Financial Planning & Regulatory Assets Under Management

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As the financial services industry continues to evolve, so, too, does the distinction between “investment management” and “financial planning” as discreet but complementary services that a registered investment adviser can provide to clients.

I’d read two of Michael Kitces’ recent posts for a more fulsome discussion of an “investment-centric” versus a “financial-planning-centric” firm culture (here and here), but suffice to say it is not a distinction without a difference. The former focuses on managing or recommending a portfolio of securities on behalf of a client, and the latter focuses on life decisions that have some sort of financial impact (managing cash flow, paying off debt, saving for a child’s education, purchasing a home, receiving social security benefits… the list could go on).

It would be too gross a generalization to suggest that investment management and financial planning are always mutually exclusive in practice, and dividing lines are blurry at best.

Yet when it comes to calculating and reporting an adviser’s Regulatory Assets Under Management (“RAUM”), the distinction necessarily must become more precise. The SEC requires every registered investment adviser to report its RAUM in response to Item 5F of Form ADV Part 1, and the instructions to Form ADV Part 1 contain a rather lengthy explanation of what should—and what should not—be counted toward RAUM.

In its RAUM calculation instructions, the SEC directs advisers to include “securities portfolios for which you provide continuous and regular supervisory or management services.” This is an important definition, and comprises essentially two prongs:

  1. Securities Portfolios
    At least 50% of the total value of a client’s account must consist of securities (including cash and cash equivalents) for that account to be counted toward RAUM. Include family or proprietary accounts, “house” accounts for which the adviser receives no compensation, and non-US client accounts. If the adviser provides continuous and regular supervisory or management services for only a portion of a securities portfolio, include as RAUM only that portion of the securities portfolio for which the adviser provides such services.

    If the adviser provides continuous and regular supervisory or management services for the entire portfolio, but 50% or less of the value of the portfolio is invested in real estate or other non-securities, include the entire portfolio value in RAUM.

  2. Continuous and regular supervisory or management services
    Here, the SEC distinguishes between discretionary client assets and non-discretionary client assets. An adviser that continuously and regularly manages or supervises an account with discretionary authority is deemed to meet the second prong.

    An adviser that does not have discretionary authority to manage an account has a higher burden to meet; a non-discretionary adviser must not only have ongoing responsibility to select or make recommendations as to specific securities or other investments, he also must be responsible for arranging or effecting the purchase or sale if such recommendations are accepted by the client.

The instructions then list a series of factors that help assess whether continuous and regular supervisory or management services are actually provided.

If the adviser agrees to provide ongoing management services in the advisory contract itself, this naturally cuts in favor of counting toward RAUM (even if the investing strategy is buy-and-hold or otherwise calls for infrequent trading).

If the adviser charges an hourly fee or a retainer, however, this cuts against counting toward RAUM. The SEC clearly suggests that an asset-based fee is more representative of an adviser that performs continuous and regular supervisory or management services (yes, hourly and retainer-based advisers will likely disagree).

A subsequent list of examples helps illustrate the two-prong test and accompanying factors, but one example stands out: an adviser that provides advice on an intermittent or periodic basis (e.g., as part of a quarterly client meeting) does not get to count such client’s assets as part of RAUM. This is perhaps the most controversial element of the RAUM instructions, as it leaves open the question of how “continuous and regular” advice must actually be. This is especially challenging for advisers that employ a more passive investment strategy that does not constantly try to outguess the market or trade for the sake of trading.

It also doesn’t account for the fact that some clients just don’t want to be bothered by the adviser on a continuous basis and are of the “don’t call me, I’ll call you” mindset. On the other hand, advice can come in many forms; sometimes the best advice is to do absolutely nothing. The best advisers not only provide proactive advice, but more importantly they are coaches and assuagers that prevent clients from making brash decisions they’ll soon regret.

The point I’m trying to make is that it is ostensibly more challenging for the accounts of pure financial planning clients to be included in the adviser’s RAUM, and the services performed for such clients should be carefully reviewed to determine if they meet the two-prong test.

In other words, it matters whether an adviser is providing investment management and/or financial planning, and which services are being provided to which clients.

As investment-centric firms add financial planning services and financial-planning-centric firms add investment management services, the RAUM math may very well change. For firms adding financial planning services, don’t forget to check the “financial planning services” box on Form ADV Part 1 Item 5G, and list the number of financial planning clients in Item 5H.

Recent enforcement actions have borne out the SEC’s intolerance for artificially-inflated RAUM, as enforcement staff are essentially trying to prevent advisers from preying on the “bigger-is-better” mentality of John Q. Public… a fraud in the inducement, so to speak.

I can’t predict if “number of financial planning clients served” will ever have the same clout as “assets under management,” but it’s important to calculate and report all such metrics accurately.

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This article originally appeared on July 29, 2016 in ThinkAdvisor.