Tips for Dealing with Investment Guidelines
Here are a few tips and tricks for dealing with investment guidelines, courtesy of Buckley Kolar partner Sara Emley:
Donít promise something that you canít deliver. Before you agree to manage a clientís account subject to various client-imposed investment guidelines and restrictions, "youíd better be sure that you can make good on them," cautioned Emley. When "someone comes with a big chunk of business," she said, "thereís a temptation" when the client asks the adviser to abide by their investment guidelines to "make them happy and say ĎSure, we can do that.í" But before agreeing to abide by client-mandated investment guidelines, "be very careful and check with operations, compliance, whatever to make sure that you really can follow them."
Get it in writing. Many advisory firms are noted for their specific investment approach, and as a result, may not be presented with investment guidelines or investment policy statements by their clients. In other words, the assumption is that if you are going to XYZ Adviser, you are doing so because of their reknowned ABC strategy.
Many advisers "have clients coming to them because they have a particular style," said Emley. However, she added, even when it is obvious what the adviser is expected to do, advisers and clients still may want to attach an investment policy statement to the advisory contract. "If they really are coming to you for a particular strategy, it seems to me that it would be useful to at least document that," said Emley. That way, if later down the line the client asks, "Why didnít you diversify my portfolio," the adviser has something to point to.
Give yourself flexibility. When documenting investment guidelines, donít box yourself in unnecessarily. In fact, Emley said that she typically suggests that advisers create a document that "might not rise to the level of guidelines," but instead be "an investment policy statement" where the accountís objectives, risks, and other features are noted. "I donít think from the beginning I would want to accept guidelines" such as "no more than 70 percent in stock," unless "there were very compelling reasons to do so," she said. "All you are doing is creating a high risk that you will violate the agreement."
Consider how you will handle client instructions that conflict with written investment guidelines. An adviser may agree to comply with client-imposed guidelines. But it also may agree to comply with any other instructions that the client provides. What if the instructions conflict with the guidelines?
To address this type of situation, Emley suggested that advisers specify in their contracts that when it comes to investment-related instructions, they will only comply with instructions from the client that are in writing and do not conflict with the clientís written investment guidelines. If the client wishes to amend its written investment guidelines, that should be accomplished via an amendment to the agreement, not on an instruction-by-instruction basis.
Have a process. "Youíre not going to necessarily remember two years from now that you agreed to something specific in Client Xís agreement," said Emley. "You have to have some process in place." To avoid human error, nearly all larger advisers have hard-wired account restrictions and guidelines into their portfolio management system. In addition, some firms provide portfolio managers and traders with quick reference guides to client investment guidelines and restrictions. Make sure to keep any front-end automated or manual restrictions updated.
Watch out for ERISA plans. Emley noted that questions about investment guidelines often arise when dealing with ERISA plans. She said that she often encounters situations where ERISA clients present an adviser with their own management contract. Buried in the contract is a representation that the adviser will comply with the planís investment guidelines. Moreover, under ERISA, she explained, investment guidelines are deemed part of the formal plan document, and therefore the adviser will likely have a duty under ERISA to comply with the guidelines, regardless of whether they are mentioned in the agreement. For those reasons, an adviser to an ERISA plan should ask to be provided with any plan investment guidelines, in writing.
Watch out for state plans. Investment guidelines also may present an issue in the context of plans governed by state law, since some state pension codes contain statutory guidelines for investments. Some state plans "are pretty big clients" and will ask you to comply with "all applicable law." That can be "a tough one," said Emley. Unless it has set up processes to do to, an adviser does not want to be in the position of "monitoring Michigan law or Florida law for changes." When dealing with such a situation, it is better to have the plan fiduciary or another person responsible for providing applicable law and any updates. "Thereís no way most advisory firmsí compliance departments can know when a certain state changes its law," she said.
Watch out for ICA Rule 3a-4. As a reminder, advisory programs that rely on ICA Rule 3a-4 to avoid investment company status must allow clients to place reasonable restrictions on the account, such as "no tobacco."