How to prepare clients for changes to their BDC and nontraded REIT investments

While the Department of Labor’s newly unveiled fiduciary rule has dominated industry headlines in recent months, another fresh regulatory shift also has the potential to cause significant upheaval for countless advisers.

The Financial Industry Regulatory Authority Inc.’s Regulatory Notice 15-02 announced changes to NASD Rule 2340 and Finra Rule 2310. As a result of these changes, effective April 11, retail clients invested in direct participation programs — such as publicly registered business development companies and nontraded real estate investment trusts — will begin to see critical adjustments to their account statements this quarter.

These adjustments ostensibly will offer a greater level of pricing transparency and better reflect the fact that the fees for these investments typically are paid upfront. The planned changes have been in the works for well over a year.

A surprisingly large number of advisers have been slow to communicate to relevant end clients about these financial reporting changes and why they have been implemented. And that’s worrisome, since there are few things clients resent more than being caught off guard by unexpected changes that they feel — rightly or wrongly — their advisers should have told them about sooner.

Here’s the upside for advisers who have not yet communicated the 15-02 requirements to their clients: The message should be pretty simple.

The core message for clients should be that, while upcoming account statements may look a bit different than before, the alternative investments in their portfolio remain fundamentally unaffected. These investments have neither lost value nor undergone any structural changes as a result of this rule.

What’s more, such products still offer certain investors the same potential benefits they did previously, including providing inverse correlation to equities markets and offering potential additional income streams during an ongoing low-interest-rate, yield-starved environment.

For advisers who haven’t engaged their clients about this issue, here are four additional key best practices to prevent client relationship management headaches:

1) Take the time to gather the most precise data possible from your client list. Audit your book of business to determine which clients have midstream BDC and nontraded REIT investments. From there, build a short list, incorporate it into your CRM system and begin to contact the clients most affected by the newly implemented rule. Be proactive. Getting a call from clients angry about their statements can do irreparable harm to the relationship. At best, it could give the impression you were unaware of the changes and, thus, out of touch. At worst, it might seem as if you were attempting to hide something.

2) Determine the best communication vehicles for client outreach beyond just financial statements. As the adviser, you know your clients better than anyone. Once you have determined who will be most affected, think about the best way to communicate your message. For instance, if a client typically desires a bit more hand-holding than others, don’t rely on formal, written disclosures. Call them directly. Or even better, invite them to your office to meet in person. Not only could this be a chance to more directly address any concerns they may have, but it’s an opening to further develop and deepen your relationship with them — an opportunity no adviser should pass up.

3) Clarify the best way forward for your clients. If you are like the vast majority of advisers, these should not be difficult conversations, since it’s very likely you were very upfront about the fee structure associated with these alternative investments. In many cases, therefore, this will simply reinforce something the client already knows. Even so, explain what the changes are and why they happened, stressing that this is not a sky-is-falling event. Indeed, the expenses have always been there — it’s simply a change in the way they are disclosed. Above all, work to make it clear that, as the adviser, you will continue to do everything possible to provide them with quality service and achieve positive outcomes on their behalf.

4) Seek broker-dealer and product sponsor guidance for client education and messaging on this particular topic. If you haven’t already, you should request sample redacted client statements reflecting the new disclosure adjustments from your broker-dealer and their product sponsor partners. Obviously, these redacted samples won’t reflect how much your client is invested in these particular products, but they will give your clients the opportunity to view what they should be looking for when their statements come and, specifically, what the changes look like. Additionally, it’s worth emphasizing that a number of leading product sponsor companies also have fully fleshed-out FAQs and client-response statements regarding this issue to help guide your client conversations.

Too many independent advisory practices have had their heads in the sand about the impact of the changes outlined in Regulatory Notice 15-02, even though they have been afforded a great deal of time to prepare for it.

The good news for advisers is that you still have time to get out in front of the changes. The new rule doesn’t have to damage the trust you have built up over time with your clients.

In fact, with the right approach, this could be the perfect time to establish a better rapport with them and further demonstrate the value you bring.

Clive Slovin is president and CEO of The Strategic Financial Alliance, a privately owned independent broker-dealer and registered investment adviser based in Atlanta.

Related Topics: Nontraded REITs