RIA Client Suitability In a Nutshell
Client suitability starts with information about how the RIA firm's investment managers will provide its advisory services and the information about the client or fund that will be relied upon to guide those decisions. For a typical retail RIA situation, this may include your client profile, risk tolerance questionnaire, investment policy statement (IPS), or client notes capturing similar information. For structured investment products this may include the operating agreements, offering documents, and similar information about the funds, parties and entities involved. As these documents are executed, modified, updated or amended the advisor should keep and maintain this additional documentation for their firm's books and records.
Risks related to strategies used by an RIA firm must be disclosed to clients through Form ADV. Specifically in Form ADV Part 2A, the Disclosure Brochure, Item 8 Methods of Analysis, Investment Strategies and Risk of Loss should contain information regarding how the firm's investment management services will be applied to the client's accounts and the potential losses that can occur due to the way the firm will invest the client's assets. It is important for firms to review these disclosures and ensure they accurately reflect the firm's investment methods and cover the risks related to the firm's advisory services.
Confirming Suitability
After collecting a client's information, having them sign an advisory agreement and providing a copy of your ADV and other new client paperwork, suitability becomes a compliance matter for the relationship as you move to digest the information and start making investment decisions for the client's account(s). While your documentation may tell the client to notify your firm of any changes to their profile, goals or objectives, every RIA firm still has an obligation to reach out to the client and confirm the information you have is still accurate and that ultimately to confirm your current understanding of what is suitable for that client.
Confirming suitability can take the shape of having the client complete a new risk questionnaire, sign a new IPS, or to have a meeting with the client where you discuss the management of their account and address suitability matters. Documenting this confirmation is critical to the firm's books and records for compliance purposes on this topic, and can take the form of client notes indicating suitability was discussed and the results of that discussion, or the updated formal documents such as the questionnaire or IPS. For fund managers, this activity means ensuring that the decisions being made for the fund are reasonably accomplishing the objectives of the fund as described in its documentation and ensuring that due diligence documentation is retained for various non-public investments. By having this documentation in your firm's books and records you can demonstrate that your firm has upheld their fiduciary duty when making investment decisions for its various clients.
Through the Regulator's Eyes
Regulators expect RIA firms to maintain documentation on each advisory client to support the investment decisions made for their account(s). During an examination, regulators will typically ask firms to provide their risk questionnaires or similar documents used to obtain information about their clients, and will also request information about trades in client accounts, and will reconcile the two to ensure that decisions made for clients are suitable and that there is a rational basis between the documentation, analysis, and investments. Further, regulators will review the information in your firm's disclosure brochure to reconcile to the types of investments to ensure that the strategies and risks are properly and fully disclosed to clients.
CCO Best Practices
Conduct a random sampling review of client files to verify that suitability is appropriately documented. Run a comparison between the client's trading history and the suitability documented to ensure investment decisions are in line with investment objectives. Validate that the last outreach attempt to each client is within one year. Additionally, review your firm’s client intake/onboarding and ongoing review process to ensure you are capturing adequate information to make, or continue to make, appropriate investment decisions in client accounts and provide advice that is in the client’s best interest.
The AdvisorAssist CCO Series is a collection of blog posts that cover each of the elements of your RIA's compliance program. Each post will provide an overview of one compliance topic, including our insights on how regulators view each topic as well as some practical steps to help Chief Compliance Officers address this topic. As always, we would welcome your comments and thoughts.
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