At least one advisor thinks a
But there is little agreement that the industry needs to go to extra lengths to ensure that third-party providers of services ranging from cybersecurity to investment selection to data storage are doing their part to uphold advisors' fiduciary duties.
Ivan Illan, the founder and chief investment officer at Los Angeles-based firm Aligne Wealth Advisors Investment Management, said one little secret in the planning industry is that many advisors devote the bulk of their time to maintaining relationships with current clients and trying to bring in new ones. The actual work of investing is outsourced to services like
"Many clients just believe that their advisors are actually managing their money, that they are actually selecting investments and buying and selling assets," Illan said. "That is not at all the case."
Illan was among the scores of professionals and groups that submitted
When the SEC voted 3-2 on Oct. 26 to put the proposed rule out for public comment, it provided no exhaustive list of which services would be covered. It instead cited examples ranging from cybersecurity, investment guidance and risk assessment to portfolio management, portfolio accounting, regulatory compliance and securities valuation.
Most of the advisors and industry groups that submitted comments on the rule said the proposed changes would prove too costly for small firms and be unnecessarily duplicative of existing regulations. Industry groups including the Investment Advisors Association, the Securities Industry and Financial Markets Association, the Institute for the Fiduciary Standard and the Money Management Institute all pointed out that advisors are already under a fiduciary duty to make sure any service or product they recommend to a client is in the client's best interest. That, they argued, extends to services and products from third parties. Many of them complained that the SEC's proposal would merely increase advisors' paperwork burden while doing little to provide additional protection to investors.
Illan, though, said the industry could afford to be a bit more transparent about its outsourcing practices. He said his firm often works with new clients who are surprised to learn that their previous advisors had actually not been making investment decisions. Illan said Aligne Wealth Advisors Investment Management prides itself on managing clients' money on its own.
That said, Illian added, there's not necessarily anything wrong with advisors' spending most of their time keeping in touch with current clients and trying to recruit new ones. But if they're not the ones making the investment decisions, he said, investors deserve to know it.
"Some will probably ask, 'Why am I paying you 1% a year to not manage my money?'" Illan said. "But the thing is to bring it up with clients, to put it into red-letter language and make it understood. And if you can still justify what you are charging, that's great. That's what we need for clients to have more trust in our industry."
Under the rule, advisors who choose to outsource would have to subject their third-party subcontractors to monitoring at regular intervals and periodically reassess whether that provider is, in fact, the best choice. They would also have to keep detailed records of their monitoring activities and of any covered functions they've farmed out.
Critics of the rule complained the SEC overestimates bargaining power that advisory firms have in contract negotiations with third parties like Amazon Web Services, a cloud-computing company that provides data storage and other services. The 10-month compliance deadline for the SEC rule would also give advisors little time to revise third-party contracts they've already been locked into.
In putting the rule forward, various SEC commissioners cited scandals they argued might have been avoided had fiduciary responsibilities been extended to third-party service providers. In one example, the Bank of New York Mellon had to pay a $3 million settlement after a system it brought on to calculate securities prices for 1,200 mutual funds and exchange-traded funds crashed for several days in April 2015 following an update by one of the bank's subcontractors, SunGard Systems.
Critics, though, say the disaster stories are far from common enough to justify further regulatory tightening.
"Although the (SEC) cites a handful of settled enforcement actions over the past decade that involved advisers' inadequate due diligence and monitoring of service providers, these few examples do not begin to justify the adoption of a prescriptive new outsourcing rule,"
The proposal would prevent advisors from outsourcing any given service without first taking into account six considerations:
- the nature and scope of the service to be outsourced
- the potential risks from outsourcing the service and ways to mitigate those risks
- the third party's competence and capacity to perform the service
- the third party's own subcontracting relationships
- steps the third party has taken to comply with federal securities laws
- And ways the relationship with the third party could be terminated in an orderly way should the need arise
Another big concern is the cost. The SEC has estimated that advisors would have to spend $132,320 on average to comply with the rule in its first year and $44,107 every year afterward. Jonathan Rogers, an investment advisor at Lombard, Illinois-based Forum Financial Management, told the SEC in
Rogers further warned the cost would extend beyond advisors to third-party contractors. Third-parties, for instance, would have to keep records for any financial matters entrusted to them and provide data that federal regulators could use to track outsourcing trends in the industry.
"The actual result of this regulation will be that small vendors will not enter the market to compete because of the high cost of producing such due diligence to the first few hundred customers is cost-prohibitive," Rogers wrote.
Investor advocates, meanwhile, tended to agree that a little more regulation would be good for the industry. Rather than being pared back or abandoned, groups like the Public Investors Advocate Bar Association, which represents investor interests, and the North American Securities Administrators Association, which represents state security regulators, think the rule could go further in some ways. Both groups questioned why the proposed rule contains an exemption for the outsourcing of various services related to clerical, ministerial, utility or general office functions.
"Clients have no ability to conduct the due diligence and oversight of a vendor; they expect the RIA with whom they chose to invest will ensure that all aspects of the services will be provided in an appropriate fashion," wrote Hugh Berkson, the president of PIABA, in
