January 28, 2019 | ARTICLE | BY KELLY LYNCH
Financial intermediaries take “Know Your Customer” (KYC) guidelines seriously. Many banks, independent broker-dealers, insurance broker-dealers and other financial intermediaries spend significant dollars and compliance resources ensuring they meet banking and/or anti-money laundering surveillance and compliance requirements. However, one type of customer account inherently poses greater challenges from both a KYC and more broadly, a surveillance/compliance standpoint: direct-at-fund accounts.
While there are some benefits to direct-at-fund business, most firms would acknowledge that the process poses challenges. For starters, opening and funding customer accounts direct-at-fund using a paper “check and app” process is less than ideal from a logistical, operational and compliance standpoint. It’s also more difficult to facilitate future transactions, monitor accounts, and get customer data back from each fund company. Some firms admit they aren’t confident that they have complete and accurate records of their direct mutual fund account data on the back end. Others wait until they get commission files back from the fund companies at the end of each month to see what customer positions are. Regardless of the methods broker-dealer firms employ to monitor their direct-at-fund business, even the best-intentioned financial intermediaries may lose sight of direct accounts altogether, particularly smaller-balance accounts. This problem becomes evident when reps move to another firm and these accounts end up “orphaned,” often at the fund company where the account is held.
Clearly, providing proper oversight of direct-at-fund accounts can be challenging at multiple levels:
- KYC requirements apply not just when the account is opened, but on an ongoing basis. It’s nearly impossible to ensure customer information is accurate and up-to-date when you don’t know who or where your customers are.
- The same goes for investment suitability. Without data to marry the customers’ holdings, risk parameters or investment objectives, firms won’t know whether their customers’ investments are appropriate.
- Firms may fail to comply with the SEC and FINRA recordkeeping requirements if customer account information is not accurately captured. This includes trade blotters, which are based on receiving and translating data from the fund.
- Firms may also be failing to provide appropriate supervision over their books and records.
It’s not only that firms need to know about their customers from a compliance angle, they should also want to know about their customers from a customer retention and cross selling standpoint. Firms that pride themselves on excellent customer service will fall short if their customers are seemingly shipped off to no-man’s land where neither the broker-dealer nor the mutual fund company truly takes ownership of the account. And broker-dealers that want to serve small account customers, knowing they may accumulate more assets and develop more complex financial needs over time, will miss out on the opportunity to cultivate relationships with these customers.
Why isn’t this issue getting more attention?
While intermediaries realize their direct-at-fund business poses significant compliance risks and operational challenges and puts up obstacles to growing customer relationships, many firms simply aren’t addressing it. They may fear calling attention to their own compliance shortcomings. Or, they may be unaware that there are alternative solutions for supporting small accounts. Whatever the reason, leaders at banks, independent broker-dealers and other financial intermediaries should consider whether they truly know their customers—even those small, direct-at-fund accounts.