The client onboarding process is critical in providing clients with a positive, lasting first impression of an advisory firm. However, the process is also critical because, if done correctly, it can help an adviser manage its legal and regulatory obligations, including its fiduciary duties, more effectively and efficiently.
This article will provide a roadmap filled with practical steps designed to improve an adviser’s client onboarding process to address legal and regulatory concerns.
At the outset, as part of the adviser’s effort to gather basic background identification information for a client prospect, the adviser should also request a driver’s license, passport, or other official government identification from the client to verify his or her identity. Although this step is not specifically mandated by specific federal securities laws, rules or regulations, the SEC and many state regulators expect advisers to conduct identity verification of clients.
Investment advisers should also conduct a basic check to verify if the client presents a money laundering risk. Although investment advisers currently are not required to adopt an anti-money laundering (“AML”) program (including appointing an AML officer and adopting an AML training program), many state securities regulators nonetheless expect investment advisers to perform a basic check on the U.S. Office of Foreign Assets Control (“OFAC”) website to verify that the prospective client is not on the Specially Designated Nationals and Blocked Persons list. Advisers should document these verification steps by retaining any government identification documentation collected from clients and documenting their OFAC checks.
Additionally, if the client is a government entity, such as a government pension or retirement plan, the adviser should conduct a preliminary review to determine whether the firm or any of its covered persons has made a political contribution that would prohibit the adviser from collecting fees for advisory services rendered to the government entity. For instance, Rule 206(4)-5 under the Investment Advisers Act of 1940 (the “Advisers Act”) generally prohibits, among other things, an adviser registered with or required to be registered with the SEC from receiving compensation for advisory services from a government entity within two years of the making of a contribution to an official of the government entity by the investment adviser or any covered associate of the investment adviser (including a person who becomes a covered associate within two years after the contribution is made).
“Covered associates” generally include the executive officers of an adviser as well as any employee who solicits business from a government entity or anyone who supervises such an employee. The term “official” means anyone who was, “at the time of the contribution, an incumbent, candidate or successful candidate for elective office of a government entity, if the office: (i) Is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity; or (ii) Has authority to appoint any person who is directly or indirectly responsible for, or can influence the outcome of, the hiring of an investment adviser by a government entity.
It behooves an adviser to ensure that it does not enter an advisory relationship with a government entity client where the adviser is not permitted to be compensated for its services.
Apart from gathering and reviewing a prospective client’s basic identifying information, advisers should collect detailed information relating to a client’s financial situation (including current employment, total income, total and liquid assets, financial liabilities and obligations, etc.), financial goals and objectives, risk tolerance, time horizon, liquidity needs and desired investment guidelines or restrictions. Such information is critical to an adviser’s ability to fulfill its fiduciary obligations to its clients, which generally include, among other things, the duty to make investment decisions consistent with any mutually agreed upon client objectives, strategies, policies, guidelines and restrictions. This information is typically gathered through carefully curated questionnaires or forms provided by an adviser. An adviser should carefully discuss any responses provided by the client to ensure that the information is accurate and complete and to ensure that the adviser can provide advisory services in line with the client’s financial circumstances and needs. Additionally, depending on the advisory services offered, an adviser may want to collect tax returns, insurance documents, estate planning documents and other documents pertinent to a client’s financial circumstances.
Once such financial information has been gathered, an adviser can document the mutually agreed upon investment objectives, guidelines and restrictions in an investment policy statement. Of course, any information gathered from a client must be periodically updated to reflect changes in the client’s financial circumstances and needs. Careful documentation of a client’s financial circumstances and needs is critical because if regulators or the client later question the adviser’s investment recommendations or decisions, the adviser can point to documentation evidencing the fact that it acted in line with the client’s stated financial circumstances, objectives and needs.
