The quintessential document governing investment decision making by fiduciaries is the investment policy statement. Brokers acting in a non-fiduciary capacity, on the other hand, typically haven't treated the IPS as an important tool of their trade, as they never have been required to develop thorough customer profiles and consider portfolio strategies to justify the suitability of transactional recommendations.
That may change, however, under the Financial Industry Regulatory Authority Inc.'s expansion of responsibilities for brokers under new Suitability Rule 2111, which requires brokers to capture and consider information that is part and parcel of a well-crafted IPS. Moreover, the IPS can serve to document the non-fiduciary role of the broker, which is critically important for compliance purposes.
An IPS serves as the business plan for a portfolio.
Broker-dealer firms may now find it useful to capture customer profile information, investment strategy considerations and disclosures of limitations to the scope of the brokerage relationship in a template IPS format geared to the business model that they intend for their representatives to provide.
This brokerage-specific form of an IPS isn't intended to provide the retail customer with a holistic set of guidelines for all their portfolio management needs but rather for this particular brokerage relationship. It allows the customer to determine if the relationship helps fulfill at least some of those needs and allows the broker-dealer to dem-onstrate compliance with suitability obligations.
There are three suitability obligations that brokers must fulfill, all of which can be addressed in the IPS.
The first is reasonable-basis suitability, which requires the broker to have sufficient understanding of the features, risks and rewards of the securities and investment strategies.
Special provisions of the rule allow asset allocation models to be recommended if certain objectivity-oriented re-quirements are met. The broker-dealer's template should delineate the securities and strategies in which their reps are trained and which the firm supports.
The second obligation is for customer-specific suitability.
It is focused on the customer profile, which must address at least nine specific attributes: age, investment experience, time horizon, liquidity needs, risk tolerance, investment objectives, tax status, other investments owned, and financial situation and needs. Any other material information shared by the customer also must be considered.
A broker must reasonably determine that, based upon his product knowledge and information gathered from the customer profile, the broker's specific recommendations are suitable for the particular customer. The template IPS necessarily captures the required customer profile elements, including other material information raised by the customer.
Finally, quantitative suitability is required.
In a broader context, Finra requires that a “broker's recommendations must be consistent with his customer's best interests.”
Finra's best-interests obligation falls short of the fiduciary duty of loyalty. Certain conflicts of interest are permitted, but brokers are not to make recommendations that are intended specifically to subordinate customer interests to their own by capitalizing on the conflicts.
Disclosure of the broker-dealer's conflicts-of-interest policies and practices should be addressed in the IPS as a material aspect of the relationship.
Finra's new suitability rules require brokers to know more about their products and their customers, and to apply that knowledge for the benefit of investors. This is undeniably positive, but it also could serve to further blur the line between fiduciary advice and non-fiduciary brokerage recommendations.
To avoid customer confusion and to help prevent brokers from unintentionally assuming functional fiduciary status, the brokerage-specific IPS should clearly state that the broker isn't a fiduciary, recommendations made are incidental to the transactional services offered, fiduciary services such as continuing monitoring of securities and investment strategies aren't within the scope of the engagement, and the customer is responsible for exercising independent judgment in making investment decisions.
Of course, in order to steer clear of fiduciary accountability, the broker's actions must match the disclosures provided.
Blaine F. Aikin is president and chief executive of fi360 Inc.