Stratifi is a web-based platform that quantifies portfolio risk into an understandable score, assisting advisors in navigating an increasingly complex regulatory environment fueled by the impending best interest rule from the SEC. With rising compliance costs and enforcement actions, financial advisors must adapt to heightened scrutiny and implement comprehensive risk mitigation strategies while preserving client interests. The evolving regulatory landscape signals a critical shift towards fiduciary responsibilities, necessitating robust monitoring and documentation practices to satisfy regulatory demands.

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A web-based platform that measures and quantifies portfolilo risk into an easy to understand score. Our technology helps identify and distinguish
risk across thousands of securities on a simple, visually-detailed platform.
Steve Sears and Akhil Lodha
How To Thrive As
Compliance Pressures Rise

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Introduction
Benjamin Franklin famously observed that death and taxes are the only certainties in this world. Had the great
polymath been able to see into the future for financial advisors, he would have added a third certainty: an ever
shifting, ever expanding, regulatory environment. As all advisors are painfully aware, the regulatory regime that
surrounds the industry is increasingly nuanced, somewhat unpredictable, and incredibly time consuming to follow.
Many advisors and advisory firms exist in a perpetually reactionary state as they try to provide the best care for
clients, while being ever mindful that regulators often view everything that they do with a jaundiced eye. Those
challenges are likely to increase, and intensify.
The advisory industry faces a regulatory overhaul that history will memorialize as perhaps the most profound
reshaping of the relationship between advisors and clients and advisors and regulators. In the shadow of the
greatest financial crisis since 1929, the Securities and Exchange Commission will soon release a controversial,
intensely debated policy that has sharply divided the securities industry. The so-called Best Interest Rule, simply
states, albeit in rather complicated ways, that advisors must put their clients best interests first. A final version of
this standard of care should be released by September 2019, although it is likely that the final policy will spark a
period of further refinement and debate that could take years to finalize. In short, advisors should be prepared to
operate under a heightened regulatory environment in which it will be increasingly critical to demonstrate, dare we
say provide evidence, that they actually acted in a client’s best interest.
While such efforts may seem redundant, and even insulting, “Reg BI,” as the SEC policy is known in shorthand,
embodies one of the most polarizing episodes in the industry’s regulatory history. In 2016, the Department of Labor,
which oversees the nation’s retirement accounts, proposed a fiduciary rule that would require advisors to put their
clients interests ahead of their own. Such a standard of care seems uncontroversial, but the securities industry
has become so complex that some critics feared it could create more difficulties than anticipated when trying to
care for the often complex needs of individual investors and their families. Others disagreed, and contended that
it was imperative that a standard exist to protect Main Street from Wall Street. The two sides waged an intense
battle and the Labor Department’s fiduciary rule was ultimately defeated in the courts in 2018. Yet, the spirit of
the rule has remained very much alive as evidenced by the SEC’s decision to rebirth the rule, which has created a
cloud of uncertainty for financial advisors.

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The Uncontrollable Cost of Compliance
As is true with all major regulatory revisions, lawyers, consultants and compliance executives are key beneficiaries.
They are in enormous demand as firms seek to implement new rules, and review processes to make sure that
everything is calibrated. Even now, standard compliance expenses are growing faster than inflation, and at a rate
that is oppressive for even the fastest growing firms. By some measures, compliance oversight expenses are
annually increasing by about 10%, and that expense simply reflects the cost of keeping pace with the natural
evolution of regulations.
Meanwhile, as the regulatory environment is evolving, advisors are facing even greater enforcement actions. In
2018, for example, the SEC’s advisor enforcement actions was 31% higher than the previous year. Unfortunately,
securities regulation and enforcement is often something of a competitive sport among agencies.
The nation’s political instability creates even greater regulatory risk. Should the U.S. Congress veer toward populist
policies - and it is a fact that populist politicians now sit on committees that have direct oversight of the securities
industry, and also provide funding for the SEC - every facet of Wall Street will likely face even greater scrutiny. The
issues are nuanced, and complicated, which unfortunately may work against advisors who could be punished and
made into examples to warn others.
FINRA and SEC seem to be mindful of this new era. FINRA has explicitly stated that it “will continue to be extremely
committed to vigorous enforcement” with an emphasis on reporting, suitability and supervisory procedures. When
SEC finalizes the best-interest rules, SEC Commissioner Hester Price contends that it will be ”substantially easier
for us to bring enforcement actions against brokers who have subordinated their clients’ interest to their own.”
In face of this pending reality, it is no longer sufficient to simply react to new rules and standards. Advisors and
their firms must develop broad-based risk mitigation strategies to offset what will certainly be a more intense
focus, and perhaps even competition, among enforcement agencies.

