Weekend Reading For Financial Planners (September 9-10)

SEC Provides Roadmap For (More Targeted) Investment Advisory Firm Examinations

(Mark Schoeff | InvestmentNews)

Remaining in compliance with relevant regulations is an important part of running a Registered Investment Advisory (RIA) firm. And while compliance is an ongoing process (e.g., maintaining books and records), many firms are particularly focused on the specter of a state or SEC audit examination, which can involve a lengthy and deep look into whether it is complying with the rules governing RIAs. In practice, the SEC has been examining about 15% of all RIAs each year (meaning that firms can expect an examination approximately every 7 years). But the regulator’s process for determining which firms to examine, and exactly what it is looking for during these exams, has been less clear.

To help clarify the processes surrounding its examinations, the SEC this week issued a risk alert outlining how it selects firms to examine, the areas it focuses on during exams, and how it chooses which documents to request. The regulator said that its examinations division may select an RIA to examine based on the firm’s risk characteristics; a tip, complaint, or referral; or the SEC staff’s interest in a particular compliance risk area (e.g., for 2023, the SEC’s annual list of its examination priorities identified compliance with its new marketing rule and recommendations of complex investment products as areas of focus). Potential firm-level risk characteristics cited in the risk alert include deficiencies identified in previous examinations, business activities that might create conflicts of interest (e.g., outside business activities and the conflicts associated with dually registered advisers), material changes to the firm’s leadership or other personnel, and indications that the adviser might be vulnerable to financial or market stresses, among others.

When it comes to the examinations themselves, the SEC noted that while the scope of examinations and the documents requested will vary by firm, the regulator said exams typically include “reviewing advisers’ operations, disclosures, conflicts of interest, and compliance practices with respect to certain core areas, including but not limited to, custody and safekeeping of client assets, valuation, portfolio management, fees and expenses, and brokerage and best execution”. Which puts a particular focus on firms that don’t simply use traditional third-party custodians or otherwise have custody of client assets, those using hard-to-value assets (which can impact everything from portfolio balances used for billing purposes to the values used for performance reporting), the firm’s trading practices, and whether it is properly billing its fees.

When notifying a firm about an upcoming examination, the SEC includes an initial request list identifying certain firm information and documents that its staff will review. The list typically includes general information about the adviser’s business and investment activities, information about compliance risks the adviser has identified and what the firm has done to address them, information to facilitate testing with respect to advisory trading activities, and information for SEC staff to perform its own testing for compliance in various areas.

Altogether, the risk alert provides RIAs with greater clarity on how firms are selected for examinations and what to expect when they are selected for one. Which could not only better help firms anticipate what will occur during their next exam, but also perhaps allow the SEC to conduct more exams annually (as the number of RIAs continues to grow) if firms are better prepared to respond to the regulator’s requests! Most significantly, though, the SEC’s more risk-based approach to targeting examinations going forward means that while RIAs may be examined on average once every 7 years, the SEC actually appears to be making an effort to examine higher-risk firms more often (at the implied trade-off that firms deemed ‘low-risk’ will be examined even less frequently!).

New CFP Board Enforcement Rules Kick In Sept. 1

(Melanie Waddell | ThinkAdvisor)

As a part of maintaining its CFP trademark and determining which advisors will be permitted to license its use, CFP Board is responsible for managing its standards of conduct and creating a disciplinary process that is fair to the CFP certificants who use the marks, while also pursuing its mission of protecting the public (and ensuring the CFP marks remain in high esteem). Of course, these disciplinary rules and procedures are subject to change, including in 2021, when the CFP Board changed its procedural rules and sanctions guidelines to update the sanctions that CFP certificants receive when failing to follow the standards of conduct, and in 2022, when it created an appeals commission to hear cases of disciplinary actions imposed on CFP professionals.

Late last year, CFP Board proposed a new slate of changes to its procedural rules, and after receiving comments from industry participants and the public, adopted a set of revised rules, which went into effect on September 1. Among other changes, the revised rules will transfer some administrative functions from CFP Board’s Enforcement department to the Adjudication department and expand the role of the Disciplinary and Ethics Commission (DEC) Counsel to make the adjudication process more efficient.

Beyond ‘streamlining’ the enforcement process, though, the new rules would also establish a process for admitting expert testimony in CFP Board disciplinary hearings (as cases against CFP certificants become more complex and nuanced). In addition, the new rules modify when respondents must provide documents to CFP Board; while the rule previously required that documents under their “possession, custody, or control” be provided, the revised rules specify that only documents under the respondent’s control need to be provided (as they might not have been able to access documents controlled by their firm).

