Registered Advisers Often Confused by Custody Reporting

Form ADV includes a number of questions about the custody of client assets; these questions continue to be a source of widespread confusion and inconsistent interpretations in the asset management industry.

The Investment Adviser Association (IAA) and National Regulatory Services (NRS) released their 18th annual “Evolution Revolution” report, highlighting robust growth in the investment advisory industry.

According to the report, the universe of Securities and Exchange Commission (SEC) registered investment advisers continues to grow at a steady pace, creating a record number of investment advisory positions.

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

The analysis also includes a snapshot of the “typical” registered adviser, generated by taking a median average of various key practice metrics. Generally speaking, most of the typical adviser’s clients are individuals, but he is also highly likely to have at least one pension or profit sharing retirement plan as a client. At the median, the report shows, SEC-registered advisers consult on nearly $360 million in assets while relying on an average of nine staff employees.

According to IAA and NRS, advisers broadly exercise discretionary authority over most assets and accounts served—but only rarely do registered advisers have actual physical custody of client assets or securities.  

The research suggests the industry’s recent focus on the Department of Labor’s (DOL) fiduciary rule is ostensibly reflected in the decrease in the number of firms charging commissions, which dropped to 3.6% of all SEC-registered advisers in 2018, down from 4.1% and 4.5% in 2017 and 2016, respectively. While the DOL fiduciary rule has been vacated by a federal appeals court, the reporting suggests commissions are still likely to remain unpopular.

“Another, perhaps related, trend is the increase in the number of advisers reporting charging fixed fees,” the analysis states. “Many factors are potentially contributing to this increase in fixed fees, including generational turnover as younger investors may prefer a subscription-like model when paying for financial advice.”

The report goes on to warn that advisers broadly seem to have some misconceptions about how to define asset custody.

“Form ADV includes a number of questions about the custody of client assets,” the report points out. “These questions—and the investment adviser custody rules—appear to continue to be a source of widespread confusion and inconsistent interpretations in the asset management industry.”

As the report explains, back in 2013, a Risk Alert published by the SEC’s Office of Compliance Inspections and Examinations (OCIE) emphasized that non-compliance with the custody rule, as amended in 2009, “was one of the most common issues found in routine investment adviser examinations and that, in fact, many advisers failed to realize they even had custody as defined in the rule.”

“These issues persist today,” the report warns. “The confusion stems from the fact that while advisers, in general, are prohibited from having physical custody of client assets, advisers are also deemed to have custody under certain other circumstances. Many of the questions in Form ADV relate to advisers that are deemed to have custody, although to complicate matters further, advisers that are deemed to have custody for certain types of reasons (such as the ability to deduct fees) are not required to answer certain custody questions on Form ADV.”

The report concludes the regulatory framework under the Advisers Act custody rule is “overly complex, unduly burdensome, and has caused unnecessary confusion for advisers.”

“We are encouraged that amendments to the custody rules for investment companies and investment advisers were added to the SEC’s Regulatory Flexibility Agenda in the spring of 2018 as a long-term action,” the report states. “Generally, long-term actions are items for which agencies expect to take regulatory action more than 12 months after publication of the agenda.”

The full 2018 Evolution Revolution report is available on the IAA website  and on the NRS website.

Republicans Flesh Out Tax Reform 2.0, Taking Aim at Retirement Issues

A trio of bills introduced before the House Ways and Means Committee this week offer the first detailed look at Republican Congressional leaders’ hopes for “Tax Reform 2.0,” which include many initiatives supported broadly by retirement industry stakeholders. 

Republican members of the House Ways and Means Committee have introduced three bills aimed at advancing their “Tax Reform 2.0” agenda ahead of the November mid-terms, including the “Protecting Family and Small Business Tax Cuts Act of 2018,” the “Family Savings Act of 2018,” and the “American Innovation Act of 2018.”

House Ways and Means Committee Chairman Kevin Brady, R-Texas, suggests the three bills “collectively build on the growing economic successes of the Tax Cuts and Jobs Act.”

For more stories like this, sign up for the PLANADVISERdash daily newsletter.

“These bills constitute Republicans’ Tax Reform 2.0 package and will lock in the individual and small business tax cuts made law in the Tax Cuts and Jobs Act, make it easier for families and businesses to save for retirement, and boost American innovation by growing startup businesses,” he adds.

The most wide-ranging of the proposals is H.R. 6760, the Protecting Family and Small Business Tax Cuts Act, which seeks to make permanent many of the temporary tax cuts implemented as part of the Tax Cuts and Jobs Act of 2017. Among other changes, under H.R. 6760, the near-doubling of the standard deduction would be made permanent, along with the doubled child tax credit and the 20% pass-through deduction for businesses.

The second bill, H.R. 6757, or “the Family Savings Act,” is probably of the most relevance for retirement industry stakeholders—as it includes many of the provisions written into the popular Retirement Enhancement and Savings Act. Title I of the bill would allow for wider adoption of multiple employer plans, referred to here as “pooled employer plans.” Title I further seeks to ease the offering of safe harbor 401(k) plans, and it would adjust “certain taxable non-tuition fellowship and stipend payments treated as compensation for individual retirement account (IRA) purposes.”

Other sections of Title I of the Family Savings Act seek to repeal the maximum age for traditional IRA contributions, and to prohibit plans from making loans “through credit cards and other similar arrangements.” Additionally, this part of the bill includes proposals for improving the portability of lifetime income investments: “Except as may be otherwise provided by regulations, a trust forming part of a defined contribution plan shall not be treated as failing to constitute a qualified trust … solely by reason of allowing—(i) qualified distributions of a lifetime income investment, or (ii) distributions of a lifetime income investment in the form of a qualified plan distribution annuity contract, on or after the date that is 90 days prior to the date on which such lifetime income investment is no longer authorized to be held as an investment option under the plan.”

Other items addressed in Title I include the treatment of custodial accounts on termination of section 403(b) plans; clarification of retirement income account rules relating to church-controlled organizations; exemption from required minimum distribution rules for individuals with certain account balances; clarification of treatment of certain retirement plan contributions picked up by governmental employers for new or existing employees; and elective deferrals made by members of the “ready reserve of a reserve component of the armed forces.”

Title II of the Family Savings Act provides for certain technical modifications of nondiscrimination rules “aimed to protect older, longer service participants.” Likely of some interest to retirement industry stakeholders, Title II calls for further “study of appropriate Pension Benefit Guaranty Corporation premiums.”

Apart from calling for an expansion of 529 college savings plans and establishing “penalty free withdrawals from retirement plans for individuals in case of birth of child or adoption,” Title III calls for the creation of a tax law framework supporting the creation of “tax-exempt universal savings accounts.” These would basically be tax-advantaged savings accounts with an annual contribution limit of $2,500.

The third and most narrowly focused bill introduced this week is formally titled H.R. 6756, the “American Innovation Act of 2018.” It runs just 15 pages and calls for various simplifications and expansions of tax deductions for start-up organization expenditures.

«