Category: Standard of Care

In Case You Missed It: Broker-Dealer Regulation & Litigation Digest – Winter 2023

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.

The DOL’s New Fiduciary Rule: What We Can Expect

By Fred Reish and Joan M. Neri
The current Department of Labor fiduciary rule says that a broker-dealer and its registered representatives (advisors) are fiduciaries to a plan under ERISA if a functional five-part test is satisfied. This same five-part test applies to determining whether an advisor is a fiduciary to an IRA under the Internal Revenue Code.

You Might Want to Write Down Why You Recommended That Rollover

By Sandra D. Grannum, Jamie L. Helman and Emmanuel Brown
The Division of Examinations of the Securities and Exchange Commissions (the Division) has been busy implementing examinations of broker-dealers to assess compliance with the regulation. The Division is planning to include Reg BI compliance into future examinations of broker-dealers. Therefore, the Division issued a Risk Alert on January 30, 2023, calling attention to deficiencies found during broker-dealer compliance examinations, as well as certain inadequate practices that might lead to deficiencies. Broker-dealers should pay attention to the issues identified by the SEC so that they do not expose themselves to regulatory trouble later down the line.

Managing IRAs: Charging Different Fees for Different Investments

By Fred Reish and Joan M. Neri
Registered investment advisers, including dual registrant broker-dealers, who provide discretionary investment management services to individual retirement accounts (IRAs), are fiduciaries under the Internal Revenue Code (the Code). While the Code does not have a fiduciary standard of care, it does have a duty of loyalty in the sense that most conflicts of interest are prohibited.

You Might Want to Write Down Why You Recommended that Rollover

Since Regulation Best Interest’s (Reg BI) June 30, 2020 compliance date, the Division of Examinations of the Securities and Exchange Commissions (the Division) has been busy implementing examinations of broker-dealers to assess compliance with the regulation. The Division is planning to include Reg BI compliance into future examinations of broker-dealers. Therefore, the Division issued a Risk Alert on January 30, 2023 calling attention to deficiencies found during broker-dealer compliance examinations, as well as certain inadequate practices that might lead to deficiencies. Broker-dealers should pay attention to the issues identified by the SEC so that they do not expose themselves to regulatory trouble later down the line.

Some of the exposed weaknesses and deficiencies regarding the Reg BI Care Obligation1 involved inadequate written policies that directed financial professionals to document the basis for their recommendations but failed to state when doing so is required or which information is needed. Under Reg BI, financial professionals are required to make account recommendations that are in the best interest of the retail investor. Doing so is especially important when a financial professional is recommending a significant financial transaction to a retail investor, like an account rollover recommendation.

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New Year’s Priorities: FINRA Releases its 2023 Report on its Examination and Risk Monitoring Program

Yes, (somehow) it is that time of year again. FINRA recently released its 2023 Report on its Examination and Risk Monitoring Program (the “Report”). As is typical (and this blog has well-covered), it contains a mix of old and new priorities.

Priorities Previously Included: Reg BI and Form CRS, Consolidated Audit Trail (CAT), Cybersecurity, Mobile Applications, Best Execution

New Priorities: An entire new category labeled Financial Crimes, Manipulative Trading, Fixed Income – Fair Pricing, Fractional Shares: Reporting and Order Handling, Regulation SHO

In general, FINRA breaks down the Report into five Categories: (1) Financial Crimes; (2) Firm Operations; (3) Communications and Sales; (4); Market Integrity; and (5) Financial Management. Within these categories, FINRA highlighted certain discrete topics. We discuss FINRA’s highlighted topics at greater length below.

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Managing IRAs: Charging Different Fees for Different Investments

Key Takeaways:

Registered investment advisers, including dual registrant broker-dealers (collectively “advisers”) who provide discretionary investment management services to individual retirement accounts (IRAs), are fiduciaries under the Internal Revenue Code (the “Code”). While the Code does not have a fiduciary standard of care, it does have a duty of loyalty in the sense that most conflicts of interest are prohibited.

The Code prohibits an investment adviser fiduciary to an IRA from using its authority as a fiduciary to receive additional compensation. This means that an adviser with the authority to make asset allocation decisions in an IRA cannot charge a different fee for different investment categories (e.g., equities vs. fixed income) unless a prohibited transaction exemption is available. Alternatively, there are other compensation structures that can be considered.

 

Advisers who manage IRAs may have discretionary authority to determine the asset allocation among equities and fixed income assets based on the investor’s investment objectives, financial needs and circumstances. The fee charged for this service may be a level fee based on the value of all assets – equity and fixed income; in that case, there would not be a conflict that it was a prohibited transaction. But, let’s suppose the adviser wants to charge one fee for advising on the portion of the investor’s IRA portfolio that is allocated to equities, and a lower fee for the portion allocated to fixed income investments, and the adviser has the discretion to decide how much is allocated to equities and how much is allocated to fixed income. As explained later in this article, the allocation to the higher fees (that is, to equities) is an exercise of discretion that is a conflict and a prohibited transaction because it increases the adviser’s compensation.

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Recent State Fiduciary and Best Interest Developments

To date, 27 states have adopted rules that follow the Suitability in Annuity Transactions Model Regulation issued by the National Association of Insurance Commissioners (NAIC). Recent additions reflected in the following State Fiduciary and Best Interest Development chart include: Hawaii, Maryland, Minnesota, North Carolina, South Carolina, South Dakota and Wisconsin. Also, the chart reflects the Robinhood Financial v. Galvin decision by a Massachusetts Superior Court Judge declaring the Massachusetts fiduciary duty rule unlawful as well as a proposed rule issued by the Nevada Commissioner of Insurance imposing new requirements for training producers in connection with the recommendation of annuities.

To view the updates, visit the Resource page.

Download the chart of all the states.

Rollover Recommendations – Do the SEC and DOL Requirements Align?

Key Takeaways

The SEC and the DOL have separately issued guidance on rollover recommendations – however, a close examination indicates that the guidance by both agencies is very similar. The SEC’s guidance for broker-dealers is in Regulation Best Interest and a recent Staff Bulletin on account recommendations. The DOL’s guidance about rollover recommendations came in the form of an expanded interpretation of fiduciary advice found in the Preamble to PTE 2020-02 and a set of Frequently Asked Questions. These pieces of guidance share the following three principles: (1) a best interest standard, (2) a process to support that best interest standard that requires consideration of relevant factors about the investor, the investor’s current retirement account and the recommended rollover account, and (3) documentation supporting the basis for the recommendation.

There are a few differences between the SEC and the DOL guidance that broker-dealers and their registered representatives should know about, including that the SEC rollover guidance is applicable to a much broader array of retirement plans and accounts, and also that the SEC guidance does not require a disclosure about the best interest reasons for the rollover recommendation as does the DOL under PTE 2020-02.

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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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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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