Broker-dealers have written supervisory policies (WSPs) that cover almost all aspects of their business. But more WSPs may be needed to address the DOL fiduciary rule.
While it may seem that no such requirement exists, the Department of Labor (DOL) has turned this around … if the firm intends to rely on the Best Interest Contract Exemption (BICE).
During the current transition period (June 9 to December 31, 2017 – which is being extended to June 30, 2019), broker-dealers and their reps have to comply with the Impartial Conduct Standards but are relieved of many of the other BICE requirements, including the specific obligation to adopt policies and procedures to ensure compliance. However, in its May 2017 release, “Conflict of Interest FAQs (Transition Period),” the DOL seems to backtrack on this relief.
FAQ 6 is the one that raises the WSP issue:
During the transition period, the Department expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisers comply with the impartial conduct standards. During that period, however, the Department does not require firms and advisers to give their customers a warranty regarding their adoption of specific best interest policies and procedures…Instead, financial institutions retain flexibility to choose precisely how to safeguard compliance with the impartial conduct standards, whether by tamping down conflicts of interest associated with adviser compensation, increased monitoring and surveillance of investment recommendations, or other approaches or combinations of approaches. For example, some firms have indicated that they intend to rely upon or build on existing regulatory compliance structures to monitor their advisers’ sales practices and recommendations, document the bases for those recommendations, and ensure that the impartial conduct standards are met (e.g., by subjecting transactions involving conflicts of interest to heightened scrutiny and surveillance).
During the transition period, the only specific BICE requirement for firms and their representatives is compliance with the three elements of the Impartial Conduct Standards:
- The best interest standard of care.
- No more than reasonable compensation.
- No materially misleading statements.
Through FAQ 6, however, the DOL has basically added a fourth element: a requirement to adopt policies, procedures and practices to ensure compliance. The FAQ seems to grant some leeway, by leaving it to the broker-dealer to “reasonably conclude” what is necessary. The analysis could include, for example, some or all of the following:
- Reviewing existing WSPs to see if they are adequate for ensuring that the impartial conduct standards are met.
- Revising WSPs as needed and implementing practices to provide for heightened supervision of transactions involving conflicts of interest, such as additional monitoring of sales practices and recommendations.
- Implementing additional documentation requirements to explain the basis for recommendations.
- Adjusting compensation to reduce or manage conflicts that can arise as a result of varying or “incentive” compensation.
Doing nothing doesn’t seem to be an option. In a “non-enforcement policy” released at the same time as the FAQs, the DOL also said that broker-dealers have to make a “diligent and good-faith” effort to comply with BICE in order to have the protection of that exemption. As a practical matter, that almost mandates adoption of appropriate WSPs and supervisory practices.
It may be possible, of course, to conclude that existing policies, procedures and practices are sufficient. Where a firm does that, it should prepare an internal memo (or other documentation) on why it reached this conclusion (in case that decision is ever challenged).
While we hope the DOL will adopt a somewhat relaxed approach to enforcement – a “reasonable efforts” standard – during the transition period, it seems unlikely that attorneys representing investors as claimants will do the same. As a result, broker-dealers need to consider the issue of additional “BICE WSPs” thoughtfully and promptly.