Subject: Compliance

Compensation Requirements under Proposed Amendments to PTE 2020-02

Broker-dealers and their registered representatives (advisors) providing services to private sector tax-qualified and ERISA-governed retirement plans, participants in those plans and IRA owners (collectively, Retirement Investors) are subject to a number of compensation rules.

ERISA’s fiduciary responsibility rules mandate that ERISA plans pay no more than reasonable compensation to service providers (including advisors).

In addition, the prohibited transaction rules that apply to Retirement Investors set limitations on compensation. For example, if a service provider receives compensation in excess of a reasonable amount, the excess is a prohibited transaction for both the plan fiduciary and the service provider. It is also a prohibited transaction if an advisor receives compensation that varies based upon the recommendation made (i.e., variable compensation) or third-party compensation as a result of the recommendation, unless a prohibited transaction exemption applies. Lastly, some prohibited transaction exemptions – like Prohibited Transaction Exemption (PTE) 2020-02 – have other limitations on compensation. This post focuses on the compensation limitations in the DOL’s proposed amendments to PTE 2020-02.

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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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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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Broker-Dealer Regulation & Litigation Digest – Summer 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.

Compliance with PTE 2020-02: Mitigating Conflicts of Interest
By Fred Reish and Joan M. Neri
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. 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. One of the conditions for relief under PTE 2020-02 is mitigation of conflicts of interest. This article discusses various compensation structures, mitigation techniques and related DOL FAQs.

And Now for the SEC’s First Substantive Reg-Bi Action
By Sandra D. Grannum, Emmanuel L. Brown and Jamie L. Helman
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.

What Broker-Dealers Need to Know About Correcting PTE 2020-02 Mistakes
By Fred Reish and Joan M. Neri
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.

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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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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PTE 2020-02 Compliance: Avoiding Five Common Mistakes

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.

So what’s ahead this year regarding fiduciary advice and exemptions? First, DOL is working on a new proposed definition of ERISA fiduciary investment advice to replace the 1975 regulation, and could publish the new proposal for comments this spring. This proposal may also include changes to DOL’s new Prohibited Transaction Exemption 2020-02 (the PTE). If DOL succeeds in rewriting these rules, they likely will go into effect in 2023. That means the current rule and the current version of the PTE will likely remain in effect for the next 12-18 months.

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Reg BI: What’s Going On and What May Happen Next?

SEC Chair Gary Gensler has not publicly stated much regarding Reg BI since Spring of this year. Generally, though, the messaging from SEC leadership regarding the Division of Examinations and the Division of Enforcement continues to be aggressive. In the retail investor area, for example, in late August Chair Gensler appointed Barbara Roper, the Director of Investor Protection for the Consumer Federation of America, as a Senior Advisor to the Chair. Turning back to Reg BI specifically, what we continue to hear out of the SEC is that Chair Gensler’s regime is going to play the Reg BI “hand that it has been dealt” aggressively.

On November 4, 2021, SEC Commissioner and former Acting Chair Allison Herren Lee gave a speech at ACLI’s CLE 2021 Conference on Life Insurance Products entitled “A Call to Action: Recommendations for Complying with Reg BI.” Commissioner Herren Lee covered several Reg BI topics, including what constitutes a recommendation and mitigation. Regarding recommendations, she noted that the Commission’s supplemental materials accompanying Reg BI speak of a “call to action” that may be viewed as influencing an investor to invest in or trade a particular security being enough to constitute a recommendation. On this topic, she emphasized the importance of the account opening process. Commissioner Herren Lee also addressed mitigation, in particular to manage the risk of an associated person putting their interests ahead of their customers, perhaps due to limitations in the firm’s products menu.

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New York Insurance Regulation 187 Found Unconstitutional: Now What? A Faegre Drinker Podcast

On April 29, 2021, the State of New York Supreme Court Appellate Division in the Third Judicial Department issued an Opinion and Order finding that the amendment to New York Insurance Regulation 187 was unconstitutionally vague. In this Faegre Drinker podcast, a cross-disciplinary team of our attorneys discusses the preliminary implications of this important decision.