In reviewing a client’s background, an adviser should also determine if the client is an insider (e.g., officer or director) of a public company. Such status might present an increased risk of an adviser being exposed to material nonpublic information about the public company. As such, to mitigate insider trading risk, an adviser with such a client might want to consider imposing restrictions on trading in the securities of the public company for the client or for all clients of the firm.
Typically, after the information gathering process has been completed, an adviser will deliver a copy of the client agreements covering the services (e.g., investment management, financial planning, or consulting) to be provided by the adviser. As part of the contract process, the adviser should carefully review the client agreement(s) with the client to ensure that the client understands the terms of the engagement and has an opportunity to ask any questions he or she has about the advisory agreement.
The contract process also allows the adviser to obtain several consents that are strongly advised. For instance, if the client wishes to receive any documents electronically from the investment adviser, the SEC expects the client to consent to such electronic delivery. To evidence such consent, advisers should obtain such consent in writing, which can be done by including a provision authorizing electronic delivery of documents in the client agreement.
Separately, during the contract process, an adviser can obtain consent from a client to share information with a designated trusted contact person in the event that the adviser becomes concerned that the client has gone missing, is experiencing a physical or mental impairment, or may be the victim of financial exploitation. Obtaining such a consent allows the adviser to share concerns about a client with a trusted third party without raising concerns that the adviser has violated its fiduciary duty to keep client nonpublic information confidential or Regulation S-P, which requires an adviser to maintain administrative, physical and technical safeguards to protect clients’ records and information. Such a consent can be included in the client agreement to protect the adviser.
Certain disclosure documents must be delivered by the adviser during the onboarding process that help the adviser fulfill its fiduciary duty to provide full and fair disclosure of all material facts about the advisory relationship to its clients.
For instance, Rule 204-3 under the Advisers Act requires an adviser to deliver the firm’s Form ADV Part 2A disclosure brochure to clients before or at the time that the adviser enters into an advisory agreement with the client. If the client will participate in a wrap fee program sponsored by the adviser, the adviser must deliver an Appendix 1 to the disclosure brochure before or at the time that the parties enter into the advisory agreement.
Rule 204-3 also generally requires an adviser to deliver a current disclosure brochure supplement for each supervised person before or at the time that the supervised person begins to provide advisory services to the client. While this technically does not require an adviser to deliver such brochure supplements before an advisory agreement is signed, often it is more administratively efficient for the adviser to deliver such brochure supplements when other disclosure documents are delivered to the client.
Separately, Regulation S-P requires that an adviser deliver a copy of its current privacy notice to clients before entering into the customer relationship.
Although not explicitly part of the contract process, an adviser can use the opportunity available to verify that the client has executed all of the pertinent account opening and other documentation with the custodian. This could include, as applicable, an authorization to open a margin account that would allow trading on margin or a prime brokerage relationship where other executing brokers can be used other than the custodian to effect trades on behalf of the client. Finally, if the client wishes for the adviser to disburse funds from the custodial account from time to time through a standing letter of authorization, the adviser should confirm that the client has taken the appropriate steps to authorize the adviser to assume such authority.
Additionally, if the prospective client was referred by a third-party solicitor, the adviser should obtain an acknowledgment executed by the client confirming that the solicitor provided the prospective client with a copy of the adviser’s Form ADV disclosure brochure, as well as a solicitor disclosure document outlining the details of and conflicts associated with the solicitation arrangement. Depending on the adviser’s arrangement with the solicitor, the adviser can obtain the executed acknowledgment either from the client or from the solicitor.
Once the adviser has taken the foregoing steps, the adviser can request the executed advisory agreement from the client. Once received, the adviser should confirm that the advisory agreement has been properly completed and executed. The adviser then can confirm with the client the date when it can begin providing advisory services to the client.
The foregoing is not an exhaustive list of the steps that an adviser should take as part of its client onboarding process as each advisory firm’s business, operations and clients can vary greatly. However, these steps, when followed, can help an adviser manage the legal and risks associated with serving its clients.