If your firm is charging advisory fees without providing ongoing advice to so-called orphan accounts, you can expect scrutiny from Securities and Exchange Commission examiners and maybe even an enforcement proceeding.
Just ask $1.9-billion, Michigan-based Regal Investment Advisors and its two principles, who were hit with nearly $1 million in fines in September after SEC examiners found that 81 of the firm’s orphaned clients (those left behind when advisors depart the firm) were still being charged ongoing advisory fees, but not receiving advice.
The SEC’s case against Regal alleged the firm and its partners, John Kailuna and Brian Yarch, with “improperly charging $85,432 in advisory fees to client accounts for which Regal failed to provide advisory services after the departure of the assigned IARs.” The firm and both its partners settled the charges, without admitting or denying guilt.
Making sure your firm is notifying and servicing orphaned accounts “should definitely be a priority for RIA firms,” Max Schatzow, a partner in the law firm of Stark and Stark, told Financial Advisor magazine. “I’ve seen this issue come up in SEC exams for years, but this is the first time I’ve seen it become an enforcement action.”
Ever since the Department of Labor started to roll out its fiduciary rule in 2016, the brokerage business has been forced to address the issue of small, incidental clients. The $8 trillion RIA industry has always dealt with orphaned clients—small accounts and those unassigned accounts left behind when an advisor departs, retires or dies—but now because of its soaring growth and regime change at the SEC, investment advisors appear to have a bigger target on their back.
“Every firm should have a process in place to make sure clients don’t slip through the cracks when an advisor leaves or passes away,” Schatzow said. That should include notifying clients that their advisor has departed and that either they’ve been assigned a new advisor or that the firm is referring them to another firm if they don’t meet asset minimums.
The level of ongoing advice a client can expect “is a contractual matter between an advisor and the client, as long as the client has consented to it,” he said. If a client is on track and doing great, an advisor may not need to reach out.
“But if the client agreement says, ‘we’ll have an annual meeting and do financial planning every year,’ that’s what the firm needs to provide and that’s what the SEC will expect you to do,” he added.
The stakes get even higher if there is a market downturn and the client experiences losses while an advisor is AWOL, Schatzow said.
Beyond SEC enforcement, if the losses are high enough a plaintiff’s attorney may also step in to recover investor losses, he said.
“Any time there are substantial losses, you always hear about claims and one of those claims is ‘you neglected me, you breached our client agreement and I have losses in my portfolio because you failed to contact me,'” Schatzow said.