The new Procedural Rules also provide CFP Board more latitude to conduct “pre-investigation outreach” – in essence, conducting "informal inquiries” in response to complaints to better identify potential wrongdoing (that would then merit a full investigation and go through CFP Board’s enforcement and adjudication process). Which gives CFP Board more latitude in situations where there is an allegation of potential wrongdoing against a CFP certificant that doesn’t contain enough specificity to move forward based on the merits of the complaint alone (but otherwise merits at least an ‘informal inquiry’ to explore further).

Notably, CFP Board in responding to comments also reserved its right to conduct such informal inquiries without the CFP professional or their legal counsel being present, as the informal inquiry process is what also makes it more feasible for CFP professionals to report on the wrongdoing of fellow advisors based on client activity they may see (and in this manner, CFP Board can preserve their anonymity to the CFP professional they reported). While still trying to preserve due process by requiring that if an actual enforcement action is initiated, the CFP professional will have an opportunity to see the full details of the complaint and respond accordingly.

Altogether, the proposed changes appear to attempt to make the disciplinary process more efficient for respondents as well as CFP Board staff, and expand the CFP Board’s ability to pursue more complaints against CFP professionals (including via ‘whistleblowing’ from fellow CFP certificants) as CFP Board continues its efforts to ramp up enforcement (having opened 907 investigations in 2022 and closed 957), while also looking to improve the adjudication process through the use of expert witnesses. Which could ultimately better serve CFP certificants and maintain the public’s confidence that CFP Board is actually enforcing its standards effectively and doing more to clean up its own ‘bad apples’!

NASAA Launches Program Letting Advisors Maintain Licenses Longer While Out Of Industry

(Mark Schoeff | InvestmentNews)

Employees who decide to take extended time away from their current job—whether to explore a new career path, care for family members, or other reasons—can find it difficult to break back into their previous field. In the financial services industry, the issue is especially problematic, as employees who lose their securities licenses (or other designations) potentially face the daunting task of retaking qualification exams and other measures to regain their prior status.

To help reintegrate previous registrants, the SEC in 2021 approved amendments to Financial Industry Regulatory Authority (FINRA) rules to allow individuals who terminate their registrations to reregister after an extended period, without retaking qualification exams (e.g., their Series 6 or 7 exams), as long as they maintain their continuing education (CE) requirements during the period. In turn, FINRA’s board subsequently approved a plan to charge a $100 annual fee on individuals who take the CE path to reregister within five years after terminating their registration, effectively turning the existing 2-year window (after which FINRA licenses lapse) into a 5-year window for a nominal fee.

Building on these rule changes, the North American Securities Administrators Association (NASAA) in September 2022 adopted a broker-dealer exam validity model rule allowing eligible state-registered broker-dealer registered representatives to extend their Series 63 exam qualification for up to 5 years and in April of this year adopted a similar rule for Investment Advisor Representatives (IARs). And in late August, NASAA announced the launch of its Exam Validity Extension Program (EVEP), the technology component that will help registered representatives enroll in extended leave (NASAA plans to roll out a similar program for the Series 65 exam for IARs later this year). Under the program, interested advisors can extend their qualifications as long as they meet continuing education requirements and pay a $35 annual fee. Importantly, the extended validity is recognized when an advisor reenters the industry and registers in states that have adopted the program (NASAA has set up a website that allows advisors to see which states have adopted EVEP).

Notably, the 5-year window is similar to that offered by the CFP Board, which also gives certificants the opportunity to reinstate their certification within five years of relinquishment without retaking the CFP exam if outstanding CE requirements have been met, bringing the requirements of various organizations overseeing the financial advice industry in sync. Which means that a broader swath of registered representatives and advisors will be able to take advantage of time away from their current jobs, whether to tend to personal matters or to pursue other professional opportunities!

3 Behavioral Marketing Hacks To Get More Clients

(Sam McCue | XY Planning Network)

While few financial advisors are also trained mental health professionals, psychology can play an important role in client decision-making, from their risk tolerance to their decision to seek out a financial advisor in the first place. With this in mind, advisors can use behavioral science principles to help inform their marketing and potentially attract more clients.

