Morningstar Magazine - August/September 2018 - 23

Likewise, an advisor who doesn't want to see
an elderly client's account size shrink
might be tempted to advise him to hold higheryielding, riskier securities so that he can
live off their investment income alone.
This may conflict with what's in the client's best
interest, which is to draw down from his
retirement savings. It's these and other types
of anti-investor behavior, rather than just
commission conflicts, that the regulators seek to
address in their proposals for client-focused
reforms. The changes fall far short of a statutory
best-interest standard.
Still, the proposed reforms that the regulators
published on June 21 represent progress.
At the very least, they establish the principle that
the best interests of investors must be
taken into account and spell out in some detail
what best practices would look like.
However, the proposals cut the industry a lot
of slack by avoiding specific requirements
concerning how to address conflicts of interest
and what constitutes suitable investments.
The proposals are industry-friendly, in that
they accommodate all legitimate business models,
including proprietary, embedded-commission,
and robo-advice.
The proposed reforms, for which the regulators
have set a 120-day period to receive
comments, cover five main areas of advisor
relationships:

1 Know Your Client Advisors must have a

3 Suitability The most significant suitability reform

"meaningful understanding" of their clients. This
involves obtaining details of financial
circumstances, investment needs and objectives,
investment knowledge, risk tolerance, and
time horizon. Advisors must take into account
whether there are priorities other than
investing that are more likely to help clients
achieve their goals. The regulators warn that
a client's risk profile should not be "manipulated"
to justify recommending higher-risk products.
Though these are all best practices that advisors
should already have in place, spelling
them out in detail is a welcome development.
As for robo-advisors, the regulators say
that these requirements can be met through
online questionnaires and do not require
face-to-face contact.

being put forward is the emphasis on a
portfolio approach, as opposed to trade-by-trade
review. There are new requirements to assess
whether investors are overly concentrated
in illiquid exempt-market securities, or in a single
issuer, industry, sector, or asset class. Advisors
will also be required to consider multiple accounts
that investors may hold. Advisors must explain
to clients the difference between commissioned
and fee-based accounts, and why it's in the
client's best interest to be placed in a particular
compensation model.
4 Conflict of Interest New proposals address

2 Know Your Product There are new requirements

for firms to analyze and monitor securities that
they intend to make available to clients. They must
maintain written policies and procedures
and apply these consistently. In a nod to embedded
trailer commissions, the requirements include
knowledge of the initial and ongoing costs of a
security and the impact of those costs on investors.
Individual advisors are subject to these
requirements for any approved securities that
they offer to clients. Firms must understand how
their approved securities compare to others
available in the market. This requirement applies
even if the firm deals only in proprietary products.

conflicts arising from proprietary products. But for
the most part, the regulators make suggestions
about what firms "could" do as opposed to
what they must do. One of the many suggested
courses of action, for example, is that periodic due
diligence be conducted to assess whether
proprietary funds are competitive with alternatives
available in the market. On the issue of trailer
commissions or other third-party compensation,
firms should be able to demonstrate that
their fund and recommendations are based on the
quality of the security. The regulators spell
out various ways that this could be accomplished,
but again, they are only suggestions, not
specific requirements. The regulators also say the
investment firm's consent concerning a conflict
of interest does not automatically let an
individual employee off the hook. Advisors are still

Energy to Peak, Renewables to Grow....
1900-2050E: World Annual Primary Energy Consumption by Source

Terawatt-hour per year
PROJECTION

Coal
Oil
■ Gas
■ Biomass
■ Nuclear
■ Renewables

160K

■
■

120
Fossil fuels (coal, oil, gas) still 50% by 2050

80

The good news is that improvements in green
technology are also accelerating. The costs
of new wind and solar energy are now cheaper
than coal and nuclear, and battery costs are
plummeting. The bad news is that it's not enough.
By 2050, even with the use of renewables
surging, fossil fuels will still account for 50% of
energy consumption.

40
0
1900

1920

1940

1960

1980

2000

2020E

2040E

Source: DNV GL, OurWorldInData.org, Vadav Smil. Data as of 09/30/2017.

global.morningstar.com/Morningstarmagazine

25
23
27
http://www.OurWorldInData.org
Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018
