On May 24, 2018, President Trump signed into law the Senior Safe Act, which is aimed at curbing elder financial abuse. The Senior Safe Act is the latest effort to protect senior investors, as both FINRA and the SEC included protecting senior investors among their 2018 priorities. This blog has previously covered, at length, the SEC and FINRA 2018 exam priorities. Elder protection was also one of the SEC’s 2017 priorities and has been a FINRA priority since 2016.
Why Fiduciary Status Still Matters in a Post-Fiduciary Rule World: A Look at Prohibited Transactions And Compensation
In a previous post, we discussed why broker-dealers and their representatives will likely still be fiduciaries to ERISA plans and IRA investors in many cases despite the DOL Fiduciary Rule’s impending death (we say “impending” because, while the Fifth Circuit’s ruling in mid-March vacates the Fiduciary Rule in its entirety, the court’s official order implementing this decision has yet to be issued). To review, this is because broker-dealers and their representatives often satisfy all the prongs of the soon-to-be reinstated 1975 fiduciary regulation’s “Five-Part Test” defining when investment recommendations rise to the level of “fiduciary” advice. Previous industry assumptions that brokers and other “sellers” of investments generally were not fiduciaries under the 1975 regulation should no longer be relied upon. In this post, we’ll examine how the Fiduciary Rule’s impending demise will affect prohibited transaction and compensation issues for broker-dealers in light of their likely continuing status as fiduciaries. Continue reading “Why Fiduciary Status Still Matters in a Post-Fiduciary Rule World: A Look at Prohibited Transactions And Compensation”
Bad Brokers Beware: FINRA Aims to Further Tighten the Screws on Ill-Behaved Brokers and the Firms That Employ Them
FINRA recently posted two regulatory notices aiming to further rein in so called “high risk brokers,” as well as the firms that choose to employ them. The first, Regulatory Notice 18-15, is aimed squarely at firms that employ brokers with a history of previous misconduct. It advises firms on (1) Identifying Individuals for Heightened Security and (2) Developing and Implementing a Heightened Supervision Plan for such individuals. The second, Regulatory Notice 18-16, seeks comment on a variety of FINRA rule amendments relating to “high-risk brokers and the firms that employ them.” We discuss the notices in further detail below.
Old Standard, New Day: The Death of the Fiduciary Rule Doesn’t Mean That Broker-Dealers Won’t be Fiduciaries
The “old” rules will again prevail—but the old rules will not be applied in the old ways, and this will have some significant impacts on broker-dealers.
As the DOL has not asked for a rehearing of the Fifth Circuit’s decision vacating the Fiduciary Rule, or yet sought to appeal the decision, it is widely anticipated that the March 15 ruling will soon take effect, restoring the DOL’s 1975 regulation defining fiduciary investment advice to plan and IRA investors (we say “widely anticipated” because, while the official mandate vacating the Fiduciary Rule is expected soon, it has been delayed while the court considers efforts from certain states and other third parties to intervene in the case). While the SEC has proposed new regulations for broker-dealers, and while we expect the DOL to propose new prohibited transaction exemptions or regulations that will coordinate with the SEC’s actions, it will be at least a year before these initiatives could begin to apply. Continue reading “Old Standard, New Day: The Death of the Fiduciary Rule Doesn’t Mean That Broker-Dealers Won’t be Fiduciaries”
FINRA Moves to Amend the Suitability Standard in Lockstep with the SEC’s Efforts
“There is a Chinese curse which says ‘May he live in interesting times.’ Like it or not, we live in interesting times.” (Robert F. Kennedy – June 6, 1966, Speech at University of Cape Town)
May 7, 2018, has come and gone and we have not yet seen a mandate from the Fifth Circuit Court of Appeals in the Chamber of Commerce of United States of Am. v. United States Dep’t of Labor, 885 F.3d 360 (5th Cir. 2018) litigation, which is the final step necessary to effectuate that court’s order vacating the DOL Fiduciary Duty Rule. Presumably that mandate is imminent; however, we do not know for sure. We do know, however, that the DOL will not be filing a motion for rehearing to the Fifth Circuit on its decision, as that deadline has passed. We assume there will not be a DOL writ of certiorari to the United States Supreme Court seeking to challenge the Fifth Circuit Court’s opinion, but we do not actually know that either. Continue reading “FINRA Moves to Amend the Suitability Standard in Lockstep with the SEC’s Efforts”
The Fate of the Fiduciary Rule: What is Not Affected
While we won’t know until the end of the month whether the DOL fiduciary rule will survive beyond May 7, there are some activities that won’t be affected, regardless of what happens.
Let’s start by reviewing basics. A fiduciary under ERISA and the Internal Revenue Code (the “Code”) includes one who provides investment advice to an ERISA plan and/or IRA for a fee –an “advice fiduciary.” Before the new DOL fiduciary rule, a broker-dealer or RIA (referred to here as a “firm”) would be considered an advice fiduciary if a five-part test was satisfied: (1) its advisor provided advice for compensation about a security or other property, (2) on a regular basis, (3) pursuant to a mutual understanding, (4) that the advice would form a primary basis for the investor’s decision and (5) it was individualized based upon the investor’s particular needs. If the DOL’s new fiduciary rule does not survive, the five-part test will come back into effect.
