What Broker-Dealers Need to Know About Correcting PTE 2020-02 Mistakes

Key Takeaways

The DOL expanded its interpretation of fiduciary advice in the Preamble to PTE 2020-02 and as a result, many more broker-dealers and their registered representatives (investment professionals) are fiduciaries for their recommendations to retirement investors, including rollover recommendations. Therefore, they will need the protection provided by PTE 2020-02. The PTE contains a number of conditions and if those conditions are not met, a prohibited transaction will result.

The good news is that the PTE provides a self-correction process. Unfortunately, some conditions of the self-correction process are difficult to interpret and additional DOL guidance is needed.

To avoid these challenges, broker-dealers should implement good processes and documentation to satisfy the PTE conditions and closely supervise their investment professionals to ensure that the processes are followed.

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And Now for the SEC’s First Substantive Reg BI Action

We have made it a point previously in this blog to track developments of the SEC’s Regulation Best Interest (Reg BI), even speculating more aggressive enforcement actions could be coming due to certain Reg BI deficiency letters sent to firms late last year. Since Reg BI went into effect in June 2020, however, many have waited with bated breath to see what enforcement of the regulation would look like in practice. While the SEC has pursued some cases regarding firms missing deadlines and omitting certain information in disclosure documents, it had taken no further action until June. On June 15, 2022 the SEC finally took its first substantive Reg BI action by filing a civil regulatory complaint in the U.S. District Court for the Central District of California against Western International Securities, Inc. and five of its brokers for allegedly selling a risky debt security, known as corporate L Bonds, to its retail customers. The Complaint invokes Section 15l-1(a) of the Securities and Exchange Act of 1934 — Regulation Best Interest — and seeks to enjoin the Defendants from the acts, practices and courses of business described in the Complaint.

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Compliance with PTE 2020-02: Mitigating Conflicts of Interest

Key Takeaways

  • PTE 2020-02 requires that financial institutions—such as broker-dealers—mitigate conflicts of interest “to the extent that a reasonable person reviewing the policies and procedures and incentives as a whole would conclude that they do not create an incentive for the firm or the investment professional to place their interests ahead of the interest of the retirement investor.
  • The DOL has issued FAQs that provide examples of mitigation techniques to reduce compliance risks in connection with compensation structures.
  • While there are a variety of mitigation techniques that can be used for different types of conflicts, the following two elements need to be part of mitigating every type of conflict: (1) an appropriate best interest process for developing the recommendation; and (2) supervision of the proper implementation of that process.

Background

The DOL’s prohibited transaction exemption (PTE) 2020-02 (Improving Investment Advice for Workers & Retirees), allows broker-dealers and their registered representatives (advisors) to receive conflicted compensation resulting from non-discretionary fiduciary investment advice to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans, and IRA owners. (The PTE refers to those 3 classes of investors as “retirement investors.”) In addition, in the preamble to the PTE, the DOL announced an expanded definition of fiduciary advice, meaning that many more broker-dealers and their advisors are fiduciaries for their recommendations to retirement investors – including rollover recommendations – and therefore, will need the protection provided by the exemption.

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Having a Senior Moment

In connection with the 2022 SIFMA C&L Seminar, the Best Interest Compliance Team submitted a white paper entitled “Having a Senior Moment: Recent Legislation and Rules to Protect Seniors from Financial Exploitation,” that was made available to conference attendees on a mobile app.

As its title suggests, our paper covers recent laws and regulations passed to protect senior investors. We specifically cover: (1) the Senior Safe Act, a law passed to provide immunity to financial institutions/advisors who disclose financial exploitations; (2) FINRA Rule 2165, which allows FINRA members to place temporary holds on the disbursement of funds or securities; (3) an SEC No Action Letter relating to FINRA Rule 2165; (4) FINRA Rule 4512, which requires member firms to make reasonable efforts to obtain a trusted contact person on customers’ accounts; (5) FINRA Rule 3241 which attempts to minimize conflicts where a registered person is named as a beneficiary or executor to their customer’s estate; and (6) “Report and Hold Statutes” that have been passed in a number of states and that require/encourage broker-dealers to report any suspicions of financial abuse. As part of our white paper, we also prepared a 50-state survey of the states that have passed Report and Hold Statutes.

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Broker-Dealer Regulation & Litigation Digest – Winter 2022

The Broker-Dealer Regulation & Litigation Digest is a periodic compilation of the most read blog posts published on the Broker-Dealer Law Blog during the last few months. Here you can catch up on what you missed or re-read these popular posts.

