Category Archives: SEC

Interesting Angles on the DOL’s Fiduciary Rule #83


DOL, General, prohibited transaction, SEC

Part 2 of Undisclosed (and Disclosed) 12b-1 Fees

This is my 83rd article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In last week’s post (Angles #82) I discussed the fiduciary and prohibited transaction rules that should be considered in light of the SEC’s “Share Class Selection Disclosure Initiative” (“SCSDI”). As a refresher, the SCSD Initiative is a self-correction and self-reporting program where RIAs can identify, correct and report failures to adequately disclose the receipt of 12b-1 fees in addition to their advisory fees. My article discussed the consequences under the DOL’s guidance for the receipt of 12b-1 fees—on top of advisory fees—for both non-discretionary investment advice and discretionary investment management, where the results are quite different.

This article builds on that. The topics for this article:

  • When will, or could, a recommendation of a higher-cost share class (and, therefore, a more expensive investment) satisfy the best interest standard of care (that is, the prudent person rule and the duty of loyalty)?
  • What kind of disclosure of 12b-1 fees would be adequate under the fiduciary rule?

Let’s look at each of those issues.

When will, or could, a recommendation of a higher-cost share class (and, therefore, a more expensive investment) satisfy the best interest standard of care (that is, the prudent person rule and the duty of loyalty)?

As a general principle, a fiduciary adviser should not recommend or select investments that are more expensive than reasonable and necessary. That is one of the considerations under the prudent man rule and under the duty of loyalty. On the other hand, investment advisers are entitled to receive reasonable compensation for their services.

A fiduciary adviser could recommend mutual funds that pay 12b-1 fees as long as the total compensation to the adviser and the firm does not exceed a reasonable amount and as long as the cost of the investment (e.g., expense ratio) is not unreasonably high. (This assumes that there is adequate disclosure of the 12b-1 fees.) So, for example, if an adviser recommends a mutual fund that has a 1% expense ratio, and 25 basis points is paid as 12b-1 fees, the reasonableness of the cost for the mutual fund should be the net expense ratio, or .75%. The adviser needs to determine whether that cost is appropriate and reasonable for the particular qualified account.

On the other hand, if the payment of the 12b-1 fee to the adviser’s firm—when added to the advisory fee—results in excess (or “unreasonable”) compensation for the services, the compensation would not be justifiable and it could mean that the cost (or expense ratio) of the mutual fund was unreasonably expensive (since the cost of the 12b-1 fee was not justified). The former is a prohibited transaction and the latter is a fiduciary breach.

In a nutshell, the prudent man rule and duty of loyalty require an evaluation of the cost of the investment (e.g., mutual fund). However, that analysis is connected at the hip to the reasonableness of the adviser’s compensation.

What kind of disclosure of 12b-1 fees would be adequate under the fiduciary rule?

While the Department of Labor (“DOL”) hasn’t issued any specific guidance on this subject, it has issued guidance about disclosures of compensation in other situations. For example, the DOL’s 408(b)(2) regulation requires that service providers disclose their compensation to plan fiduciaries. While 408(b)(2) applies only to compensation for plan services, it may help understand the expectations for other fee disclosures under the fiduciary rule.

Simply stated, the 408(b)(2) guidance is that the retirement plan fiduciaries must be provided with adequate information to make two determinations. Those are:

  • Whether the compensation of an adviser and the firm is reasonable relative to the services provided.
  • Whether, and to what extent, an adviser and the firm have conflicts of interest.

With that understanding, it seems reasonable to think that the expectation of the fiduciary rule is that the disclosures would enable an investor to calculate a relatively accurate estimate of the compensation paid. For example, it would be risky to say that the adviser or his firm “may” receive 12b-1 fees. The question is, would a reasonable person be able to approximate the total compensation based on that information. Another example would be where the disclosure is that the firm will, in addition to the advisory fee, receive 12b-1 fees in the range of -0-% to 1.00%. Again, the issue is whether the investor can reasonably calculate the total compensation when provided with that information.

A significant risk is that, where the disclosures are inadequate, the adviser and the firm are receiving compensation that was not approved—and that the DOL and IRS would take the position that the payment was a prohibited transaction.

These rules—and particularly, the prohibited transaction rules—are complex and, if not understood, can result in significant problems.

