In today’s increasingly competitive landscape for advisory firms, financial advisors are looking for any way they can to differentiate. Whether it’s their experience and credentials, specialization or depth of services, or simply the sheer size of the firm, based on its assets under management. After all, the reality is that – justified or not – a sizable reported AUM does imply a certain level of credibility and represents a form of social proof (the firm “must” be good, or it wouldn’t have gotten so much AUM, right!?).
As a result of this trend, though, advisory firms are increasingly pushing the line in counting – or potentially, over-counting – their stated assets under management. Which is important, because not only is overstating AUM a potential form of fraudulent advertising, but the SEC has very explicit rules to determine what should be counted as AUM (or not) for regulatory purposes.
Specifically, the SEC states in its directions for Form ADV Part 1 that regulatory AUM should only include securities portfolios for which the advisor provides continuous and regular supervisory or management services. And while most financial advisors today are regularly working with clients regarding their investment securities, not all advisors are necessarily providing “continuous and regular” services on their client accounts. In fact, if the advisor doesn’t have direct authority to implement client trades (either with discretion or after the client accepts the advisor’s recommendation), it’s virtually impossible to include the account as part of regulatory AUM.
The greater challenge, though, is that the increasingly common offering of comprehensive financial planning services – where advisors provide holistic financial planning advice on all of a client’s net worth – does not mean the advisor can claim all of those assets as regulatory AUM. In fact, most of the time the advisor should not include outside 401(k) plans and other non-managed assets that were advised upon as part of the financial plan, nor the value of brokerage accounts holding mutual funds and various types of annuities (unless the advisor truly provide ongoing management services), nor TAMP or SMA assets (unless the advisor retains the discretionary right to hire/fire the manager and reallocate to another one). In fact, even having discretion over an account doesn’t automatically ensure it being counted as regulatory AUM, particularly if it’s a passive buy-and-hold account, unless the advisor can actually substantiate that monitoring and due diligence is occurring outside of any ad-hoc or periodic client review meetings!
Fortunately, for advisors who want to report some number representing the total scope of their advice – including the amount of assets that don’t count as regulatory AUM – it is permissible to report on Assets Under Advisement (AUA) in the advisor’s marketing and in Part 2 of Form ADV, as long as the advisor can document and substantiate the calculation process. But the fact that it’s permissible to report both AUM and also a (typically large) AUA amount doesn’t change the fact that, when reporting regulatory AUM itself, it’s crucial to report the right number!