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Heightened Interest in Best Interest
It is a cold fact that regulators are often perceived to battle each other for jurisdictional dominance. This has
historically happened between the Department of Justice and the Securities and Exchange Commission. Now,
in an era when penalizing Wall Street, rightfully or wrongfully, is a distinct pathway to higher office, consumer
protection rules have essentially redrawn, and extended, battle lines.
The Labor Department’s failure to implement a fiduciary rule, for example, clearly inspired the SEC to protect its
traditional role as the guardian of markets and especially for individual investors. On the SEC website, in an area
in which the commission explains itself to the public, the focus is simply stated: “As more and more first-time
investors turn to the markets to help secure their futures, pay for homes, and send children to college, our investor
protection mission is more compelling than ever.”
Protecting investors has also become a key issue for other regulators, including the Financial Industry Regulatory
Authority, or FINRA, and state governments. In practical terms, the pending enforcement of best interest policies
means that there is a heightened potential for increased regulatory burdens.

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FINRA’s Role in Best Interest Enforcement
One of the primary objectives of the SEC’s best interest policy is clarifying the differences between investments
advisors who are registered under the Investment Advisers Act, and brokers who are registered under FINRA.
Registered Investment Advisors, or RIAs, are held to a strict fiduciary standard. They are obligated to put their
clients’ interests before their own. However, brokers follow a suitability standard that does not require them to
recommend the most appropriate or lowest cost investment option.
There is an implied requirement in the suitability rule that recommendations are consistent with a client’s best
interest, but the SEC’s best interest policy would make it an explicit requirement, fundamentally changing the
broker-client relationship.
Specifically, under “Reg BI,” broker-dealers would be required to
• Disclose key facts about customer relationships, including material conflicts of interest
• Use reasonable diligence, care, and skill to ensure recommended products are in the customer’s best
interest
• Establish and enforce practices to identify, disclose, mitigate or eliminate conflicts of interest
The SEC rule also clarifies the respective roles of supervision and enforcement for both FINRA and the SEC.
While FINRA will continue supervising broker-dealer compliance, so will the SEC. Broker-dealers that are not
complying with SEC Reg BI, could be subject to enforcement action by both agencies. According to FINRA
CEO Robert Cook, FINRA does not independently interpret SEC rules. Rather, FINRA examines broker-dealers
for compliance with the SEC’s rules and enforces them in a manner consistent with the SEC’s authoritative
interpretations.”

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Firms Still Struggle with FINRA’s Suitability Rule
The expected added layer of compliance could prove challenging to some firms. According to the 2018 FINRA
Report on Examinations Findings, firms are struggling to implement effective supervision programs, citing
numerous mistakes by brokers in devising suitable investment strategies for clients and making appropriate
product recommendations.
FINRA standard examinations continue to discover unsuitable recommendations for retail investors, and
deficiencies in how firms supervise registered representatives. For example, many firms and brokers fail to
adequately determine the proper investment profiles of their clients. They frequently neglect critical factors, such
as risk tolerance, experience, and even considering a client’s investment time horizon.
Advisory firms that have sound supervisory practices for suitability, in contrast, generally identified risks, developed
policies and implemented controls that were tailored to the specific features of the products offered and their
customer base. In many cases, firms with good exam results credited enhanced compliance training programs
and the automation of supervisory processes.