However, once understood—and with appropriate disclosures and agreements—compliance is not conceptually difficult.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Interesting Angles on the DOL’s Fiduciary Rule #82


BICE, DOL, fiduciary, FINRA, registered investment advisers, SEC

Undisclosed (and Disclosed) 12b-1 Fees: The Different Views of the SEC and DOL

This is my 82nd article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

On February 12, 2018, the SEC announced a remedial program called the “Share Class Selection Disclosure Initiative” (“SCSDI”). Simply stated, the temporary program says that investment advisers who have received undisclosed 12b-1 fees can correct and self-report. In that case, the SEC staff will not recommend financial penalties. However, if an investment adviser does not correct and self-report and the SEC later examines the adviser and discovers those undisclosed payments, the staff will likely be more aggressive about recommending penalties (because the advisers were given the opportunity to self-correct, but failed to do so).

If you would like to know more about that program, here is a link to an article written by two of my firm’s securities lawyers, Jim Lundy and Mary Hansen.

The purpose of this post is not to describe the SEC program, but instead to discuss the same issue from the perspective of the Fiduciary Rule and the prohibited transaction exemptions (and, in particular, the Best Interest Contract Exemption, BICE). This article focuses on investment advice and management for IRAs, rather than retirement plans. However, the principles are the same.

So . . . what are the consequences under the Fiduciary Rule (which became applicable on June 9, 2017) for advisory services to IRAs, where an investment adviser receives undisclosed 12b-1 fees? (By the way, the Fiduciary Rule also applies to advice by financial advisors and insurance agents and brokers. In that regard, it is of broader application than the SEC rules.)

To analyze the issues, the advice needs to be considered in two scenarios. The first is where a fiduciary adviser is providing non-discretionary investment advice; the second is where the fiduciary adviser is managing the account with discretion.

Where a fiduciary adviser has discretion, that is, where the adviser is actually managing the account, the adviser can only receive his stated fee. Stated slightly differently, the adviser cannot receive anything in addition to the advisory fee that results from the adviser’s investment decisions. BICE does not provide an exemption, or exception, for discretionary investment management; BICE only applies to non-discretionary investment advice.

And, to further complicate matters, the Fiduciary Rule prohibits the receipt of additional 12b-1 fees for discretionary investment management regardless of whether those fees are disclosed or not.

How can an adviser remedy the situation? The answer is that, to the extent that a discretionary fiduciary adviser receives additional payments (e.g., 12b-1 fees), the adviser must either offset those payments against the advisory fee—on a dollar-for-dollar basis—or must pay the 12b-1 fees over into the IRA.

As a result, the Fiduciary Rule is more demanding for discretionary investment management than the SEC rules are.

What about non-discretionary investment advice to IRAs?

Prior to June 9, 2017, the receipt of any additional payments for non-discretionary investment advice would have been treated the same as the receipt of additional payments for discretionary investment management (that is, the retention of those payments would have been prohibited). However, on June 9 the “transition” version of BICE became applicable. Under transition BICE, a fiduciary adviser can receive compensation in addition to the advisory fee so long as the adviser’s total compensation is reasonable (and so long as the firm, that is, the RIA or broker-dealer has policies, procedures and practices that ensure that the additional compensation does not incent the fiduciary adviser to make recommendations that are not in the best interest of the retirement investor).

Unfortunately, that second requirement—the policies, procedures and practices—is not well defined. Almost any additional compensation could be viewed as a potential incentive for a fiduciary adviser to increase his or her compensation. However, I believe that, if attention is paid to the subject, and if the people designing the policies, procedures and practices understand the rules, compliant programs can be developed.

But that assumes that the additional compensation was disclosed, which is different than the SEC’s SCSD Initiative. The SEC’s remedial program was designed to provide correction and reporting of the failure to disclose the receipt of additional 12b-1 fees. In that case, I believe that the DOL would take the same position as the SEC. That is, I believe that the DOL would take the position that, if the retirement investor (that is, the IRA owner) had not authorized the payment of the additional 12b-1 fees, the fiduciary adviser was setting his own compensation without the approval of the IRA owner and, therefore, the receipt of those payments was a prohibited transaction for which BICE did not provide relief.

Viewed in that way, the DOL Fiduciary Rule for non-discretionary advice is similar to the SEC’s, but still more demanding. For example, even if the additional 12b-1 fees were disclosed, the Fiduciary Rule and BICE require that the total compensation be reasonable. And, if not disclosed, there is a good chance that the Fiduciary Rule and BICE would be interpreted in a way that results in the 12b-1 fees being prohibited transactions.

Where do we end up? First, fully disclosed compensation, if reasonable, is permissible under the Fiduciary Rule and the exemptions for non-discretionary investment advice. Second, the receipt of additional amounts, such as 12b-1 fees, is prohibited where the adviser has discretion to manage the account, even if the total compensation is reasonable.