Regardless of whether the DOL fiduciary rule or the five-part test applies, there are some things that will remain unchanged:
• Investment Management Services: Discretionary investment management for ERISA plans or IRAs is and will continue to be a fiduciary service. This is because under both ERISA and the Code, there is a definition of “fiduciary” separate and apart from an “advice fiduciary.” That definition says that a broker-dealer or RIA, or its representative, is a fiduciary when it has discretion over ERISA or IRA assets. This means that investment management services for ERISA plans are, and continue to be, subject to ERISA’s prudent man standard of care and duty of loyalty. Also, managing ERISA and/or IRA plan assets is, and will continue to be, subject to the fiduciary prohibited transaction rules in ERISA and the Code. Firms need to have policies, training and supervisory processes in place to ensure that advisors providing investment management services to ERISA plans and/or IRAs comply with these rules, even if the DOL fiduciary rule does not survive.
• Reasonable Compensation: Firms also need to make sure that compensation for services to ERISA plans or IRAs is reasonable, because unreasonable compensation is a prohibited transaction under both the Code and ERISA. This requirement applies to all service providers to plans, participants and IRAs, and to service providers who are not fiduciaries. Firms need to develop systems and data to determine reasonable compensation for different products and services and to manage advisor compensation practices.
• Rollover Recommendations by Fiduciary Advisors: Even if the DOL fiduciary rule does not survive, some rollover recommendations may still be fiduciary acts. Specifically, under a DOL advisory opinion, if an advisor (and the firm) is a plan fiduciary and its advisor recommends that a plan participant take a distribution and roll over to an IRA, the advisor will be a fiduciary for that purpose. As such, the advisor’s recommendation needs to satisfy the ERISA prudent man standard. Additionally, if the DOL fiduciary rule does not survive, there will not be a Best Interest Contract Exemption to “cure” the resulting prohibited transaction. If, on the other hand, the firm is not a fiduciary to the plan and the advisor recommends a rollover, it will not be a fiduciary act if the DOL fiduciary rule does not survive. Firms should examine their current rollover practices and determine what processes will need to be retained to address these issues.
• Ongoing Advisory Services: Providing ongoing investment advisory services to ERISA plans or IRAs based upon the particular needs of the retirement investor will continue to be a fiduciary act even if the DOL fiduciary rule is vacated. The reason is that under most advisory arrangements, the advisor is providing the advice on a regular basis and meeting the other elements of the five-part test. The firm should identify current arrangements that satisfy the five-part test and make sure there are policies and procedures in place to ensure compliance with the prohibited transaction rules and exemptions and, in the case of ERISA plan services, compliance with the prudent man rule and duty of loyalty.
While the possible demise of the DOL fiduciary rule will limit the scope of investment activities that are fiduciary in nature, there are still investment services that will be fiduciary and thus subject to the prohibited transaction requirements. As a result, firms should take steps now to identify those activities and take appropriate steps for compliance.
SEC Proposes Regulations to Reform Retail Investment Standards
The SEC has issued proposed rules seeking to clarify how investment professionals advise retail investors. The three-part proposal includes a requirement that brokers act in a customer’s best interest; interpretive guidance on the fiduciary duty applicable to investment advisers; and Form CRS, which mandates certain disclosures by broker-dealers and investment advisers to their clients. The SEC’s release of these proposed rules and guidance is only the beginning of what will likely be an active 90-day comment period. As the SEC Commissioners did repeatedly, we encourage interested parties to participate in the SEC’s comment letter process.
An alert that I co-authored analyzes significant parts of the proposal and offers thoughts on what to look out for as the SEC continues to address these issues.
For additional information and discussion on these SEC proposals, below is a link to Drinker Biddle’s Inside the Beltway from the day after the SEC’s open meeting in which partners Fred Reish, Brad Campbell and I discuss the SEC’s proposals and their anticipated impacts.
SEC Open Meeting on Broker-Dealer and Investment Adviser Standards
On April 12, 2018, the Securities and Exchange Commission (SEC) announced an open meeting scheduled for April 18, 2018 at 3:30 p.m. (ET) to discuss standards applicable to broker-dealers and investment advisers in their dealings with retail investors. The subject matters scheduled to be covered are threefold:
Continue reading “SEC Open Meeting on Broker-Dealer and Investment Adviser Standards”
FINRA Seeks Comments on Proposed New Rule to Govern Outside Business Activities and Private Securities Activities of FINRA Member Associated Persons
If adopted, proposed new FINRA Rule 3290 will be significant for broker-dealers who allow their associated persons to engage in outside business activities (in particular in securities related fields – such as serving with/as a third-party investment adviser) and broker-dealer staff who engage in such activities. In general, the changes may make the lives of both such groups a bit easier.
