No Skeletons in This Closet

Last Friday, the Wall Street Journal published an article by Jason Zweig titled You Don’t Know What You Don’t Know About Your Financial Advisor. In the article, Zweig explains how fee-only registered investment advisory firms (RIAs) are regulated differently from broker-dealers and dually-registered advisory firms that contain a broker-dealer division. The article has generated a lot of discussion because it describes a hole in the regulatory process that most of us were not aware of.

RIA firms, like Modera, that are fee-only must provide clients with a standardized disclosure form called an ADV Brochure. In that brochure, firms are required to disclose whether there have been “specifically enumerated legal or disciplinary events that are material [emphasis added] to a client’s or prospective client’s evaluation of our advisory business or the integrity of our management.” Among the specific events are certain criminal or civil actions, administrative proceedings or a self-regulatory organization proceeding. They must also disclose information or events that would be material to a client’s or prospective client’s evaluation of the firm’s integrity.

While this seems relatively straightforward, the problem lies in the reliance on advisory firms to make their own determinations of what constitutes “material” events requiring disclosure. The article cited two examples of firms that were subject to substantial client complaints, one of which was for millions of dollars. Yet both firms’ ADV brochures stated that there was nothing material to report. Huh?

In contrast, had these firms been under FINRA supervision, which would be the case if they were also registered as broker-dealers, disclosure would have been required. The information would be easily accessible by the public, even if the customer complaints were ultimately shown to be without merit. The mere existence of a complaint or civil suit is a disclosure event for broker-dealer firms.

Because of this difference in disclosure rules, Zweig recommends that consumers ask the following questions when interviewing prospective financial advisors: “Have clients filed written complaints or arbitration claims against you or your firm? Have you or your firm been sued by clients?”

This is good advice.

I am proud to say that Modera has a strong culture of integrity and compliance. Furthermore, I can unequivocally state that Modera has no claims or lawsuits by clients. If we did, we would disclose them on our ADV brochure.

Modera’s Chief Compliance Officer, Theresa Days, is an attorney with more than 20 years of experience in the securities industry. She believes that the case law is quite solid on what “materiality” means in our industry, and that the scenarios described in the WSJ article are indeed material and should have been disclosed.

Technically, Days said, an RIA could argue that since a case was not resolved, it doesn’t constitute a material event. But Days thinks this is flimsy logic. And she answers to a higher authority.

“My mother would be so disappointed in me if chose to only follow the letter of the law and disregarded the spirit of the law. I cannot have that, I cannot!”