For instance, the reciprocity principle suggests that when an individual does something for someone, the recipient of the gesture is hard-wired to pay the giver back. In the case of a financial advisor, this could mean giving prospects something of value (e.g., an e-book or a short, personal video) that could keep the advisor top-of-mind when the prospect is ready to start a client relationship. In addition, social proof (i.e., cues about what to do based on what everyone else is doing) can be powerful nudges to influence an individual to take action. For financial advisors, client testimonials and case studies are among the sources of social proof that can be used to demonstrate the advisor’s value to prospective clients. Finally, advisors can win more clients by helping them overcome temporal discounting, the tendency to perceive a desired result in the future as less valuable than one in the present. For instance, a prospect might discount the need to increase their savings for retirement given that it is decades in the future; in this case, an advisor could ask the client whether they can envision what their retirement will look like (even a rough framework). This could help the client realize that they have goals for their future that they want to save for now.

Ultimately, the key point is that while humans are not automatons, we do exhibit behavioral tendencies that can influence our decision to buy a product or work with a particular service provider. Which presents opportunities for financial advisors to more effectively demonstrate their value to prospects and to potentially convert more into clients!

2 Ways To Build Strong Client Relationships

(Samantha Lamas | Morningstar)

For many, one of the most satisfying aspects of working as a financial planner is the opportunity to build long-term relationships with clients. Doing so can not only be fulfilling on a personal level, but also can help support the advisor’s business through better client retention. However, given that many clients start out as strangers to the advisor, a key question is exactly how advisors can start to build strong relationships with these individuals.

Citing research from Morningstar, Lamas suggests two areas that can allow advisors to foster stronger relationships with clients: building understanding and building trust. First, advisors can get a better understanding of their client by helping the client understand themselves. This can involve asking questions to connect with clients and, perhaps more importantly, actively listening to their responses and posing appropriate follow-up questions. Next, because clients are putting themselves in a vulnerable situation by opening up their financial lives to their advisor, it is important for them to believe in the intentions and behavior of the advisor. This can be accomplished by helping clients better understand the advisor, including the services they provide, expectations for communication, and how the advisor will work in the client’s best interest.

In the end, because relationships take time to develop, advisors who start early on building an understanding of the client’s needs and gaining the client’s trust could find that they are better positioned to support their clients (and keep their business) when stressful periods (e.g., market downturns or major life changes) occur. Which not only can provide clients with greater peace of mind, but also help the advisor keep clients for the long term!

How To Show Clients You're Emotionally Compatible

(Ryan Murphy | Money Marketing)

While advisors are often focused on the technical aspects of financial planning, a recent Morningstar survey of advisory firm clients found that 60% of respondents noted at least 1 emotionally grounded reason (e.g., their degree of comfort making financial decisions or their ability to 'stay the course') for hiring their advisor, suggesting that acknowledging prospective clients' potential emotional needs (and the advisor's ability to address them) could help convince them to become clients.

The top 3 client priorities identified in the Morningstar study (which could help inform advisor marketing messages) were discomfort handling financial issues (i.e., a lack of confidence that they have the skills or knowledge needed to reach their financial goals), behavioral coaching (i.e., help with acting in a way that is beneficial to their finances), and specific financial needs (e.g., retirement planning or handling major life events). Notably, given the emotional nature of many of these issues, it is important for advisors to be tactful in their messaging. For instance, rather than emphasizing that a prospect might feel discomfort handling their finances, advisors could consider highlighting how they can promote peace of mind and help clients reach their goals. In addition, because individuals tend not to like hearing that they need behavioral coaching, using examples and being clear that these are issues that everyone faces could help bring down barriers and help prospects and clients feel less judged.

Ultimately, the key point is that while advisors can provide significant value to clients through their technical expertise on financial planning issues, they can also contribute to client wellbeing by giving them more confidence in their financial outlook and their ability to make good decisions when it comes to their finances. And by addressing both of these areas early on in the relationship, advisors can start to build stronger connections with their clients to foster a partnership that could last for years (or even decades) to come!

Many Advisors Plan To Boost Alternative Investments In Coming Year, iCapital Survey Says

(Ben Mattlin | Financial Advisor)

Last year was a challenging period for many investors (and their advisors), as both stock and bond markets experienced significant downturns. Which has led some advisors to consider seeking additional diversification for client portfolios by adding exposure to alternative asset classes (e.g., private equity, private credit, hedge funds, and real estate).

According to a survey of 400 advisors (80% of whom currently use alternative investments in client portfolios) sponsored by iCapital (a tech platform providing advisor access to alternative investment markets), 51% of respondents said they plan to allocate more client assets to alternatives in the next year, while 44% said they expect to keep the allocation the same. Respondents reported using alternative investments with about 36% of their clients, allocating between 5% and 15% of these portfolios to alts. Real estate was the most popular alternative asset used by respondents (78%), followed by private equity (62%), private credit (50%), and hedge funds (48%).

