New Year Primer: What’s Your 2016 Fiduciary Risk Management Plan?

As many begin the New Year with the formation of hopeful aspirations (or necessary modifications!), one such goal within the RIA practice could be to review one’s current strategy for fiduciary risk-transfer, or broader yet, one’s total Fiduciary Risk-Management Program.

The subject of risk-management can be categorized into four main strategy fields – let’s call them “The 4 Pillars of Risk-Management”.  These “pillars” constitute the support for your risk-management plan.  They are: (1) Risk Avoidance, (2) Risk Retention, (3) Risk Control, and (4) Risk Transfer.  Every good RM plan will possess components from each field; some avoidable, some intentional.

Clearly, the presence of fiduciary risk to the RIA professional is manifest by law (1940 Act the primary framework).  So, while it would be great to simply apply the aforementioned (1) and move on to more enjoyable activities, understandably youthful avoidance does not mean risk abated.  Further, we may innocently believe the establishment of a corporation or similar entity, applying (3), shields and therefore completes either/and (1) and (4) by removing one’s personal liability imposed by fiduciary law – unfortunately, that would be a risk management plan missing an important “capstone”; entity protection is a common misconception.  Thus, we move onward as we briefly review our 2016 risk-management program and determine proper strategies.  We know… no fun… yet imperative, unless you take pleasure in “rolling the dice”.  Last time we checked, most investment advisors avoid gambling.

Briefly, let’s examine the “4 Pillars” with some simple examples:

Avoidance:  how about the strategy of client selection (or de-selection)?… new clients interview you, but what is your process for interviewing them?… how are they suited to your investment philosophy?… what might you hear in the interview process that causes concern?… then, what about existing clients?… are there any names that arise more than twice-a-week during the lunch hour?… could it be time for a little client de-selection?!… think of your most difficult client… do they regularly disregard or counter your recommendations?… do they complain about other professionals or boast of disagreements, subsequent terminations or lawsuits aimed at past various professional counsel?… are they overly afraid of investment losses?… abusive to your clerical administration staff?… notice any unethical or immoral personality traits or activities?… some of your clients might be better served elsewhere.

Control:  how about a word on documentation?… document, document, document… a defensible file will contain (1) a documentation of your client’s life circumstances, tolerance for risk, investment objectives and style, leading to a plan and/or broad (but brief) investment policy statement, (2) file notes on client interactions, which need not be extensive, but should contemporaneous with and capture the essence of the interactions, (3) at least an annual summary (quarterly is considered “best practice”) of activity or discussion signed by the client acknowledging their understanding, and (4) complete documentation of any changes in objectives, advice given, and those not heeded.  Then, a second key example is in the area of “execution errors”… match every order against its return confirmation and promptly resolve discrepancies.  Finally, how are you handling and protecting private client information?  The subject of cyber security/data breach is increasingly on the regulators radar and RIAs are a regular target of cyber criminals.  If not already addressed, current cyber policies and procedures are a must for every RIA and in most cases an outside technology professional is needed in this ever changing landscape.

Retention:  consider an appropriate level of insurance deductible (retention)… deductibles are always per claim… understand that, historically, suitability claims can come in “bunches”… a “leader” brings a complaint and “followers” show up to the party later, based on the leader’s encouraging progress… so, if such a “wave” hit (historically tagged to market meltdowns), what would be an acceptable aggregated dollar level that you could financially support?… leading into Transfer, how does your contract of insurance (E&O) speak to “interrelated wrongful acts”?… might the deductible for “related acts” apply only once? … or individually to each claimant?

Transfer:  the primary risk-management, specifically risk-transfer, tool applied by RIA professionals falls within this category – the insurance mechanism…. yet, buyer beware!… comprehend that ISO (the Insurance Services Office), the insurance industry “body” with insurance company members, writes and issues “commodity” standard forms of insurance for most types of insurances (such as General Liability insuring a manufacturer, distributor, restaurant or retailer)… those standard forms of insurance are adopted by all insurance company members… not so with RIA professional liability and RIA cyber liability!… ISO has decided to ignore these specialty forms of coverage and allow each independent insurance underwriter to uniquely issue their own manuscripted contracts… are there differences among the carriers?… how many colors in the painter’s palette?!  Finally, think of your insurance as a not only a key risk-management tool, but as a business asset.  Paid for and, if properly written, your “army” for defense and/or financial indemnification.

As always, we remain committed to the RIA community and are here for expanded questions and discussions.  Happy New Year to all and may 2016 be a healthy and blessed year for you, your families, friends and your practice.

Golsan Scruggs is an insurance brokerage firm operating throughout the United States specializing in investment advisor E&O errors & omissions insurance (aka professional liability insurance) for RIA registered investment advisors. As one of the largest insurers of RIA firms in the U.S., we have a dedicated staff that understands the risks of the financial services industry and delivers superior results.  We make the underwriting process painless.

At Golsan Scruggs, we believe it is incumbent upon us to earn the right to be appointed as your insurance and risk-management agent. Our RIASURE process exists to serve that purpose.

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