SEC Releases SCSD Self-Reporting Initiative Settlements

The SEC recently announced its first round of settlements with registered investment advisors (RIAs) who had self-reported pursuant to the agency’s Share Class Selection Disclosure Initiative (SCSD Initiative). Additional RIA settlements pursuant to the SCSD Initiative are expected, and RIAs who did not self-report face additional scrutiny from the Division of Enforcement. Industry reaction has involved frustration, but the SEC’s focus on RIA conflicts of interest, disclosures, and more recently revenue sharing is increasing.  Jim Lundy and Mary Hansen discuss these developments in this article, SEC Releases SCSD Self-Reporting Initiative Settlements.

State Fiduciary and Best Interest Developments

A number of states are seeking to impose fiduciary or best interest requirements on broker-dealers, investment advisers, financial planners and/or insurance brokers and producers in their dealings with customers. While the rules vary from state to state, they are in addition to – and sometimes inconsistent with – federal requirements being considered by the SEC or by the Department of Labor for retirement investment advice. We have prepared a chart summarizing the activities in each state along with proposals of the National Association of Insurance Commissioners (NAIC), which we update periodically as needed. You may access the chart here.

Nevada Proposes Fiduciary Regulations

Nevada has released a proposed regulation to regulate broker-dealers and their advisors as fiduciaries. In 2017, the state amended its securities law to provide that broker-dealers and investment advisers owe a fiduciary duty to their customers, but the change didn’t provide details on what that meant. Instead, the legislation required that a regulation be issued to explain and implement the change. Nearly a year and a half later, a proposed regulation has been released.

The proposal surprised many in the broker-dealer community because the definition of “fiduciary” is very broad and the related duties are stringent. The requirements go beyond the proposed SEC rules under Reg BI. However, there is a nod in that direction – the Nevada proposal says the Securities Administrator can adopt by order any “fiduciary duty related rule” approved by the SEC, so long as that rule doesn’t “materially diminish the fiduciary duty” set out in Nevada law and regulation.

Nevada’s proposed regulations are more demanding than Reg BI in several respects. In fact, some of the requirements are similar to those in the DOL’s vacated Best Interest Contract Exemption, though stated in different terms. Here are some differences from the SEC’s proposed Reg BI:

  • One major difference is that Nevada law affirmatively states that broker-dealers owe a fiduciary duty for most of their advice to customers. Reg BI requires that firms act in the best interest of their customers, but doesn’t say they are fiduciaries.
  • Under Nevada law, a customer can sue an advisor (at a broker-dealer or RIA) for breach of fiduciary duty. This is generally referred to as having a “private right of action.” Under Reg BI, there is no private right of action.
  • The Nevada proposal requires a more in-depth disclosure of compensation than Reg BI. For example, a broker-dealer is required to disclose the “gain” it receives at the time advice is given. “Gain” is defined to include managed asset fees, commissions, mark up and mark down commissions, volume discounts given to clients, trailing fees or commissions, front end or back end loads, service fees, and payments for order flow. In contrast, Reg BI appears to require generic disclosures of the types of compensation and the amounts generally charged.
  • The Nevada proposal makes clear that a broker-dealer has a fiduciary duty to monitor a customer’s account under several common scenarios, while that is not required by proposed Reg BI. The Nevada proposal explains this monitoring requirement in a circular way. It provides for an “Episodic Fiduciary Duty Exemption,” which says that a broker-dealer has a fiduciary duty for a specific transaction, but does not have an ongoing duty — so long as it does not provide certain services or communications. However, that exemption doesn’t apply in the following scenarios: managing the customer’s assets, creating periodic financial plans, discretionary trading of the account, or a representative of a broker-dealer identifying as an adviser, financial consultant, wealth manager or counselor. There are two other situations that make the Episodic exemption unavailable: if a broker-dealer has not “otherwise developed a fiduciary relationship with the client from previous or concurrent services undertaken on behalf of the client” or if the surrounding facts and circumstances don’t indicate that ongoing advice is “reasonably expected by the client relative to [a] transaction, type of product or advice.” The latter might exist, for example, if an advisor were to tell a customer that “I’ll keep an eye on your account” or “Don’t worry, I’ll watch out for you.”

This is a proposal, and it may change before it becomes final. However, if it remains the same, the Nevada proposal will go beyond what the SEC is proposing, and it may be an indication of what we can expect in the future in other states.

The Drinker Biddle Best Interest Compliance Team has put together a chart of state investment fiduciary activity, which can be accessed here.

