Improve the Quality of Investment Advice

A volume of recommended practices shows CPAs how to deliver competent and objective financial tips.

he vast majority of the nation’s investable wealth is in the hands of fiduciaries—more than five million men and women responsible for managing others’ money. While corporate malfeasance has cost shareholders billions in losses, such damage may be far smaller than that resulting from investment advisers’ and trustees’ failure to competently manage client and trust assets.

In response, the Foundation for Fiduciary Studies and the AICPA have published Prudent Investment Practices —a handbook for investment fiduciaries—which contains a conceptual framework for following a disciplined investment process. To introduce the handbook to members and help them use it effectively, the AICPA has added explanatory sessions to this month’s Personal Financial Planning Technical Conference and the 2004 Practitioners’ Symposium in June. The aim in these efforts is to protect the average investor’s interests and to promote the delivery of competent and objective investment advice.

This article explains how fiduciaries can implement the guide’s best practices and avoid making investment decisions influenced by emotion or irrelevant market factors.

CPAs, who often are themselves fiduciaries or act as advisers to fiduciaries and others, will find the handbook useful in determining whether an investment process corresponds with defined prudent practices. It also will help practitioners understand which new investment strategies, products and techniques fit their clients’ priorities.

A fiduciary’s primary duty is to manage a prudent investment process, without which the components of an investment plan cannot be defined, implemented or evaluated. Statutes, case law and regulatory opinion letters dealing with investment fiduciary responsibility reinforce this concept.

The handbook contains practical advice for CPAs who

Work in business and industry, supervising or advising investment committees. It describes the roles and responsibilities of investment committee members. CPAs can use this information as a checklist for reviewing the committee’s investment decision-making process and identifying any deficiencies in it.

Prepare financial statements for—or serve as a business consultant to—foundations, endowments or high-net-worth individuals. The handbook is particularly useful to these practitioners because it defines the specific functions an investment adviser should perform. Armed with this knowledge, the CPA can help evaluate a client’s adviser and provide valuable insight into the performance of those on whom the client relies for investment advice.

Serve as investment advisers. Given investors’ trust in CPAs, it’s not surprising that some practitioners have agreed to play this role for their clients. But such confidence in their CPAs can raise clients’ expectations and prompt practitioners to observe performance standards—such as those communicated in the handbook—that are more stringent than even securities regulators require.

The handbook identifies 27 practices that detail a prudent investment process from beginning to end. Each practice is accompanied by a brief explanation of its intent and practical application. Among the subjects addressed are

Procedures for developing an asset allocation strategy.

Preparation and maintenance of investment policy statements.

Implementing an investment strategy with appropriate money managers.

Monitoring and supervising an investment strategy and procedures for controlling and accounting for investment expenses.

The handbook has several useful features.

You (Should) Know Who You Are
“Some practitioners functioning as investment fiduciaries don’t realize the true nature—or the attendant responsibilities—of their role,” said Anat Kendal, AICPA director of financial planning. In general, a fiduciary

Manages property for another’s benefit.

Exercises discretionary authority or control over assets.

Acts as a trusted professional, rendering comprehensive, ongoing investment advice.

“Examples—many of whom are CPAs or are advised by them—include investment advisers, trustees and investment committee members,” Kendal said. “It’s important to note that many investment fiduciaries erroneously believe they are responsible for making investment decisions, when in fact their charge is managing them.”

Money managers make investment decisions by selecting stocks and bonds for their clients’ portfolios. But fiduciaries manage the overall investment process by setting the portfolio’s goals and objectives and preparing and maintaining its investment policy statement; by overseeing due diligence and the selection of investment options; by monitoring chosen investment options and by controlling and accounting for portfolio investment expenses.

The practices are applicable to any size or type of fiduciary portfolio—private trust, foundation, endowment or retirement plan. So the CPA need become familiar with only one set of procedures, rather than learning one for private trusts, another for qualified retirement plans and so on. There is one set of practice standards; the same standards are applicable to any fiduciary portfolio, such as a private trust, foundation, endowment or retirement plan.

A Diagnostic Checklist
CPAs should ask themselves the following questions—derived from the handbook’s practices—to help them detect deficiencies in clients’ or prospects’ investment processes.

Do the members of the investment committee fully understand their duties and responsibilities as investment fiduciaries? The investment committee’s responses to the following questions are one of the best ways to test their understanding of investment fiduciary responsibility.

Does the client have an investment policy statement (IPS)? If so, is the investment committee in compliance with those guidelines? The preparation and maintenance of the IPS is one of the most critical functions an investment fiduciary performs.

Does the client’s asset allocation strategy reflect an appropriate risk/return profile, given its investment goals and objectives?

Has the client followed a consistent due diligence process in selecting investment managers? Is the process documented? A comprehensive IPS should identify and describe in detail the due diligence process to be followed in selecting each investment option.

Given the account’s level of assets and its reporting and administrative requirements, has the client chosen an appropriate custodian?

