk tolerance questionnaire.
As more advisors experienced the benefits of outsourcing and outsourcing grew in popularity, TAMP proliferation accelerated. Many of the newer firms have questionable investment credentials, offer risky investment strategies and portfolios with high expenses, and charge high fees for their services. Yet they hold themselves out as fiduciaries.
Advisors have also contributed to the problem. Many who use TAMPs don’t treat the TAMP selection process as a fiduciary decision. They don’t conduct adequate due diligence when they select a TAMP and those that do often don’t update their due diligence files.
I’ve been in the TAMP business for quite a while. I can’t tell you the number of times an advisor has said, “I love your firm, but repapering all my client accounts is just too much work.” Or “I love your firm, but I don’t want to discuss a change with my clients—let sleeping dogs lie.” Or “I love your firm and, yes, your fees are lower, but switching is a lot of work and I don’t benefit from your lower fees—my clients do.”
It is into this environment that the SEC steps, looks around, and says, “Let’s clean this mess up.”
Being a Fiduciary
Being a fiduciary is about values and attitude. It’s not, and shouldn’t be, about rules and regulations. But the SEC can’t change anyone’s values or attitude. They can only make rules and regulations. It’s a poor substitute, but the Commission has a limited tool set to work with.
Many in the TAMP industry and many TAMP users have invited the SEC’s one-size-fits-all rule upon themselves and the rest of us. Yes, being a fiduciary takes hard work and occasionally means making a little less money. But we can’t expect the SEC to sit on the sidelines if we don’t live up to the high standards expected of fiduciaries.
We’ve Got You Covered
First Ascent maintains an extensive due diligence package that is available to all advisors who work with us. We update and distribute that package annually.
We also provide a set of due diligence procedures your firm can adopt if needed.
If you haven’t received this material and would like to have it, please let us know at:
advisorconsulting@firstascentam.com
720-465-7888