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States Rights Rise Again
Securities regulation is always a bit of a Rubik’s cube with many hands and many minds trying to align the colors on
each side of the block. This is true for state regulators who are increasingly unwilling to permit federal regulations
to become delayed or diluted by court challenges and industry lobbyists. Several states are thus imposing their
own standards of conduct, which is naturally accompanied by another layer of oversight and enforcement. New
Jersey, Nevada, Connecticut, and Massachusetts among a growing number of states are crafting rules that more
closely reflect the stronger language of the defeated Labor Department rule because they are concerned that the
SEC’s best interest language is weak and ambiguous, leaving broker-dealers in a position to continue putting their
own interests ahead of their clients. Massachusetts Secretary of the Commonwealth William F. Galvin believes the
SEC’s proposed rule presents “a veneer of a fiduciary standard” that would allow existing weaknesses in FINRA’s
suitability standard for brokers to persist.
Historically, federal securities laws preempted state securities laws, while states retained significant authority
over broker-dealer activities and the regulation of securities professionals. It is not uncommon for states, such
as California, to impose stricter standards of conduct on broker-dealers and to apply their own definitions when
interpreting their own laws. In several states, regulators are intent on putting brokers on equal footing with
investment advisors who are required by federal statute to operate in a fiduciary capacity.
To be sure, early indications suggest that at least a dozen or so states may choose to run in their own direction,
which could further increase the regulatory burden for firms operating in those states.

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The New ABC Rule: Always Be Compliant
The move from a suitability standard to a fiduciary standard represents a dramatic shift for many wealth
management firms. It means that a firm’s compliance function, which has always existed as a cost center, will
become more expensive and more important to the firm’s financial success. Some advisories will find ways to
share the burden through mergers or perhaps even through the creation of compliance motherships that monitor
risks and rules at multiple companies. The common thread, however, is that the time and money spent on these
functions will increase.
Staying compliant in the “best interest” era will require more monitoring, documenting, reporting and archiving
with a greater emphasis on transparency and accountability. Firms must develop cultures of compliance that
permeate all aspects of operations, especially if compliance is now a check-the-box, reactionary process.
Advisors Are Guilty Until Proven Innocent
Underthebestinterest standard,advisory firms andbroker-dealers mustbeabletoprovedecisionsweremadethat
are consistent with the best interest of their clients. For advisors, this will require changing their internal workflow,
including the creation of additional documentation to validate their decisions should they ever be challenged by
regulators, lawyers, and clients. This means all advisors will need continuous monitoring and documentation in a
format that allows them to globally view activities.
To satisfy the evolving demands of regulatory agencies and effectively manage the continuous flow of auditable
information without overwhelming advisors and compliance staff, firms need to develop streamlined processes.
Compliance monitoring tools with the ability to automatically generate reports documenting advisor decisions
are increasingly essential.
Data-driven tools enable firms to integrate data from different channels and manage information on large
scales. These tools also enable firms to oversee their own data and review it as needed for regulatory issues.
Regulators expect firms to provide precise data sets when demanded. As regulatory enforcement becomes more
technologically sophisticated, firms must keep pace. For many firms, adopting readily available technology will
enable them to effectively align their compliance with emerging standards while more easily evolving to shifting
compliance regulations.

