The concepts of “due diligence” and what comprises a “complete” due diligence report has become more sophisticated over time. However, the purpose of conducting a due diligence review has not changed. That purpose is to help ensure that investment advice honors the “special relationship” a broker dealer has to its client, and that such advice is backed by a reasonable investigation of the securities recommended. Up until recently, broker dealers used due diligence reports to determine whether the investment program under review was suitable for at least some investors. Increasingly, due diligence will help broker dealers and advisors meet a higher standard.
Even though the DOL recently announced a delay to the effectiveness of the fiduciary rule, most broker dealers and advisors have already taken major steps toward compliance, since it was originally set to take effect in April 2017. Regardless of when, or if, it ultimately becomes effective, due diligence reporting will need to adapt to the new fiduciary environment. This is already happening if for no other reason than that retirement clients already expect their advisors to make recommendations not just suitable for the clients, but in line with the their best interests. This will put advisors’ due diligence efforts underneath an even more powerful microscope than the suitability standard did.
Advisors must consider what constitutes a conflict-of-interest under the new fiduciary regime. Conflicts most often come up in the context of fee structures. The changing law would require reasonable fees that are in line with the market.
Are investment fees reasonable and in line with the market?
What defines “reasonable” fees under the new fiduciary regime? The answer may be as unclear as the standard for performing “sufficient” due diligence. Understandably, it is difficult to keep up with the political environment and court decisions that regularly affect how these concepts are defined. Yet, it is clear that over the decades, the industry has managed to adapt and change to successfully address these issues.
In response to the changing due diligence environment, and in light of the looming fiduciary rule confusion, FactRight is helping to make sense of all of this. There is a need to add some objectivity to the subjective legal and administrative standards that are currently in flux and subject to executive, legislative and judicial interpretation at any moment.
We have analyzed the fee structures of thousands of investment products and will be progressively rolling out more benchmarking in our due diligence reports. This information can help determine if a fee structure is reasonable and appropriate for individual clients. The research will help broker dealers and advisors protect themselves when making investment recommendations and fulfill their fiduciary obligation to put a client’s best interests first.
However, the process through which advisors should analyze whether a fee is reasonable has changed. It has become more complex, requiring a deeper and longer-term investigation. Advisors should monitor fees quarterly or annually to determine their reasonableness.
Clients expect transparency and loyalty
Both the new fiduciary requirements and consumer demand for more transparent information are driving the industry trend toward more sophisticated due diligence reporting. Advisors making investment recommendations about retirement assets face additional fiduciary expectations regarding disclosure and data management. Due diligence reports must help broker dealers and advisors to service their special relationships.
