Category: SEC Rules

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.

SIFMA C&L March 2023 Annual Conference – A Focus on Crypto

The 2023 Securities Industry and Financial Markets Association’s (SIFMA) Compliance & Legal Annual Seminar, as usual, was well attended by compliance and legal professionals, including FINRA executives and SEC directors. The three-day event held, where outside San Diego skies were overcast and grey, also coincided with the run on SVB, and gloomy forecasts for Signature Bank and First Republic. Inside, industry leaders, and regulators discussed legal trends on the horizon. Not surprisingly there was a focus on crypto at this year’s conference. While Reg BI, ESG, off-channel communications, cybersecurity and the foreboding banking issues (among others) were also hot topics being discussed by industry insiders, here we focus on crypto. Below are some key takeaways.

Expect More SEC Enforcement Actions with a Focus on Crypto

SEC Director Gurbir Grewal noted the Commission’s general intent to focus on enforcement actions and swiftly bringing those actions to resolution as a way to rebuild public trust in the markets, financial institutions and the Agencies. He also urged firms to self-report and stressed the need for robust compliance programs, especially as new rules and regulations continue to be issued. He took time to speak about crypto investments and noted that traditional firms generally “do not and cannot” participate in this space due to the lack of compliance and clear rules around these investments. He also noted that the SEC is doubling the size of its Crypto Assets and Cyber Unit in order to focus on crypto’s harm to investors; indeed the SEC has already brought more than 100 enforcement actions related to crypto. A fact which is reflected on the “SEC Crypto Assets and Cyber Enforcement Actions” website.

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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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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.

16 “At One Blow” – The SEC Sanctions for Recordkeeping Failures

On September 27, 2022, the SEC announced that it had sanctioned 15 Broker-Dealers and one affiliated RIA for widespread recordkeeping violations of Section 17(a)(1) of the Exchange Act and Rule 17a-4(b)(4) thereunder resulting from the firms’ failure to maintain and preserve electronic communications. The SEC uncovered the misconduct after commencing a September 2021 sweep – a risk-based initiative to investigate the use of off-channel and unpreserved communications at broker-dealers. These firms agreed to the facts set forth in the SEC’s Order Imposing Remedial Sanctions and a Cease-and-Desist and agreed to pay total penalties of $1.1 BILLION and to implement improvements to their compliance policies and procedures.

The SEC Press Release advised that:

“Finance, ultimately, depends on trust. By failing to honor their recordkeeping and books-and-records obligations, the market participants we have charged today have failed to maintain that trust.”… As technology changes, it’s even more important that registrants appropriately conduct their communications about business matters within only official channels, and they must maintain and preserve those communications.”

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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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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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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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