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At minimum, monitoring tools can simplify workflows and account reviews, automatically flagging activities or
accounts based on predetermined criteria and tracking them through the resolution stage. They also can create
consistency leading to a unified level of risk tolerance that ensures all of a firm’s advisors are operating under the
same standards and that all activities receive the same level of scrutiny.
The best interest standard mandates that advisors demonstrate and explain the basis of their investment advice.
This means that they must know, and more importantly be able to prove, that they considered their client’s
investment profile, including age, other investments, financial situation and needs, liquidity concerns, tax status,
investment objectives, investment experience, investment time horizon, risk tolerance and any other information
the client may disclose.
The New Compliance Pressure Point
One element of the investment profile that is receiving more
regulatory scrutiny is a client’s risk profile, which the CFA
Institute Research Foundation calls the “heart of private
wealth management.” Suitability rules have always required
advisors to assess client risk profiles before recommending
specific investment products or strategies. However, under
the best interest standard, regulators can be expected to
increase their scrutiny of risk assessments in investment
selection.
Already, regulators have expressed concerns about
inadequate, generic risk questionnaires that lack the empirical
validity to explain much more than 15% of the variations
in risky assets between investments. For example, many
advisors concern themselves with correlation risk, which
measures the efficacy of portfolio diversification. While
that is an important risk factor, it only provides information
on a small fraction of their risk exposure. There are several
risk factors that, individually and collectively, have a greater
impact on an portfolios.

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Truly Know Your Client
It is a widely known that America, and this is true of other countries, faces a financial literacy crisis. Innumerable
studies show that people know far too little, or think that they know far too much, about markets and investing.
This has created a great credibility gap between Main Street and Wall Street, and put advisors in difficult, time
consuming spots. Unlike lawyers, or doctors, there is some degree of bias, and even mistrust, against the standard
of care provided by advisors. This is often largely due to the boom and bust nature of markets, but it is almost
always personalized. Hence, it is critical to establish some common framework that focuses clients and advisors
on the same issues. Facts that are simple and incontrovertible to advisors might be viewed entirely differently
by clients. In the institutional investor community, this disconnect is so well known that many conversations
simply start by defining terms to insure everyone is on the same proverbial page. In an era when the specter of
an enforcement action always seems to be looming somewhere in the background, it is paramount that advisors
establish a common framework, a lingua franca, with their clients.
This can be done in many ways, but it is perhaps most effective to use technology in the very ways that Wall Street’s
institutions handle their own money. While it is possible to measure myriad factors to analyze portfolios, four
factors are arguably the most critical, and the most relevant for advisors and their clients: volatility, diversification,
single-stock risk, and tail risk. Those factors, when identified and measured, insure that advisors and clients are
talking about what matters most. Almost every portfolio is negatively correlated to volatility, which is fixable, while
portfolio diversification is often not as a stable as many people think. Those risks are magnified by the existence
of large, concentrated holdings, all of which are susceptible to sharp market swoons. Advisors need to understand
how those factors influence client portfolios, and their own practices. The overview is easily achievable with the
proper software.
By combining institutional-quality technology with big-data analytics, advisors can manage the risk of their entire
practice on one single platform. Advisors can effortlessly analyze and visualize risk for all of their accounts, clients,
and households, individually and collectively as an entire practice. The data can and should be continuously
updated to provide real-time visibility to keep advisors abreast of risk variations inside a portfolio.
That same level of visibility is available to anyone in the firm with oversight responsibilities. Compliance officers
can benefit from a dashboard view of the firm’s risk and even at an individual account level. A central framework
for streamlining case management and resolution workflows, enables compliance officers to track and flag
accounts for unsuitable investments or strategies, concentrated and high-risk positions and more.
The use of technology reduces the burden of trying to keep pace with the increasing demands of myriad regulators,
and it offers demonstrable proof to auditors of a firm’s enhanced, proactive supervision. At its core, the proper
technology converts complex policies and procedures of compliance into accessible and understandable assets
for all the firm’s team members, helping to forge a true culture of compliance that withstands the rigors of skeptical
regulators in different jurisdictions. Moreover, it is just good business.

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Authors
Contact StratiFi
Steve Sears
Chief Investment Officer at StratiFi
steve@stratifi.com
Akhil Lodha
CEO and Co-founder at StratiFi
akhil@stratifi.com
www.stratifi.com info@stratifi.com 415-548-6421