Diversification was far and away the top benefit cited for using alts (flagged by 79% of respondents), followed by the ability for the advisor to differentiate their service offering (44%) and only 34% of those surveyed citing enhanced returns. Among the top barriers to using alts, respondents highlighted a lack of liquidity and long lock-up periods (52%), high fees (41%), and complexity (37%), among other factors.

Altogether, this survey indicates that while many advisors are intrigued by the potential diversification benefits of alternative investments, they use these assets as a relatively small portion of the asset allocation for certain clients. Which suggests that before diving into specific alternative investment options (perhaps at the behest of a client who has heard about their potential benefits), advisors can add value by considering whether alts would be appropriate for a given client and their portfolio in the first place!

Cash Is No Longer Trash, But The Opportunity Cost Might Be Greater Than You Think

(Danny Noonan | Morningstar)

During the past decade of near-rock-bottom interest rates, many investors flocked to equities under the premise that “There Is No Alternative” (TINA) to earn sufficient returns to meet their financial goals. But amid the rising interest rate environment, where cash-like investments (e.g., money market funds) and bank deposit products are yielding 4-5%, some investors (fresh off the wounds of the 2022 stock market downturn) are considering whether to increase their allocation to cash to earn these returns with less risk than equity markets.

However, Noonan suggests that investors (and their advisors) might want to reconsider a significant shift to cash, particularly for the long term. For instance, while cash has outperformed stocks 31% of the time in 1-year periods (between 1928 and 2022), it has only outperformed in 15% of 10-year periods and no 25-year periods. Further, while cash has underperformed stocks by an average of 8% in 1-year periods, the total average underperformance in 25-year periods is 1,281%! And while some clients might plan to stay in cash until they feel more confident in the state of equity markets (or perhaps until rates on cash fall to less-attractive rates), actually getting back into the market can be emotionally challenging.

Ultimately, the key point is that while an allocation to cash can serve as a source of liquidity for clients (and cash management is an area where advisors can add value for clients), historical data indicate that equities are likely to offer a significantly higher return when investing for long-term goals. Which means that advisors can potentially add value to certain clients by helping them ‘stay the course’ with their established asset allocation rather than making dramatic changes based on recent developments in interest rates and market performance.

Bonds Aren't Boring Anymore, And Investors Need To Adapt

(Lindsey Young | Quiet Wealth)

In the 40 years leading up to 2022, investors experienced a mostly uninterrupted bull market in bonds, as interest rates plummeted throughout the period, leading to higher bond prices (and strong price returns for fixed-income investors). However, the rapid rise in interest rates experienced last year brought this bull market with a screeching halt, with the U.S. bond market experiencing one of its worst calendar year returns ever.

For investors who were used to seeing their bond holdings post strong returns (with less volatility than stocks), 2022 served as a wake-up call to the presence of interest-rate risk for bond investments (particularly for longer maturity bonds), leading some investors to (at least temporarily) move to the ‘safe haven’ of money market funds that offered strong yields with little risk (and in the current inverted yield curve environment, these investments with shorter maturities offer higher yields than bonds with long maturities).

The question now for investors (and their advisors) is how to allocate the fixed income portion of their portfolio in this new environment. Young suggests that given that the purpose of fixed income allocations typically is to reduce overall portfolio volatility, moving back into longer maturity bonds might not be the best option (as they are most susceptible to interest rate risk if rates were to continue higher). At the same time, the income received from money market funds and Treasury bills alone could decline if rates were to decrease. With this in mind, Young suggests that investing in a mix of money market and traditional bond holdings could offer the best medium-term risk-adjusted returns. Because if yields come down, the likely increased value of the bond holdings could offset reduced income from the money market funds, and if yields increase, the increased income from the money market funds could temper losses experienced on the bond portion of the portfolio.

In sum, advisors and their clients are experiencing an interest rate environment not seen for decades, which could call for adjustments to their approach to fixed-income investments. Notably, this not only includes managing investments in individual bonds and bond funds, but also considering the fixed income portions of client allocations to target-date retirement funds (perhaps most likely to be found in workplace retirement accounts) as well to ensure not only that clients maintain the chosen bond allocation but also that the maturities of these bonds represent the desired level of risk!

America's Surprise Revival: The Suburbs

(Erica Pandey | Axios)

America’s suburbs often get derided for their homogeneity, from similar-looking neighborhoods to seemingly endless strip malls. Which led some observers to assume that ‘hip’ Millennials (i.e., those born between 1981 and 1996) might choose to stay in larger cities for the long haul. But recent data suggest that even before the pandemic pushed many individuals to leave cities, the suburbs just outside were thriving.