PTE 2020-02 Compliance: Avoiding Five Common Mistakes
By Brad Campbell and Joan M. Neri
It may be a New Year, but 2022 is going to seem very familiar to Broker-Dealers (BD) and their Registered Representatives who advise retirement plans and IRAs: they are going to be spending a lot of time working to comply with new exemptions and new ERISA rules coming from the Department of Labor (DOL). As some of these deadlines are right around the corner, in this post we’re going to review the five most common pitfalls and problems we’ve seen clients face, and how to better address them in disclosures and policies and procedures. READ MORE

Brace for Impact: It’s Going to be (Another) Busy Year for FINRA
By Sandra D. Grannum, Jamie Helman and Edward J. Scarillo
F. Scott Fitzgerald said “There are only the pursued, the pursuing, the busy, and the tired.” FINRA may be all of these in 2022, as FINRA CEO Robert Cook announced FINRA’s laundry list of priorities during a SIFMA Q&A last week. Here are some of the highlights from his Q&A. READ MORE

Recent State Fiduciary and Best Interest Developments: Pennsylvania’s New Law; Nevada May be Next
By Joan M. Neri
Pennsylvania has adopted legislation implementing the model regulation concerning suitability in annuity transactions adopted by the National Association of Insurance Commissioners (NAIC). This brings to 19 the total number of states adopting the NAIC suitability model. Nevada may be the next state to watch. Nevada’s Securities Administrator has indicated that she is resuming work on the state’s fiduciary rule for investment advisers and broker-dealers and expects to release the rule by November. READ MORE

The Convergence Continues: SEC Staff Bulletin on Standards of Conduct for B-Ds and RIAs

On March 30, 2022, the SEC issued “Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors” (SEC Retail Standards Bulletin). This guidance builds on prior SEC guidance regarding Regulation Best Interest (Reg BI) and the SEC’s “Main Street” initiatives impacting investment advisory firms since the SEC’s self-reporting “Share Class Selection Disclosure Initiative” announced just over four years ago. In the intervening years, the SEC issued a FAQ “Regarding Disclosure of Certain Financial Conflicts of Interest Related to Investment Adviser Compensation” and issued the Reg BI rulemaking package that included the “Commission Interpretation Regarding Standard of Conduct for Investment Advisers.” This blog has covered all of these developments and, regarding the once separate standards of conduct for brokerage and investment advisory firms, described the developing convergence of these standards as they apply to retail investors.

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Recent State Fiduciary and Best Interest Developments: New Mexico Becomes the 20th State to Adopt an NAIC Best Interest Model

Joining the growing number of states who are implementing the National Association of Insurance Commissioners’ (NAIC) model regulation concerning suitability in annuity transactions, New Mexico has issued its best interest rule to become effective on October 1, 2022. The rule will require insurance producers to act in the best interest of a consumer when making a sale or recommendation of an annuity in New Mexico or to a resident of New Mexico and will obligate the insurer to establish and maintain a system to supervise recommendations to ensure compliance.

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Exam Time: FINRA Releases its 2022 Report on its Examination and Risk Monitoring Program

A common phrase to abide by in the New Year is “out with the old, in with the new.” FINRA’s 2022 Report on its Examination and Risk Monitoring Program (the “Report”), however, contains a combination of old and new priorities. We previously previewed the Report.

Old priorities, once again included, are: Anti-Money Laundering, Reg BI and Form CRS, and cybersecurity.

New risk areas include: firm short positions and fails-to-receive in municipal securities; trusted contact persons; funding portals and crowdfunding offerings, disclosure of routing information; and portfolio margin and intraday trading.

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Recent State Fiduciary and Best Interest Developments: Pennsylvania’s New Law; Nevada May be Next

Pennsylvania has adopted legislation implementing the model regulation concerning suitability in annuity transactions adopted by the National Association of Insurance Commissioners (NAIC). This brings to 19 the total number of states adopting the NAIC suitability model. Nevada may be the next state to watch. Nevada’s Securities Administrator has indicated that she is resuming work on the state’s fiduciary rule for investment advisers and broker-dealers and expects to release the rule by November. Stay tuned.

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Brace for Impact: It’s Going to be (Another) Busy Year for FINRA

F. Scott Fitzgerald said “There are only the pursued, the pursuing, the busy, and the tired.” FINRA may be all of these in 2022, as FINRA CEO Robert Cook announced FINRA’s laundry list of priorities during a SIFMA Q&A last week. Below are some of the highlights from his Q&A.

Exam Time: Annual Exam and Risk Monitoring Findings

While Mr. Cook advised the “ink isn’t dry” on the 2022 priorities, he suggested broker-dealers can expect more of the same, with some new additions. New topics for examination will include: trusted contact person, disclosure of order routing, and intra-day trading.

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