broker vs. advisor: the need for regulatory reform (don trone)

8/7/2019 Broker vs. Advisor: The Need for Regulatory Reform (Don Trone)

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[email protected]

Donald B Trone, AIFA

DEFININGA STANDARD FOR

THEDELIVERYOF

INVESTMENTADVICE


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Copyright 1999-2005. Fiduciary360

Foundation for Fiduciary Studies Center for Fiduciary Studies Fiduciary Analytics

MANAGINGTHENATIONSINVESTABLEWEALTH

More than 5 million men and women serveas investment fiduciaries.

In turn, the 5 million manage more than80% of the nations liquid investable wealth.

As critical as their function is to the fiscalhealth of the nation, not a single federal orstate agency provides education and trainingto the 5 million.


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MAGINOT MENTALITY

Following WWI, France built a series of interlocking forts to

protect itself from another German invasion. When WWIIbroke out, Germany simply outflanked the Maginot Line andeasily overran France.

Why did this formidable structure fail? The truth is, thestructure didnt fail the failure was Frances leadership in

recognizing the fundamental changes that were taking placein modern warfare.

Today, this form of leadership failure is referred to asMaginot Mentality.

Source: www.maginot-line.com


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Example: The Fiduciary Effect*

Source: www.maginot-line.com

What does New Yorks Attorney General understand thatother regulators do not?

Spitzer understands fiduciary responsibility. He understandsthat there has been a fundamental shift in what the publicexpects from people who serve in a fiduciary capacity. The

message is clear:

If the public puts you in a position of trust, you are afiduciary, and you cannot parlay that position of trust forpersonal profit.

* Source: New York Times

MAGINOTMENTALITY


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The vast majority of plan fiduciaries andparticipants rely on investment consultants (or

similar sounding title). Unfortunately,investment consulting is a poorly regulatedprofession; the normal attributes are missing:

No one regulatory body

No defined standards of care

No advance education and trainingrequirements

THEPOORLYREGULATED

PROFESSION


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Brokers

Money Managers

Investment AdvisorsFinancial Planners (?)

Wealth ManagersFinancial Consultants

Estate PlannersBroker Consultants

Private Bankers

(Regulated by NASD)

(Regulated by newdivision of SEC)

(Regulated by SEC)

Suitability Standard Fiduciary Standard

InvestmentAdvisers

InvestmentConsultants

Brokers

PROPOSED REGULATORYOVERSIGHT


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Society depends upon professionals to

provide reliable fixed standards in situationswhere the facts are murky or the temptations

too strong They represent the best a

particular community is able to muster in

response to new challenges.Dr. Robert G Kennedy, St Thomas University

THENECESSITYFORDEFINED

FIDUCIARYPRACTICES


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ERISA

UPIA

MPERS

LEGISLATION

Employee Retirement Income and Securities Act

(Qualified retirement plans)

Uniform Prudent Investor Act

(Private trusts, foundations/endowments)

Uniform Management of Public Employees

Retirement Systems Act(State, county, and municipal retirement plans)


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UNIFORMFIDUCIARYSTANDARDS OFCARE

1. Know standards, laws, and trust provisions.

2. Diversify assets to specific risk/return profile of client.

3. Prepare investment policy statement.

4. Use prudent experts (money managers) and

document due diligence.

5. Control and account for investment expenses.

6. Monitor the activities of prudent experts.

7. Avoid conflicts of interest and prohibited transactions.


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Analyze

Current

PositionStep 1

Diversify

Allocate

Portfolio

Step 2 FormalizeInvestment

PolicyStep 3

Implement

Policy

Step 4

Monitor

and

SuperviseStep 5

FIVE-STEPINVESTMENT

MANAGEMENTPROCESS

Reconfirm goalsand objectives


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Copyright 2001, Center for Fiduciary Studies

Analyze

Current

PositionSte

1

Design

Optimal

PortfolioStep 2

Formalize

Investment

PolicyStep 3

Implement

Policy

Step 4

Monitor

and

SuperviseStep 5

Rebalance

STEPS IN THE INVESTMENT

MANAGEMENT PROCESS


UNIFORM FIDUCIARY STANDARDS OF CARE

1. Know standards, laws, and trust provisions.

2. Prepare investment policy statement.

3. Diversify assets to specific risk/return profile of client.

4. Use prudent experts money managers and

document due diligence.

