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Merrill Lynch Rule to Result in Fewer, Nimbler Financial Advisers, Back Office


MIAMI-The best way to shape the back office's response to the Merrill Lynch Rule was addressed in a presentation last month by Dr. Stephen Winks at the National Investment Company Service Association's 7th Annual Managed Accounts Technology and Operations Conference, recently held here at the Doral Golf Resort and Spa. And it's all about becoming as nimble as the front office.

The Merrill Lynch Rule allows brokers to offer fee-based accounts to clients on a non-discretionary basis, as long as any investment advice provided is "solely incidental" to their order-taking brokerage services.

Recent court and regulatory rulings require a financial adviser to either declare fiduciary status or use a consumer warning, essentially stating, "I am acting in a fiduciary capacity and am not obligated to act in your best interest."

As a result, experts say that if an adviser is responsive to his or her client's needs and offers individualized advice, they are acting in a fiduciary capacity. This makes every adviser in the industry potentially a fiduciary, thereby raising a number of regulatory and other compliance issues.

Winks, publisher of Senior Consultant newsletter, said that in light of the impact of the subprime crisis and layoffs in operations and technology, the adoption of some of the changes required by the Merrill Lynch Rule is particularly attractive.

"The implementation of an audited prudent investment program could reduce adviser cost by a third and deliver superior value," he said.

From a timing point of view, Winks said, we are now in what could be an ideal time to implement the changes in back-office functions that will support advisors in a post-Merrill Lynch rule world.

The audited prudent investment program aims to provide eligible investment advisoers with the chance to comply with the Investment Protection Act of 2006 provisions, which when audited by a prudent expert, becomes a safe harbor for advisers to acknowledge and fulfill their disclosure obligations.

Winks defined the audited prudent investment program as having six characteristics: namely, an asset liability study, investment policy, asset allocation, portfolio construction and tactical asset allocation programs.

The program should include the technology and division of labor needed to meet fiduciary responsibilities, Winks stressed.

A third best-practices consideration, he continued, should be the creation of an applied program interface standard, which allows each element of the audit process to communicate with the others.

If these three protocols are followed, Winks said it will result in an investment policy that can be upgraded and replaced easily.

Toward that end, Winks and others created the Fiduciary Standards Council (FSC), a collaboration of leading advisory services stakeholders. This group will bring fiduciary counsel within the reach of all advisers by advancing an audited prudent investment process which will be audited at least annually by a prudent expert against objective criteria for fiduciary counsel based on statute, case law, regulatory opinion letters, best practices, process, procedure, work flow and task.

The FSC will, first, define advice against objective criteria cited above so advice can become scalable. Its second mission is to define the necessary enabling resources, (3) define certified components (i.e., asset/liability study, investment policy, strategic asset allocation, portfolio construction, performance monitoring, tactical asset allocation).

The group will also establish an audit path, and define an applications program interface (API) so each component of an audited prudent investment process can talk to each other and be upgraded and replaced, while maintaining process the integration of one easy to use system.

One of the key objectives, perhaps the most important, is to support the three principle divisions of labor in advisory services: the CEO/investment advisor, the chief investment advisor and the head accountant. The goal here is to achieve extraordinary operating efficiencies and optimize the advisors value proposition.

Winks said the end objective of the program is to create a safe business environment based on statutory rules, case law and regulatory opinions-while creating a solid audit path.

Admitting that setting up the back-office functions to support the creation of this program will be somewhat disruptive for the industry, Winks emphasized that making the adjustments needed to support investment advisory firms, financial advisers and their new responsibilities will position the mutual fund and separately managed account industries to get higher margins.

Essentially, this is merely taking advantage of work financial advisers are already doing for end investors.

Efforts to implement these programs will rely heavily on industry vendors, Winks stressed.

"We can ask advisors to use special skill sets and resources that will streamline the organizations that support them," he said. "It will also improve the cost structure of the industries."

In addition to providing a superior value proposition, Winks said the asset management industry should enact changes in order to ensure that every adviser has a safe business environment in which to work.

As it is currently structured, it is difficult, if not impossible, for advisers to manage hundreds of client accounts and administrative functions, in such a way as to comply with the requirement that they provide a fiduciary level of service to clients.

Winks advised the industry to enact changes through the back office to support advisers in these efforts to fulfill their fiduciary responsibilities.

The consultant emphasized that division of labor is important and called for the creation of a chief administrative officer and a chief information officer to work together.

In remarks after his presentation, Winks said that operations and technology personnel will be able to cut costs and increase their value to their organizations as they respond to the challenges of the Merrill Lynch Rule.

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