Most of the ruckus surrounding Dodd-Frank and the SEC's proposed uniform fiduciary standard of conduct has to do with disclosures and prohibited transactions - an advisor's duty of loyalty. But the SEC has done little to define the baseline professional conduct associated with the proposed standard-an advisor's duty of care.

In this second segment of a two-part series (see financial-planning .com or our June issue for part one), we'll further examine what a uniform standard of conduct will look like. The objective is to provide you with the means to benchmark your current financial planning practice against the prospective fiduciary standard. If you're following a traditional, six-step financial planning process, you should be capable of conforming to a fiduciary standard.

Steps one through three are: Define, Analyze and Strategize. Steps four through six are Formalize, Implement and Monitor.



Once you've identified a client's goals and objectives and have determined his or her risk tolerance, asset class preferences, time horizon and short-term performance expectations, your next step is to formalize the strategy that produces the greatest probability of achieving these goals and objectives. Considerable research and experience have shown that the choice of assets and asset classes, and subsequent allocation of each, will have more of an impact on the long-term performance of a client's strategy than any other factor.

How assets are allocated among various, competing objectives requires a thorough knowledge of:

* Their availability and usefulness.

* Available choices and options.

* The risk-reward ratio of deploying or not deploying different assets.

* Redeployment and rebalancing as the market or the client's situation changes.

A proposed financial plan must be evaluated carefully to determine whether a suggested strategy can be implemented prudently, and monitored effectively and efficiently.

A planner demonstrates conformance with a fiduciary standard by the process through which he or she manages decisions. No strategy is imprudent on its face. It's how it's used and how decisions about its use are made that will be examined to determine whether the fiduciary test has been met. Even the most aggressive and unconventional strategy can meet the standard if it was arrived at through a sound process, while the most conservative and traditional strategy may not measure up if the proper process was lacking.

The final dimension is preparing and maintaining a client's investment policy statement. This is an important fiduciary dimension because it helps ensure all other elements of a client's wealth strategy are executed properly.

View the statement as a business plan and essential management tool for directing and communicating the activities of a client's wealth management strategy. It should be a formal, long-range, strategic plan that allows you to coordinate the management of the client's strategy within a logical and consistent framework. Include all material facts, assumptions and opinions.



What starts as strategy is translated into reality through implementation. This step involves developing due diligence procedures that will be used to select service providers, particularly money managers. Your main function is to set the overall strategy. The primary function of money managers is to maximize returns within the parameters-particularly risk tolerance-defined by that strategy.

Most financial planners use mutual fund databases for their due diligence process, which is wise. However, the amount of information available can be overwhelming. Therefore, consider starting with a screening process.

Once you have a workable universe (say, 10 candidates in a particular peer group), it's easier to apply additional screens to narrow your field. Consider these fields in an initial screening:

* Quarterly performance

* Six-month performance

* One-year performance

* Three-year performance

* Three-year Alpha

* Three-year Sharpe

* Three-year Sortino

* Expense ratio

* Inception date

* Portfolio turnover

* Assets in product

* Manager tenure

* Style or style drift

This is a minimum screen to demonstrate a consistent fiduciary process. A best-practices screen would be applied to the universe of candidates that make it past the initial screen.

The next dimension is to define whether the strategy will be executed with active or passive approaches, and whether mutual funds, ETFs or separate account managers will be used. In each case, service agreements with the various money managers and providers need to be reviewed carefully to ensure they do not contain provisions that conflict with the goals and objectives of the client.



Of all the steps of a uniform fiduciary standard of conduct, this is the one that might cost you the most in terms of your time and office overhead. Problems with monitoring are compounded if you do not have efficient electronic protocol with each of your clients' custodians.

The first dimension to monitoring is preparing performance evaluation reports. Though existing fiduciary acts do not specify the frequency of reporting, there is case law to suggest a performance report should be prepared at least quarterly. You should be able to demonstrate at least once a quarter you have determined that each and every investment option you are monitoring is still appropriate for your clients.

The second dimension is to monitor and analyze the fees and expenses associated with your client's strategy periodically. No matter what the business, decision-makers have a responsibility to control and account for expenses, and your role as a fiduciary is no exception. You should be disclosing to your client every party that's been compensated from his or her portfolio and the services provided, and verifying that the compensation received was fair and reasonable for the level of services rendered.

The third dimension is to periodically monitor services providers, including your staff, for conflicts of interests. With trust comes the duty of loyalty. No one involved in managing client assets should invest or make decisions in a way that even suggests a conflict of interest. Decision-makers have a duty to employ an objective, independent due diligence process at all times and have defined policies and procedures to manage potential conflicts.

Finally, you have a duty to conduct qualitative reviews of decision-makers periodically. You cannot ignore a money manager experiencing personnel turnover or one who's under investigation by a regulator. Such a manager should be reviewed carefully even if portfolio performance remains stellar. Money management organizations are highly dependent on their most important asset-people-and qualitative factors having an impact on a firm will eventually end up having an impact on performance.

That's the full benchmark. Not as bad as you feared? From experience, I've found the typical financial planner can demonstrate conformance with 90% or more of the fiduciary dimensions. The key is to be able to demonstrate your procedural prudence and the dimensions of your decision-making process-disciplines we've all learned through the financial planning process.


Donald B. Trone is chief ethos officer of 3ethos, a training and standards development firm, and a founding director of the Institute for Wealth Management Standards. He is co-author with Charles A. Lowenhaupt of the forthcoming book Freedom From Wealth.

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access