5. Control and account for investment expenses.

6. Monitor money managers and service vendors.

7. Avoid conflicts of interest and prohibited transactions.

The Matrix is constructed by using the five Steps of

the Investment Process as the horizontal axis, and

the seven Uniform Fiduciary Standards of Care as

the vertical axis.


PRACTICES MATRIX

StepsStandards

1

7

1 5

CONSTRUCTING THEPRACTICESMATRIX


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LEGAL CITATIONS, REFERENCES

AND SUPPORT

Each Practice is substantiated with a

reference to:

ERISA

UPIA

MPERS

When applicable: Case Law and Regulatory

Opinion Letter(s)


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BENEFITS OFHAVINGPRACTICES

Reduce fiduciary liability by uncovering omissions.

Provides educational outline.

Should improve long-termperformance.

Enable fiduciaries to compare practices and

procedures.

Assist in prioritizing projects.

Establish benchmarks to measure progress.

Negotiate lower E&O premiums.

1.

2.

3.

4.

5.

6.

7.


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PRIMERONPAY-TO-PLAY

1. Broker Pay-to-Play: SEC charges against MorganStanleys Partners List

Important to distinguish between paying for shelf

space and undisclosed compensation

2. Politician Pay-to-Play: Contributions to politicians inexchange for access to public funds

Watch also 529 Plans and Tobacco Settlement

3. Consultant Pay-to-Play: Selling services to moneymanagers

Most egregious because consultant is hired to be

an objective source


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TRIANGULATINGTHESECS POSITION

Mutual funds cant direct

brokerage for shelf space

Investigation into consultant

pay-to-play schemes

Failure to repeal of broker-

dealer exemption?


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MANAGERDUEDILIGENCE

Performance relative to peer group.

Performance relative to assumed risk.

Inception date of product.

Correlation to peer group.

Assets in the product.

Holdings consistent with style.

Expense ratios or fees.

Stability of the organization.

1.

2.

3.

4.

5.

6.

7.

8.


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FIDUCIARYSCORE

Each field is given a numerical value and thenranked against other funds in its peer group.

Passed No fiduciary due diligence shortfalls.(Top Percentile)

Appropriate Shortfalls, but still ranks in TopQuartile.

Watch (2) (3) and (4) There are shortfalls; thefund may not be the best choice if beingconsidered in a search, but may not need to be

replaced (2nd and 3rd Quartiles).


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UPPER PARTOF PAGE 1


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LOWER PARTOF PAGE 1


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UPPER PARTOF PAGE 2


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LOWER PARTOF PAGE 2


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Fiduciary 360

438 Division Street

Sewickley, PA 15143www.fi360.com

Donald B Trone, AIFA

[email protected]

(412) 741-8140Foundation for Fiduciary Studies

Center for Fiduciary Studies

Fiduciary Analytics

Don Trone is the president of the Foundation for Fiduciary Studies, the mission of which is to definethe practices that detail a prudent process for investment fiduciaries.Don is also the co-founder and Co-

Director of the Center for Fiduciary Studies, which operates in association with the University ofPittsburghs Katz Graduate School of Business. In addition, Don is the CEO ofFiduciary Analytics whichdevelops web-based tools to support the decision making process of investment fiduciaries.

In 2005, Don was selected to the prestigious IA25, the listing of the twenty-five most influential people inthe investment advisory industry. In 2004, The Center for Fiduciary Studies was selected to providefiduciary training to the Directors of the Federal Retirement Thrift, the retirement plan for 3.2 millionFederal employees, including members of Congress and the uniformed services. The Federal RetirementThrift is the largest defined contribution plan in the world. In 2003, Don was appointed by the U.S.Secretary of Labor to represent the investment counseling industry on the ERISA Advisory Council.

Don is co-author of two industry bestsellers, Procedural Prudence and The Management ofInvestment Decisions (McGraw-Hill Publishing), and lead the development of the fiduciary handbook,Prudent Investment Practices. He graduated as president of his class from the United States CoastGuard Academy, and with honors from the US Naval Flight Training Program in Pensacola, Fl. He servedon active duty for ten years as a long-range search and rescue helicopter pilot. In 1997 he was therecipient of the Coast Guard Academy Alumni Medal of Achievement for his distinguished military andbusiness career. Don received his Masters degree in Financial Services from the American College, andhas completed post-graduate studies at Pittsburgh Theological Seminary and Trinity Episcopal Seminary.

broker vs. advisor: the need for regulatory reform (don trone)

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