Data & Research February 14, 2018

Robo-Adviser Tech Enthusiasts Report Less Provider Trust

While they are less trusting of their advisers and providers, clients who identify as “online enthusiasts” have increased the amount of market risk they are taking.

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Cerulli Associates’ latest reporting offers a deep dive into the differences in investor preferences measured across those who seek out and prefer traditional, in-person advisory relationships, compared with those who prefer Web-based advisory programs.

According to Cerulli, in most cases, those who identify as online enthusiasts opt to take control away from financial advisers because they believe financial firms are not looking out for them. To combat this belief, providers are working to be “more transparent with fees and offer products and services that are a fair trade-off for the client’s and the firm’s interests.”

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Cerulli finds investors who identify as “traditionalists” are marginally more trusting that financial services firms look out for their best interests, at 55%, as of 3Q 2017. While the average outlook on trusting financial services is improving over time, Cerulli warns that a lack of trust remains a lingering and potentially debilitating issue for close to half of traditionalist investors.

Interesting to note, while they are less trusting of their advisers and providers, online enthusiasts over time have increased the amount of market risk they are taking, as 7% overall described their investment strategy as “aggressive” in 2015 compared with 12% in 2017. As Cerulli sees it, allowing technology to manage or aid in managing investments as a byproduct may desensitize investors from taking either inappropriate high or low risk.

“A move toward greater acceptance of portfolio risk is an overall positive, especially among younger investors, but providers must ensure that clients understand the implications of these decisions when facing what could be peak equity markets,” Cerulli warns.

Cerulli data shows traditionalist investors’ self-reported risk tolerance has remained “remarkably consistent” during the past two years. These investors generally prefer to outsource portfolio management to their advisers rather than keeping abreast of market developments. As such, they are less likely to have dynamic risk tolerances in the short term.

“Providers should use the opportunity presented by current equity market highs to revisit portfolio allocations with these investor households to make sure that they remain properly allocated with respect to the investor’s goals,” Cerulli suggests. “If certain goals have already been achieved, the situation may warrant a reduction in portfolio risk.”

More information about obtaining this research and other Cerulli data is available here.

Compliance February 14, 2018

Self-Reporting to SEC of 12b-1 Conflicts of Interest Not Without Risk

Offering some preliminary commentary on the SEC’s newly announced adviser 12b-1 fee conflict of interest “amnesty” program, as it’s being referred to in the trade media, Wagner Law Group attorneys warn of the inherent risks in the self-reporting of violations.

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This week the U.S. Securities and Exchange Commission (SEC) revealed its new temporary policy of offering “amnesty” to advisers who self-report and correct violations of conflict of interest rules pertaining to the collection of 12b-1 fees.

Under the new program, advisers have until June 12, 2018, to self-report to the SEC’s Division of Enforcement “any conflict of interest situations in which clients were placed in more expensive share classes of mutual funds and advisers received 12b-1 fees, without proper disclosure, when lower-cost shares of the same funds were available.”

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In its announcement, the SEC cited “potential widespread violations of this nature,” and so naturally the advisory industry is taking head.

As laid out in preliminary commentary shared by the Wagner Law Group, the SEC enforcement agents will recommend that the commission “accept a settlement and not recommend penalties against the adviser if client funds (plus interest) are promptly returned.” Investment advisers that have already been contacted by the Division as of February 12, 2018, about possible violations of share class selection are not eligible to take part in the initiative. “However, those subject to pending examinations by the Office of Compliance Inspections and Examinations related to this issue, but who have not been contacted by the division, are eligible to participate,” the Wagner attorneys note.

While the term “amnesty” conjures up an image of full forgiveness, the Wagner attorneys warn that amnesty under this new self-reporting initiative, “or any future voluntary remediation, for that matter,” is not without risk.

“For one thing, it is not required to self-report, although dual registered firms must consider their FINRA reporting obligations under FINRA Rule 4530(b),” the attorneys note. “Missteps in crafting the correction can increase a firm’s legal and reputational risk. Cease and desist orders carry their own consequences.”

The attorneys urge advisers to be cautious even as they do the right thing: “The goal of correcting past violations is to make injured parties whole, prevent recurrence and avoid increased scrutiny by regulatory authorities. Remedial efforts generally, and the decision whether to participate in the SCSD Initiative, require a thoughtful, well-documented and careful review by the investment adviser.”

The Wagner attorneys offer some additional helpful context, as follows: “To take part in the initiative, advisers should self-report by notifying the Division by 12:00 am EST on June 12, 2018. Advisers must then complete a questionnaire confirming eligibility under the program within 10 business days of notification. The settlement will include the following terms depending upon the adviser’s eligibility: (i) the firm’s consent to an administrative and cease-and-desist proceeding for violations of Section 206(2) and 207 of the Advisers Act, where the adviser neither admits nor denies the Commission’s findings; (ii) an order to cease and desist from committing or causing any violations and future violations of Section 206(2) and 207, and a censure; (iii) disgorgement of the ‘ill-gotten gain’ and prejudgment interest, along with a certification as to the accuracy of the questionnaire, and agreement to an order requiring the firm to make a respondent-administered distribution to affected clients; (iv) either an acknowledgement that the adviser has taken certain prescribed steps, or an order requiring the adviser to complete such steps within 30 days, which includes correcting disclosure documents, evaluating whether clients should be moved to lower-cost share class, etc.; and (v) a recommendation by the Division that the Commission not impose a penalty on the adviser.”

Because the initiative covers only eligible individual advisers, the attorneys warn, other individuals associated with the same firm have no assurance that they will be offered similar terms for violations.

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