According to U.S. Census data, the share of Americans living in the suburbs grew by 10.5% between 2010 and 2020, and the pandemic further accelerated this trend as employees working remotely no longer needed to live as close to their offices and those working from home sought larger living spaces, driving many to the suburbs. This trend also reflects the aging of the Millennial generation, which might have preferred the amenities that cities have to offer in their 20s but are now seeing the potential benefits of the suburbs as they marry and have children. This shift has also brought more retail and restaurant options to these suburban areas; for example, in 2022 urban retail vacancies surpassed suburban vacancies for the first time since 2013.

In the end, the pandemic appears to have accelerated an ongoing population shift from cities to suburbs. Which could remain the case in the years to come if the suburbs are able to supply sufficient housing and if remote and hybrid work continue to be commonplace (though if this shift leads to reduced rents in cities, some suburbanites could be drawn back in?).

Why Poverty Persists In America

(Matthew Desmond | The New York Times)

The output of the U.S. economy, in the form of real gross domestic product per capita, has grown significantly over the past several decades, rising from about $24,000 in 1970 to about $57,000 in 2019. At the same time, measures of economic distress have remained stubbornly high, with the official poverty rate ticking down from 12.6% of the population in 1970 to 10.5% in 2019 (and had reached 15.1% in 2010 amid the Great Recession). Which raises the question of how the country has not been able to strike a sharper blow to poverty given the increased overall national wealth.

Desmond argues that “exploitation” in the labor, housing, and financial markets can help explain how poverty has persisted despite a growing economy and increasing government investments in anti-poverty programs. First, he cites the decline in private-sector unionization rates (declining from nearly a third of workers in the 1950s and 1960s to only about 6% today) as a cause not only of low wages for many workers (particularly those without a college degree), but also for job insecurity that can lead to periods of poverty. In terms of housing, Desmond notes that rents have increased faster than renters’ incomes over the past 2 decades; while this can partly be attributed to not enough available housing supply, he cites several cities where rents rose despite high vacancy rates. In addition to insufficient supply, his research has suggested that landlords operating in poor neighborhoods take in higher profit margins than those in affluent communities, limiting these renters’ ability to spend on other needs. Finally, he argues that the financial system often makes it hard for poor individuals to get ahead, whether in terms of onerous fees, sky-high interest rates for alternative financial products (e.g., payday loans), or difficulties obtaining small-dollar mortgages.

Altogether, Desmond suggests that reducing poverty will take a concerted, multi-pronged effort at the national level. Though, on a more micro level, financial advisors can potentially help low-income individuals and families improve their financial picture through pro bono planning, which offers the opportunity to help these clients get answers to their most pressing questions, from how to access high-quality financial products (e.g., bank accounts with low or no fees) to creating a plan that can help them start to save for their goals and hopefully have a brighter financial future.

Inside A Sales Army Turning The Employee Retention Credit (ERC) Into A Modern-Day Gold Rush

(Ruth Simon and Richard Rubin | The Wall Street Journal)

In response to the economic shocks caused by the pandemic, Congress passed a series of measures in an effort to keep businesses afloat and help them retain their employees. One of these measures, the Employee Retention Credit (ERC) was created in 2020 to reward businesses and nonprofits for keeping employees on payrolls during the pandemic.

While the ERC expired in late 2021, business can still claim the credit by filing amended tax returns until April 2025, which has led to aggressive marketing efforts from companies offering to help business owners claim the credit. Some of these companies operate on an affiliate basis, offering commissions to individuals to refer business to the company if the referred entity ends up receiving a refund. This has led to a flurry of cold calls and emails, as well as in-person introductions, by individuals to try to find businesses willing to pursue the credit, often suggesting the potential for business owners to receive tens or hundreds of thousands of dollars from a successful ERC claim.

Nonetheless, the actual value of the services provided by the companies hawking the ERC (which typically only get paid if a business working with them actually receives a refund) is unclear. For instance, while one of these companies helps calculate the size of the tax break a business might receive, it is largely up to the business itself to determine whether it is eligible (which can be tricky, given that applicants for the ERC typically must show a significant decline in revenue or that a government order fully or partially suspended their operations).

As the deadline to apply for the credit gets closer, financial advisors might find that many of their clients are approached with offers to help them apply for the ERC (and advisors might receive these approaches themselves!). Though given the uncertain value of some of these services being offered (and the incentives of their affiliate sales force to hype up the potential benefits), instead turning to clients’ trusted tax advisors to determine whether they might be eligible could prove to be a safer path.

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

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