Does the client receive, at least quarterly, a performance report? If so, does the report specify each money manager’s performance against stated objectives in the IPS, the manager’s peer group and the manager’s appropriate performance index?

Is the client monitoring the soft dollars, best execution, and proxy voting (if it is delegated) of each one of its money managers?

Does the client follow formal procedures for placing money managers on a watch list when a manager’s performance begins to deteriorate?

Does the client follow formal procedures for terminating money managers?

In the case of participant-directed defined contribution (401k) plans, has the client elected to follow the “safe harbor” provisions of the Sarbanes-Oxley Act of 2002? If so, has the client communicated to plan participants the intent to seek section 404c protection; provided at least three investment options, each with a different risk/return profile; and provided education and training and enabled participants to change their investment allocation at least quarterly?

If the client charges marketing expenses to its shareholders by means of 12-b-1 fees, are the fees being properly used and accounted for?

If the client has retained an investment consultant, has the consultant acknowledged cofiduciary status in writing? Is the consultant aware of his or her duties and responsibilities? Is the consultant’s compensation (whether in hard or soft dollars) fair and reasonable for the services he or she rendered? Is the consultant objective in the search for and monitoring of money managers?

The Handbook Can Help You…
n Assist fiduciary clients to establish evidence that a prudent investment process is being followed in order to minimize litigation risk and enable clients to negotiate lower insurance premiums for errors and omissions coverage. Litigation involving breaches of investment fiduciary responsibility is growing at the compounded rate of 22% per year; in 2002 plaintiffs filed an estimated 15,000 suits and arbitration cases.

Apply the handbook’s recommendations to all parties involved in the client’s investment decisions, including money managers, investment advisers, consultants and attorneys. The handbook also provides an educational outline of an investment fiduciary’s duties and responsibilities.

Work with clients to increase long-term investment performance by identifying more appropriate procedures for

Managing their portfolios across multiple asset classes and peer groups.

Evaluating fees and expenses for investment management services.

Selecting appropriate money managers.

Terminating ineffective or otherwise inappropriate money managers.

Assist clients in detecting investment and/or procedural risks not previously identified, which may help prioritize investment management projects with consultants, advisers and vendors. In addition, the handbook can supply information for establishing benchmarks to measure the progress of an investment committee and/or consultant.

A Practitioner’s View of the Handbook
Joel Framson, CPA, PFS, chairman of the AICPA personal financial planning executive committee and principal of Allied Consulting, a financial planning, wealth management and investment advisory practice, discussed how various constituencies will benefit from the handbook’s recommendations.

Q: How will this handbook help protect the interests of the investing public?

A: As employee pension plans deteriorate because of poor investment practices and the SEC prosecutes fiduciaries for having conflicts of interest, the handbook reassures the public that there are financial advisers who will put their clients’ best interests ahead of those of their own investment advisory firms. It does this by providing investors with criteria for identifying competent and ethical advisers and for comparing the scope and level of their services. And it protects the public by showing the benefits of requiring investment planners and advisers to identify prudent processes within the legal and regulatory framework.

Q: How can the handbook help CPAs provide personal financial planning services?

A: The handbook lays out prudent practices that serve as investment planning guidelines for CPA financial planners and, more specifically, for AICPA personal financial planning (PFP) section members. Following the guidelines outlined in the handbook will help CPAs reduce their financial planning practices’ exposure to lawsuits and investment regulation pitfalls. Much of the handbook’s technical and legal content came from a law firm specializing in pension plans. Among the subjects covered are fiduciary work, case law, regulations and other information related to the fiduciary aspects of investment practice. Following these practices will help CPAs differentiate themselves from other types of fiduciary service providers.

Q: Will the fiduciary handbook help improve the image of CPAs?

A: As CPAs in public practice and those in industry embrace the practices contained in the fiduciary handbook, the public will see how CPA financial planners deliver the best financial advice with the highest standards of integrity. That will significantly enhance the image of CPAs willing to observe the high level of fiduciary care the handbook recommends.

The practices are equally applicable to trustees and investment advisers. CPAs can use the handbook to inform investment committee members of their duties and functions. They also can go to it for guidance in assigning to an investment adviser specific responsibilities as part of its management of a client’s account.

Each of the practices has been fully substantiated by legislative acts that define general fiduciary procedures and, when applicable, regulatory opinion letters and case law. In the handbook a discussion of each practice is accompanied by the relevant legal citations. The publication represents the investment industry’s first attempt to create a compendium of all the citations associated with the subject of investment fiduciary responsibility. These citations also help show the industry does not need new legislation and/or regulations as much as it needs to provide education and training on existing fiduciary requirements.

The handbook, Prudent Investment Practices, can be ordered online at or by calling 866-390-5080. The cost to AICPA members is $20 plus shipping.

The handbook is concisely written in plain English. (Information on ordering this publication can be found above.)

Donald B. Trone is an accredited investment fiduciary auditor. He also is president and founder of the Pittsburgh-based Foundation for Fiduciary Studies, whose mission is to develop and advance fiduciary standards of care for trustees, investment committees and advisers. He can be reached at .

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