You receive a phone call out of the blue. It’s the SEC. Three examiners will be in your office next week for an audit and they expect to be there all week.
I’ve received those calls. If you are an investment adviser representative (IAR) or a stand-alone registered investment advisor (RIA), this is always a possibility. Are you ready?
Whether you’re an RIA or an IAR, you have a fiduciary duty to act in the best interest of your clients. As such, you have a “duty of loyalty” and a “duty of care” to your clients and must always place their interests above your own. Part of this duty is to identify and either eliminate or fully disclose any conflict of interest. The SEC emphasizes this in their “Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation.”
According to the SEC, “An adviser must eliminate or at least expose through full and fair disclosure all conflicts of interest that might incline it—consciously or unconsciously—to render advice that is not disinterested.” In addition, they go on to say that “an adviser disclosing that it ‘may’ have a conflict is not adequate disclosure when the conflict actually exists.”
The disclosure requirement is met using the firm’s form ADV and/or the advisor’s form ADV-2. For the most part, advisors address the fact that they will receive commissions on sales of insurance or annuities above and beyond their advisory fees. Here’s where the plot thickens. Let’s assume the advisor does annuity business with IMO X and has used them for years. He likes IMO X because of any of the below reasons:
- They have an expense reimbursement program.
- They pay him an extra 0.50% compensation above the published commission rates.
- They pay for his seminars once he produces above a certain amount.
- They have a top-producer trip to Maui.
This is an obvious conflict of interest, yet I have never seen it fully disclosed on the advisor’s ADV-2 form. Any hard or “soft” dollars received from a vendor to sell their products creates a conflict of interest and must be “fully and fairly disclosed.” Now ask yourself, have I done so?
Let’s say you are an insurance-only producer. You’re not immune. Under Reg BI that went into effect on June 30, 2020, transactions involving a qualified account—which probably makes up about 60% of your business—are also subject to the above guidelines.
Let’s assume every time you have a possible annuity case, you call your favorite IMO organization that happens to be owned by an insurance company and, coincidentally, every product recommendation they make just happens to be a policy from that company. What about your duty of care? When the SEC comes calling, they’ll be looking at you and not your buddy, the wholesaler.
So, how do you protect yourself? Here are six suggestions:
- Ask the IMO tough questions like: Who owns your organization? Do you receive more compensation by recommending one product over another? Is there a bonus involved if you push this product or carrier?
- Compare several options from different carriers side by side. We’ve created an Annuity Total Benefits of Ownership (TBO) tool to do this. We recommend sharing
it with your client and have them initial the product that best fits their needs. Keep it in your file to defend your position later, if necessary.
- Be extremely cautious with “marketing dollar” offers from IMOs. This is often a thinly disguised way of “buying” your business. This will also make your job of defending your recommendation significantly harder when there may
have been other options on which you would have earned less.
- Document, document, document. It’s rarely today’s client you must worry about. It’s that client (or their kids) five or ten years down the road when they (or their lawyer) question your recommendations. Keep good notes, either in
a CRM system or on a Client Contact Memo.
- Pay attention to your product mix. You know everything about product A. That’s great, but can you justify that it is the best choice in every situation?
- Beware of illustrations. Unfortunately, almost all carriers can provide an illustration of how their product would have performed over the last ten years. How realistic is it to suggest that the next ten years will be anywhere near what we experienced in the last ten? Set realistic expectations for your clients.
Although some of the suggestions above have nothing to do with marketing dollars, rest assured that if a complaint does arise, the marketing dollar conversation will occur. The best offense in this situation is always a good defense—avoid complaints in the first place and prepare for the inevitable.
Author
Thomas R. Kestler, CFP®, CLU®, ChFC®, CMFC®
Vice President, Advanced Sales
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