Last month the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued its “2019 Examination Priorities.” The release of OCIE’s 2019 Priorities this year was earlier than in years past. In retrospect, the date of issuance being the last day before the vast majority of the SEC staff was furloughed may just be coincidental, but the federal government shutdown allowed the industry more time to study OCIE’s 2019 Priorities for compliance planning for the upcoming year. Another impact of the shutdown and furloughs in an area directly related to OCIE’s first priority is that the SEC’s efforts and the timing of the finalization of the Reg BI proposals have very likely been slowed as well. The recent ending of the SEC furloughs and OCIE’s continuing prioritization of retail and retirement regulatory issues presents us with an opportune time to re-visit these important topics.
In this Priorities Letter, OCIE continues and expands on Chairman Clayton’s prioritization of “Main Street” issues. Specifically, the first topic of the letter is “Matters of importance to retail investors, including seniors and those saving for retirement.” This post focuses on and summarizes these issues and weaves in related perspectives pertaining to ERISA and IRAs on fees and expenses, conflicts of interest, and senior investors.
OCIE’s 2019 Priorities, consistent with OCIE’s past practices, do not delve into the same level of detail that FINRA provides with its annual Regulatory and Examination Priorities Letter to FINRA member firms. So we are left to analyze the summary information provided, and compare and contrast it with what we know about the applicable regulations covering retirement accounts.
Regarding fees and expenses, OCIE’s 2019 Priorities provide:
Fees and Expenses: Disclosure of the Costs of Investing
Every dollar an investor pays in fees and expenses is a dollar not invested. It is critically important that investors are provided with proper disclosures of the fees and expenses they pay for products and services and that financial professionals accurately calculate and charge fees in accordance with these disclosures. OCIE will continue to review fees charged to advisory accounts, ensuring that the fees are assessed in accordance with the client agreements and firm disclosures. For these examinations, OCIE will select firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses, or other charges. With respect to mutual fund share classes, OCIE will continue to evaluate financial incentives for financial professionals that may influence their selection of particular share classes. In addition, OCIE remains focused on investment advisers participating in wrap fee programs, which charge investors a single bundled fee for both advisory and brokerage services. Continued areas of interest include the adequacy of disclosures and brokerage practices.
ERISA requires that qualifying “ERISA Fiduciary Advisers” recommend only products and services with reasonable costs. The recommendation of excessively expensive investment products or services, or insurance or annuity products, would be a breach of fiduciary duty by ERISA Fiduciary Advisers. This would apply to recommending a share class that was more expensive than what was reasonable for the plan. There is not a separate ERISA fiduciary duty for IRAs. In other words, the standard of care advice to IRA owners would be governed by the securities laws. However, the prohibited transaction rules in the Internal Revenue Code apply to fiduciary advice to IRA owners that increases the adviser’s compensation (e.g., 12b-1 fees, revenue sharing or payments from custodians).
Regarding ERISA disclosure requirements, there is a separate disclosure regime for ERISA service providers, including investment advisers, to ERISA retirement plans. This is referred to as the “408(b)(2)” disclosure requirement. It requires disclosure of services, compensation and status. There is not a separate disclosure requirement for services to IRAs.
Regarding conflicts of interest, OCIE’s 2019 Priorities provide:
Conflicts of Interest
As fiduciaries, investment advisers have a duty to act and provide advice in the best interests of their clients. Ensuring that investment advisers are acting in a manner consistent with their fiduciary duty and meeting their contractual obligations to their clients is paramount to maintaining investor confidence in the markets and investment professionals.
OCIE further provides that conflicts of interest provide incentives for financial professionals to recommend certain types of products and services and that OCIE examinations will focus on the following in their reviews: use of affiliated service providers and products because these arrangements present conflicts of interest related to, among other areas, portfolio management practices and compensation arrangements; and borrowing funds from clients because this presents a number of conflicts of interest for an investment adviser, and where examiners observe this practice, emphasis will be on whether adequate disclosures were made.
Financial conflicts of interest are “prohibited transactions” under ERISA. At this time, there is a non-enforcement policy at the Department of Labor (DOL) for conflicts resulting from nondiscretionary fiduciary advice, so long as the adviser adheres to the DOL’s Best Interest Standard of Care. But there is not a similar policy for discretionary investment management. For IRAs, if an adviser satisfies the DOL’s fiduciary definition, then similar rules apply under the Internal Revenue Code. These rules apply to proprietary investments, and separate prohibited transaction rules also apply to loans to the adviser.
Lastly, but perhaps most notably, the SEC continues to increase its focus on retirement accounts; an area of the industry for which the SEC historically deferred to ERISA regulation and DOL oversight. As such, OCIE’s 2019 Priorities provide:
Senior Investors and Retirement Accounts and Products
OCIE will conduct examinations that review how broker-dealers oversee their interactions with senior investors, including their ability to identify financial exploitation of seniors. In examinations of investment advisers, OCIE will continue to review the services and products offered to seniors and those saving for retirement. These examinations will focus on, among other things, compliance programs of investment advisers, the appropriateness of certain investment recommendations to seniors, and the supervision by firms of their employees and independent representatives.
ERISA does not have specific regulations or practices for senior investors; however, the ERISA guidance discussed above applies. For example, ERISA’s fiduciary and prohibited transaction rules can apply to rollover recommendations to retirees (i.e., to “senior” investors). While not explicit, rollover recommendations are likely also included in the SEC’s focus on senior investors.
OCIE’s 2019 priorities continue the mantra from Chairman Clayton to prioritize retail and retirement investor issues as the main priority of his chairmanship. This prioritization has led to a continuing convergence of the SEC’s priorities with the DOL and ERISA. As we move through 2019 and Reg BI continues to move toward its expected finalization, we expect this convergence to continue. We will continue to monitor this and report important developments here on our blog.