CRM: Customer Relationship Management or Compliance Regulatory Machine?

How financial services regulatory pressure can shift the intended use of a technology and a definition of a word.

CRM has traditionally stood for Customer Relationship Management system but with new FINRA regulatory requirements and mounds of risks to manage, we are starting to see a shift, particularly with Broker Dealers and CRM is starting to have a much different meaning- Compliance Regulatory Machine.

New FINRA Rule 2111 requires Broker Dealers to take a closer look at the investment advice that advisors are providing their clients. These rules coupled with potential holes in the documentation processes between advisors and Broker Dealers present a huge opportunity for CRMs and Business Apps to close this gap.

FINRA Rule 2111 requires, in part, that a broker-dealer or associated person have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the [firm] or associated person to ascertain the customers investment profile. In general, a customers investment profile would include the customers age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance.

Broker Dealers are now required to do their due diligence in regards to the investment suitability that their advisors are recommending for the investor clients. This suitability is determined based on a series of 9 parameters that FINRA has recommended as important such as client age, financial circumstances and risk tolerance. This entirely new regulation is a very daunting task for Broker Dealers when you figure the amount of data that is required to determine this suitability and the means that Broker Dealers currently have to collect it.

There are an estimated 150 million+ individual investors in the United States, 9 parameters that FINRA recommends the Broker Dealers should consider and that the majority of advisors are housing their data and technology independent from their Broker Dealer. This shift will require CRMs to adopt slick, interconnected technology platforms for managing compliance which include business apps for vendors across the board.

We believe it is a step in the right direction that one of the 9 parameters the FINRA Rule 2111 recommends for reviewing product suitability is risk tolerance. This means risk tolerance will have to be quantifiably measured and documented in the financial planning process. Therefore, the traditional approach of? advisors asking the question to the client: What is your tolerance to risk? will not suffice for this measurement. Not only is this method not properly capable of documentation but it also is now proven that this type of question is heavily biased based on the advisors intuition and cannot be properly measured. The days for advisors of making intuitive assessments of a clients risk tolerance based on their perception of the clients factual position and representations made during discussions are over. There is no room for advisor or client blind spots getting in the way.

What this means is that advisors will be obligated to start deploying validated systems that objectively measure risk tolerance on a highly reliable basis. Then the advisor will need to have systems for linking the risk tolerance to the suitability of investments. Further, they will need to have processes for monitoring that suitability on a long term basis and documenting it for compliance.

The FINRA Rule 2111 does not define risk tolerance. This will bring us to the next issue as to what is it and how is it measured. Whilst some people think that the term risk tolerance is clear because it is commonly used the fact is it is not. Does it mean a persons propensity to take risk or capability to emotionally accept losses? These are different behaviors. Then comes the broader issue that knowing the risk tolerance of the client is of itself not enough to make suitable investment recommendations. This is because risk tolerance does not cover the broader behavioral biases of the client and advisor which will impact the suitability of recommendations. For instance, the Newness Bias, Benchmarking Bias, Pattern Bias, Optimism Bias etc. So, advisors thinking they can hide behind any risk tolerance tool with a tick in the box may be fooling themselves. The UK regulator (Financial Conduct Authority) is taking this broader approach.

The implication of the need to take account of these broader behavioral biases up-front when initially making recommendations and then monitoring them is huge for the Compliance Regulatory Machine. We are certain that this means the future of behavioral systems which reliably predict all of the behavioral biases of the clients and advisors (to mitigate the impact of advisor blind spots) is very bright and almost guarantees a place in this compliance regulation.

In the 21st Century we all use apps to get things done and even if it takes 5-10-15 more years, the same will go for Broker Dealers with their compliance regulations. This is where we see the future for compliance regulation and how behavioral discovery systems? will fit in. With the modern enterprise CRMs, Broker Dealers will have a greater opportunity to more robustly monitor the activity of the advisors without getting in their way. All advisors will be on the same platform that are interconnected and operate in real time.

Lets take a quick look at how our DNA Behavior discovery systems will soon take a leap forward in this next gen revolution. We have built Financial DNA apps for the Salesforce and Redtail CRMs- two of the most widely used CRMs for financial services, with others proposed in the near future. By utilizing a web like architecture that these CRMs provide, the Financial DNA app will be able to speak to other financial planning apps maintained by the advisor.

This is how heavy compliance regulations can be displayed visually for the advisor to follow and understand.

Portfolio Compliance, Risk Tolerance, Risk Measurement

The above figure depicts a scenario recognized as Not Compliant with our mock compliance CRM app. This app puts Risk Tolerance, Calculated Financial Circumstances and Portfolio information in one screen- thats easy to use.

In the above example an advisor is using 3 apps inside their CRM to monitor compliance: Financial DNA, Morningstar and a custom compliance app the advisors Broker Dealer has built to measure the clients financial circumstances. The independently validated Financial DNA app states the behavioral level of risk that the client is naturally comfortable taking is Below Average, The Broker Dealer compliance app says that the client can afford to take Average risk and Morningstar has rated the current portfolio risk level at Above Average. We see this scenario time and time again when working with advisors. Other methods of measuring risk tolerance are often flawed, or non-existent, and not capable of proper documentation- because of this, the clients are invested in too much risk for their preference level. When investments start to decline, the clients become uncomfortable and stressed and leave the advisors watch. Now, with this new FINRA regulation, not using a validated instrument for measuring investment risk tolerance, and possibly other behavioral biases? is not just a matter of lost client engagement for the advisor (and hence revenue), but also a substantial legal liability for Broker Dealers and advisors.behavioral finance, risk tolernace, finra regulatory requirements

For additional information, visit the Financial DNA website or contact

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Ryan Scott

Ryan Scott

Ryan Scott - CTO, Prod Dev & Integrations

As the CTO, Prod Dev & Integrations, Ryan designs, develops, and maintains all of the web-based DNA Behavior products and solutions in addition to providing support for clients.

He has a passion for creating and implementing efficient business processes and leveraging technology throughout our business.

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