Posted by Dave Palascak, AIF®, CFA on August 17, 2017
I have spoken to many home office supervisory personnel and practicing advisors over the past year about how often investment reviews and monitoring reports need to be produced. What frequency is appropriate from a fiduciary standpoint and what is practical from an operational standpoint? Is it acceptable to depart from fiduciary norms based upon practical circumstances?
Did you know that the duty to monitor a retirement plan or client account is one of the most overlooked fiduciary obligations?
Fiduciary breaches that occur during monitoring are frequently traced back to inadequate preparation earlier in the investment process. For example, a poorly written investment policy statement undermines effective monitoring by being vague about when, how, and by whom monitoring will be conducted.
Errors of omission (not doing what is prudent or prescribed) are more common than errors of commission (doing something that is prohibited by law, regulation, or governing documents). Establishing and following clear, concise and practical policies and procedures for monitoring (such as the frequency of investment reviews) reduce compliance risks and help ensure that clients’ best interests are served.
Getting to the question at hand – Are annual investment reviews enough? – let’s first examine the fiduciary requirement for investment monitoring frequency.
Practice 4.1 of the Prudent Practices Handbook1
states, “Periodic reports compare investment performance to an appropriate index, peer group and investment policy statement objectives.”
If you review the handbook in detail, you will find three specific tasks embedded in this Practice;
1. The advisor must generally review the investments at least quarterly against their index, peer group and IPS watch list criteria as a basis for formulating ongoing advice.
2. The advisor must summarize and document this quarterly review so it can be distributed to and considered by the client in some fashion.
3. The advisor must generally conduct a personalized review with the client at least annually to help ensure that the client fully understands the information presented and the advice that has been rendered and any actions that have been taken.
So, how does this match what advisors are doing in practice today?
From my experience, most advisors with smaller retirement plans and individual clients are performing the third task. Unfortunately, given the revenue generated from those clients and the expenses incurred with doing tasks one and two quarterly, many advisors only review the investments and produce documentation annually when they meet with their client.
Given the Practices and the legal substantiation from which they were derived, we believe this process is ripe for a fiduciary lawsuit.2
Here’s how we see advisors and their firms dealing with this operational challenge when working with smaller clients.
1. Reduce the amount of time it takes to perform the investment reviews and document any suggested actions. To the maximum extent possible:
a. Adopt a consistent IPS watch list process and apply it across your entire client base, making adjustments only when special facts and circumstances require;
b. Craft one set of investment commentary for each investment and apply it across all share classes of that investment and for all clients who own it, unless unique factors associated with certain share classes or clients require different commentary;
c. Recommend and execute trades to replace investments consistently for all clients whose facts and circumstances conform to criteria that make replacement advisable;
d. Use a consistent and manageable set of investments that promote operational efficiency as well as portfolio effectiveness, taking into account such factors as recordkeeper capabilities and priorities and constraints imposed by your clients.
2. Reduce the amount of time it takes to deliver the investment review to the client.
a. Use online client meetings and interactive reports to quickly summarize the review focusing on areas that need action.
b. Meet with your smaller clients annually, but email them (or post to a client vault) a monitoring report quarterly.
As you begin to take steps toward this methodology, the process of conducting and documenting quarterly investment reviews will become significantly more efficient allowing you to do it consistently for every client.
The Fi360 Fiduciary Focus Toolkit was built specifically to help advisors profitably implement proven fiduciary processes in their practice. Check it out! My team would love to hear about your experiences and challenges with quarterly investment reviews. Direct feedback from advisors allows us to make our software better for your business.
1Center for Fiduciary Studies and Fi360 (2013). Prudent Practices for Investment Advisors. Retrieved from http://www.fi360.com/prudent-investment-process/advisors-practices
2Prudent Practice for Investment Advisors – Practice 4.1 Legal Substantiation
Employee Retirement Income Security Act of 1974 [ERISA]
§3(38); §402(c)(3); §404(a); §405(c)(2)(A)(iii)
Leigh v. Engle, 727 F.2d 113 , 4 E.B.C. 2702(7th Cir. 1984);
Atwood v. Burlington Indus. Equity, Inc., 18 E.B.C. 2009
Interpretive Bulletin 75-8, 29 C.F.R. §2509.75-8 (FR17);
Interpretive Bulletin 08-2, 29 C.F.R. §2509.08-2
Investment Advisers Act of 1940
SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963)
Study on Investment Advisers and Broker-Dealers (SEC Staff,
January 21, 2011); Compliance Alert (June, 2007)
Uniform Prudent Investor Act [UPIA]
Uniform Prudent Management
of Institutional Funds Act [UPMIFA]
§3(b); §3(e); §5(a)
Uniform Management of Public Employee
Retirement Systems Act [UMPERSA]
§6(a); §6 (b)(1-3); §6(d); §6 Comments; §8(b)