FINRA Rule 3290 would be a replacement for both current FINRA Rule 3270 (Outside Business Activities (OBA) of Registered Persons) and current FINRA Rule 3280 (Private Securities Transactions of an Associated Person) for its member broker-dealers. As explained in Regulatory Notice 18-08, compliance with proposed FINRA Rule 3290 would involve only modest and mostly clarifying changes for most traditional “3270” activities. The impact on what are now “3280” activities could be more pronounced.
Probably of the greatest interest for many broker-dealers: proposed Rule 3290 would ease current requirements with respect to the investment advisory activities of their registered persons. Under Rule 3280, FINRA members must supervise and record on the members’ books and records the transactions resulting from a variety of outside “IA” activities of their associated persons. Under proposed Rule 3290, any IA activity conducted on behalf of a dually registered “BD/IA” or for an IA affiliate of a member would be excluded from the rule. Any IA activity conducted for a third-party, non-affiliated IA would constitute an “investment-related” activity under the rule – as a result, it would require that the registered person provide prior written notice of such activity, and the FINRA member would then be required to conduct a risk assessment and based on its assessment, to: (a) approve the registered person’s participation, (b) approve it subject to conditions or limitations, or (c) disapprove it. However, the proposed rule would not impose a general supervisory obligation over the IA activities and would not require the FINRA member to record on its books and records transactions resulting from such IA activities.
Under the proposed rule, if an activity is not “investment related,” the broker-dealer would effectively have no material obligations (other than receiving notice of the activities and recording the activity on the associated person’s Form U-4). If the activity is “investment-related,” then the broker-dealer would be required to perform a risk assessment. The proposed rule defines “investment-related” as “pertaining to securities, commodities, banking, insurance, or real estate (including, but not limited to, acting as or being associated with a broker-dealer, issuer, investment company, investment adviser, futures sponsor, bank, or savings association).”
The proposed rule would impose a supervisory obligation in two key situations:
-First, if a broker-dealer decides to impose its own conditions or limitations on a registered person’s participation in an investment-related activity, the broker-dealer would then be required to “reasonably” supervise the registered person’s compliance with those specific conditions or limitations. Actual supervision of the underlying activities would not be required.
-Second, to the extent that a broker-dealer approves a registered person’s participation in a proposed investment-related activity and such activity would require, “if not for the person’s association with a member, registration as a broker or dealer under the Exchange Act and the person is not so registered,” the activity would be deemed to be part of the broker-dealer’s own business. So, if an associated person could only legally engage in an “OBA” because the individual is associated with a FINRA member, the FINRA member approving that activity must treat the activity as its own in all respects. Accordingly, all applicable securities laws and regulations and FINRA rules, including supervision and recordkeeping, would apply to the FINRA member with respect to the approved activity.
Under this second situation, if the registered person is associated with more than one FINRA member, the individual FINRA members would be permitted to develop a formal allocation arrangement whereby at least one member agrees in writing with specificity to comply with all applicable securities laws and regulations and FINRA rules (including supervision and recordkeeping obligations) regarding the proposed activity.
As provided in summary as part of Regulatory Notice 18-08:
Selling Private Placements Away from Member | Subject to the proposed rule, potentially to the fullest extent – prior notice by the registered person and risk assessment by the member. If the member disapproves the activity, it has no further obligation. If the member approves the activity, the activity becomes part of the member’s business and must be supervised and recorded as such. |
Activities at Third-Party IA | Subject to the proposed rule, but in an intermediate manner – prior notice by the registered person and risk assessment by the member because it is investment related and not excluded from the proposed rule, but the member is not required to supervise or keep records of the IA activities. |
Non-Investment Related Work (e.g., car service, seasonal retail) | Subject to the proposed rule, but in a limited manner – a registered person must provide prior notice to the member, but the member is not required to perform a risk assessment of or supervise the activity. |
Activities at Affiliates (e.g., IA, Insurance and Banking Affiliates) | Generally excluded from the proposed rule – the proposed rule excludes activities at affiliates, whether or not investment related, unless those activities would require registration as a broker or dealer if not for the person’s association with a member. |
Personal Investments (e.g., Buying Away) | Excluded from the proposed rule, but potentially subject to other rules (e.g., FINRA Rule 3210) or firm-imposed notice requirements. |
Bye-Bye Fiduciary Rule?
Should you say goodbye to the Fiduciary Rule? Maybe, but not just yet. The DOL has until the end of April to decide whether to let the 5th Circuit decision vacating the Fiduciary Rule stand or try to get it over-turned. If they do nothing, the ruling becomes effective May 7, and bye-bye Fiduciary Rule – the regulation re-defining fiduciary investment advice for plans and IRAs and the related prohibited transaction exemptions.
Many pundits say this is what will happen. But it’s possible that the DOL will either ask the court to reverse itself – this would mean the 15 judge panel agreeing to re-hear and re-decide the case – or try to get the Supreme Court (SCOTUS) to accept an appeal. SCOTUS doesn’t have to do that, so those who think the DOL won’t let this go are betting on the re-hearing request. While requests for rehearing are rarely granted, in this case there might be a better chance. The decision vacating the Fiduciary Rule was a split decision, with Chief Judge Carl E. Stewart dissenting in favor of the Rule.