Financial regulators worldwide are enforcing suitability and supervisory requirements designed to protect investors working with wealth management firms, retail brokers and registered investment advisors. The Consumer Financial Protection Bureau, under the direction of the Dodd–Frank Act (DFA), requires financial professionals to check the suitability of products and adhere to a strict code of conduct when selling to investors – with householding a clear standout issue. Similar rules apply to firms who do not fall under DFA, typically promulgated by FINRA.
The concept of householding allows firms to consider the entire relationship of the household when evaluating what is suitable for the individual's situation. Householding is often beneficial to both the firm in the form of reduced operational costs and to the client in the form of reduced management fees or larger breakthrough discounts. Householding can also help advisors spot investment opportunities or risks not apparent at the account level. For instance, if an individual seems properly leveraged in a high yield product but the household is underweighted in the same product, a recommendation can be made to the client on that basis.
As advantageous as it sounds in theory, in practice householding can be a complex situation since the precise definition varies by firm. Furthermore, householding may change over time due to external factors – divorce/marriage/death/birth.
Many compliance programs are proficient at monitoring individual accounts, but struggle when multiple accounts of varying situations are aggregated together. This leaves the firm vulnerable to regulatory violations such as exceeding the household's concentration threshold in a sector or not giving the correct breakthrough discount.
Additionally, firms will often fall short when assessing if the sales practices employed are in line with the expectations of the household, not simply the individual. For example, mutual funds discounts on sales charges are flagged on individual accounts, but are often overlooked if incorporated into a household agreement since most solutions are not sophisticated enough to examine that level of granular detail.
Furthermore, many compliance monitoring programs isolate searches for churning or other illicit behavior to the account level, and not across associated accounts. In other words, a rogue trader could sell products in one account, and purchase similar products in another account associated in the household, thereby generating greater commissions and making a seemingly suitable transaction.
The size and growth of this market ensures that the compliance bar will rise rather than fall.
- Assets Under Management (AUM) at wealth management firms is expected to double to $145T by 2020 according to PWC. Asset & Wealth Management Revolution: Embracing Exponential Change. 2017.
- Registered broker-dealers have $3.6 trillion in balance sheet assets.
- Investment advisors have $12T in AUM.
As the level of sophistication increases regarding the volume, structure, and nature of investment products, so too does the expectation that those investments will be diligently monitored. Regulators will continue to heavily focus on documents, such as investment policy statements, particularly when aimed at increasing cross selling among households or corporate entities. Firms must monitor, and more importantly prove consistent compliance, with the expectations set out with their clients at the onset of the relationship at the individual as well as the household level. Failure to do so will undoubtedly result in fines and reputational damage.