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The ABCs of Fintech: Always Be Compliant

By Dana Rhodes, Managing Director of Enterprise Solutions

While the DOL rule is DOA, the financial services industry is still faced with increasingly more regulatory scrutiny from FINRA and the SEC. Being a fiduciary comes with a strict set of guidelines that get more stringent each year. The SEC’s 2019 exam priority list provides a glimpse into what regulators are looking for, and what RIAs have to guard against.

I spent the last dozen years running the RIA of an independent broker dealer.  While my role was sales and NOT compliance, we were all responsible for the compliance of our advisors and platforms. I used to describe my role as “herding cats” because the world of independent advisors means independent ideas about everything from the technology advisors use to the way they manage their client portfolios. Each advisor I met had a different philosophy about how to invest client portfolios, yet the home office was responsible for monitoring everything from the process to the portfolios. The SEC is very specific about their expectations for broker dealer corporate RIAs as well as Independent RIAs. From the 2019 Exam Priorities:

Portfolio Management and Trading
Reviewing portfolio management processes is an integral component to investment adviser examinations. OCIE will review firms’ practices for executing investment transactions on behalf of clients, fairly allocating investment opportunities among clients, ensuring consistency of investments with the objectives obtained from clients, disclosing critical information to clients, and complying with other legal restrictions. OCIE will also examine investment adviser portfolio recommendations to assess, among other things, whether investment or trading strategies of advisers are: (1) suitable for and in the best interests of investors based on their investment objectives and risk tolerance; (2) contrary to, or have drifted from, disclosures to investors; (3) venturing into new, risky investments or products without adequate risk disclosure; and (4) appropriately monitored for attendant risks.

While this seems very cut and dried, it is anything but. Let’s start with the evaluation of risk.  What does a moderate portfolio look like? Some clients think that moderate means they don’t want to take on a lot of risk while others believe that moderate is the amount of risk in the S&P 500. Likewise, what does a moderate investor look like?  Is it a 40 year old? 50 year old? The answer is that it varies. Using a term like “moderate” means different things to different investors. That’s why Riskalyze invented the Risk Number, an objective, mathematical approach to removing subjectivity by quantifying the risk of investors and portfolios. The Risk Number is calculated based on downside risk. On a scale from 1 of 99, the greater the potential loss, the greater the Risk Number. Once the client’s risk number is determined, it becomes much easier to allocate a risk-appropriate portfolio. When assessing securities and portfolios on the same Risk Number scale, advisors, and their home offices, can have more confidence in the outcome as well as the client comfort level.

While more than 20,000 advisors use Riskalyze for the Risk Number and absolute alignment with clients and portfolios, home offices still struggle with proving this to regulators.  And how do you account for the advisors who (God forbid) DON’T use Riskalyze? Imagine if home offices had a way to see the client assessed risk, current portfolio risk, and accounts/households out of alignment in one simple view?

Compliance Cloud Icon in Circle

That’s Where Compliance Cloud Comes In

This intuitive technology empowers large wealth management institutions to sift through their data, spot issues before they become problems, and uphold their compliance obligations. We start by taking in a data feed from the home office custodian or data aggregator. From there, we apply the Risk Number to each position within the client or household portfolio to assess an overall score that can be tied back to the original client-assessed risk. The data is outlined in an easy-to-view format with search and case management capabilities. Compliance Cloud can help find accounts with inappropriate investments for their investment objective; with concentrated positions; with high-risk positions; with excessive cash; with periods of inactivity, and more. Searches can be sliced by client, advisor, balance, risk level and more.

I recently met with a broker dealer with fewer than 250 advisors with a rapidly growing RIA.  Their advisors use both custodial trading tools and Envestnet for rebalancing. They recently went through an SEC audit where they were reprimanded for their risk management of advisor models in the Advisor as Portfolio Manager (APM) program. As a result, the firm needed a systematized way to 1) ensure advisor models matched the appropriate risk level based on the model name presented to clients, and 2) Ensure client accounts are ultimately aligned with their investment objectives and risk tolerance.

In order to meet the SEC’s requirement to better supervise their advisors, the firm is going to require their APM advisors to use Riskalyze with their clients. The home office will have a license to be able to review all of their advisors’ models to ensure their nomenclature matches the Risk Number and, of course, they’re implementing Compliance Cloud across their book to automate the ongoing monitoring of those accounts to ensure risk alignment.

These days, it’s not enough to simply know your advisors are acting in the best interests of their clients. You have to prove it quantitatively. You have to use data to stay ahead of the game. And that’s what I’m proud to help wealth management enterprises do every day.

Ready to join the movement? We’d be happy to give you a personal tour of our game-changing compliance platform.