Alert: FINRA’s 529 Plan Share Class Initiative to Self-Report

On January 28, 2019, FINRA released its Regulatory Notice 19-04 announcing its 529 plan self-reporting initiative. This initiative is part of FINRA efforts to have broker-dealers promptly remedy potential supervisory and suitability violations related to recommendations of share classes for 529 plans. Continue reading “Alert: FINRA’s 529 Plan Share Class Initiative to Self-Report”

Fiduciary Status for the Unwary

If you thought that avoiding fiduciary status would be a slam-dunk after the “new” DOL fiduciary advice rule was vacated, think again. The DOL’s old fiduciary regulation is back and it casts an unexpectedly wide net.

Let’s start with the background. The reinstated fiduciary definition says that a broker-dealer and its advisor (a “broker”) are fiduciaries to a plan if a functional five-part test is satisfied: (1) the broker provides advice about investments for a fee or other compensation, (2) on a regular basis, (3) under a mutual understanding, (4) that the advice will form a primary basis for the plan’s decisions, and (5) that the advice is individualized based upon the plan’s particular needs. For this purpose, a “plan” includes not only an ERISA plan, but also an IRA. (In the context of IRAs, being a fiduciary under the five-part test does not itself implicate a standard of care, but does apply to the applicability of certain prohibited transactions.)

Continue reading “Fiduciary Status for the Unwary”

A Summary of FINRA’s 2018 Report on Examination Findings

Last week, FINRA issued its 2018 “Report on FINRA Examination Findings.”  This report tracks FINRA’s 2018 Priorities letter, which this blog has previously covered.  Putting its member firms on notice, FINRA advised that it issued the report as another resource for firms to “strengthen their compliance programs and supervisory controls.”  Not surprisingly, the first highlighted observation is “Suitability for Retail Customers.” Specifically, FINRA reported that:

Continue reading “A Summary of FINRA’s 2018 Report on Examination Findings”

Recommending Rollovers in the Evolving Regulatory Environment (Part 3)

In Parts 1 and 2 of this post, we talked about the current and proposed rules applicable to rollover recommendations by broker-dealers and RIAs. Part 1 discussed the DOL and FINRA rules that apply now. In Part 2, we explained the SEC proposals. In this post, we talk about how to make a compliant rollover recommendation, regardless of which set of rules applies.

(“Rollover recommendation” refers to advice to a retirement plan participant to take a distribution of his or her account and roll it over to an IRA that is being advised by the broker-dealer or RIA.)

Continue reading “Recommending Rollovers in the Evolving Regulatory Environment (Part 3)”

Third Circuit Affirms Right to FINRA Arbitration, Widens Circuit Split

The U.S. Court of Appeals for the Third Circuit recently ruled that a broker cannot avoid FINRA arbitration with a customer through contractual forum selection clause that fails to specifically mention arbitration (Reading Health v. JP Morgan, No. 16-4234 (3d Cir. Aug. 7, 2018)). The court’s opinion denying the company’s appeal widens an existing circuit split on the issue of contractual forum selection clauses superseding FINRA’s mandatory arbitration rules.

Under FINRA Rules 12200 and 13200, disputes arising between a FINRA member and its associated persons or customers must be arbitrated through the FINRA arbitration process. In the Third Circuit case, the customer had filed a statement of claim with FINRA in relation to various auction rate securities (ARS) offerings the company had underwritten. The broker refused to arbitrate, and the customer filed in the Eastern District of Pennsylvania seeking to compel arbitration.  The customer won at the district court level, and the broker appealed based on a forum selection clause in its broker-dealer agreements that stated:
Continue reading “Third Circuit Affirms Right to FINRA Arbitration, Widens Circuit Split”

Drinker Biddle Launches Best Interest Compliance Team

As discussed regularly on this blog, the financial industry has seen a stream of rules and regulations in recent years that relate to the standard of care and management of conflicts for broker-dealers, investment advisers, insurance agents and companies.

The need for experienced counsel to help navigate the evolving and overlapping federal and state “best interest” obligations has increased. It’s the reason we’re excited to announce the launch of our Best Interest Compliance Team.

This interdisciplinary group of more than 20 lawyers consists of attorneys with experience across Investment Management, ERISA, SEC & Regulatory Enforcement Defense, Litigation/FINRA Arbitration, and Insurance Regulatory and Transactional practice areas.

The Best Interest Compliance Team will help clients make decisions about questions such as:

  • What does the SEC’s proposed Regulation Best Interest mean?
  • How does the SEC’s RIA interpretive guidance impact the standards currently applied to RIAs?
  • What is the effect of the court order vacating the DOL’s Fiduciary Rule and what already-implemented changes will continue under the SEC proposals for RIAs and broker-dealers?
  • How should written supervisory procedures be revised in light of these changes and proposals?
  • What measures should be taken to show good-faith compliance with the DOL’s non-enforcement policy?
  • Where should broker-dealers/RIAs/insurance companies go from here?
  • How should insurance agents deal with conflicting state regulatory schemes?

To learn more about the new Best Interest Compliance Team, read our press release or visit our team page on the Drinker Biddle website.