While financial advisors often have discretionary control over a client’s entire investment portfolio, sometimes new clients enter an advisory relationship with large, ‘legacy’ positions that they do not want (or are not able) to liquidate. For instance, the client might own a significant number of shares in a closely held business, hold a large position in company stock subject to a lock-up period, or have inherited shares of stock from a loved one that hold emotional value. While an advisor might be tempted to view such positions as peripheral (particularly if the firm isn’t charging a fee on those assets), they can be subject to regulatory and civil litigation risks if the firm doesn’t have a clear process for advising on (or around) them – including thorough documentation and consistent disclosure of recommended actions to clients.
In this guest post, Rich Chen, the founder of Brightstar Law Group, discusses how RIAs’ fiduciary obligations apply to legacy positions, common scenarios (and traps) when dealing with them, billing considerations for firms, and best practices for advisors in managing legacy assets.
Under the Investment Advisers Act of 1940, investment advisers, whether or not they are registered with the SEC, owe clients a Federally-defined fiduciary duty comprised of two distinct obligations: a duty of care and a duty of loyalty. Notably, both duties apply to legacy assets; while the scope of an advisor’s fiduciary obligations may be shaped by agreement between the client and advisor, the duty cannot be waived completely.
There are several ‘traps’ advisors can fall into when managing legacy assets, from assuming that limited trading authority means limited responsibility (when it does not), over-reliance on verbal understandings that are never documented (and that a client might remember differently years later), inconsistency across documents (e.g., an advisory agreement saying one thing and billing statements implying another), and arrangements that were reasonable when established but have become increasingly problematic as a client’s circumstances have changed. Presenting alternatives (to continuing to own the legacy position) to the client – and documenting this communication – is the advisor’s best defense against regulatory examination and civil litigation.
Billing on legacy assets presents another challenge, as regulators will want to ensure that the advisor’s fees are reasonable given the level of service they’re providing. Firms have multiple options for handling billing around legacy investments, including excluding legacy assets from billing entirely, continuing to bill on those assets while documenting client-imposed restrictions, and adopting alternative fee structures (e.g., charging a flat planning fee plus an asset-based fee on managed assets) designed to better align compensation with services rendered. Importantly, there is no one ‘right’ approach; a firm might choose a particular approach based on its own service model and the unique circumstances of its clients.
Amidst this backdrop, several best practices emerge for working with client assets to prevent misunderstandings and mitigate the risk of civil litigation and/or regulatory actions, including documenting client restrictions, clearly defining the advisor’s role, evaluating the asset’s impact on the overall portfolio, reassessing legacy asset arrangements periodically, ensuring billing practices remain appropriate, and preparing for examination scrutiny in advance. In sum, the most effective firms recognize that legacy assets require more process than advisor-managed assets, not less, because the advisor’s limited authority makes documentation and communication all the more important.
Ultimately, the key point is that because there is no universal rule concerning handling legacy investment positions, firms can best serve their clients’ interests (and protect themselves) by building a repeatable, consistent framework to deploy when working with a client with such a position!
 |
And if you want to go deeper on this topic, hear directly from the author on the Financial Advisor Technician podcast. |