In this brave new world of the Fiduciary Rule, it’s important to understand the differences between the rules of the SEC, FINRA and the DOL. That is particularly true for advisory services to IRAs, since my experience is that many advisers to IRAs have little, if any, understanding of the new Fiduciary Rule and exemptions.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Interesting Angles on the DOL’s Fiduciary Rule #79


BICE, broker-dealers, DOL, fiduciary, FINRA, prudent, registered investment advisers, SEC

The Fiduciary Rule: Mistaken Beliefs (#4)

This is my 79th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

This post continues my series on myths about the fiduciary rule and prohibited transaction exemptions. This article focuses on the issue of “reasonable compensation” for RIAs, broker-dealers and their advisors for their services to retirement plans and IRAs (“qualified accounts”), and what, if any, changes will be made to that requirement. The myth is that the SEC will draft rules that eliminate the reasonable compensation rule. That is incorrect. The reasonable compensation limitation on advisors and their supervisory entities is here to stay.

This article explains why the reasonable compensation limits are here to stay and what advisors and their supervisory entities need to do to comply with those rules.

The fiduciary regulation is currently in effect. It first applied on June 9, 2017. And, it applied in full force. That is, while there are transition versions of the prohibited transaction exemptions, the fiduciary regulation was not modified to be a transition version.

The effect of the fiduciary regulation is to broadly expand the definition of who is a fiduciary. Because of the regulation, virtually anyone who makes an investment or insurance recommendation to a plan, a participant, or an IRA owner, is a fiduciary.

The conflict of interest exceptions (called “exemptions”), on the other hand, only partially applied on June 9th. The most important exemption—the Best Interest Contract Exemption, or BICE—requires only that advisors and their supervisory entities adhere to the Impartial Conduct Standards. Those standards are:

  • The best interest standard of care, which is, in its essence, the prudent person rule and the duty of loyalty.
  • No materially misleading statements.
  • No more than reasonable compensation for the individual advisor and the entity.

However, even if the reasonable compensation condition in BICE is removed from the exemption, that will not mean that advisers and their supervisory entities can ignore that limit. And, even if the SEC or FINRA do not impose a reasonable compensation limitation, that will not change the rule. Why is that?

The reasonable compensation limit is found in both the Internal Revenue Code and ERISA. In other words, it is a statutory requirement. Neither the DOL, the SEC nor FINRA can issue a rule that overrides a statute.

But, what if the definition of fiduciary is changed and an advisor is no longer a fiduciary? That doesn’t matter either. The reasonable compensation limitation in the Code and ERISA applies to all service providers, regardless of whether they are fiduciaries.

With that background, the essential question is, how do advisors and their financial institutions determine the reasonableness of their fees? Before I answer that question, though, I want to explain two threshold issues. The first is the definition of compensation and the second is the definition of reasonableness.

ERISA and the Code use “compensation” to cover all payments, monetary and non-monetary, that are compensatory. A compensatory payment is one which is partially or entirely, directly or indirectly, attributable to an investment or insurance recommendation. The DOL uses a “but for” test to determine if a payment is compensation, that is, would the broker-dealer or RIA firm have received the payment “but for” the investment recommendations. If the payment is partially or entirely, directly or indirectly, attributable to investment recommendations, it is compensatory.

With regard to “reasonableness,” the DOL explains that the reasonableness of compensation is determined by the services provided by the advisor. In effect, the marketplace defines “reasonable” because, in most cases, the ordinary and customary compensation for the services associated with particular transactions is reasonable.

More specifically, the DOL explained in its preamble to BICE:

The reasonableness of the fees depends on the particular facts and circumstances at the time of the recommendation. Several factors inform whether compensation is reasonable including, inter alia, the market pricing of service(s) provided and the underlying asset(s), the scope of monitoring, and the complexity of the product. No single factor is dispositive in determining whether compensation is reasonable; the essential question is whether the charges are reasonable in relation to what the investor receives.

Now, let’s turn to the steps that advisors and their supervisory entities should take to determine whether the compensation for a particular type of investment transaction is reasonable. Financial institutions and advisors need to obtain information about the marketplace pricing for various types of transactions. For example, what is the range of customary compensation for individual variable annuities? What is customary for referrals to third party asset managers? What is customary for mutual funds? And so on.

While it may be possible for financial institutions to collect that information on their own (and to update it periodically . . . perhaps annually), the more practical and cost-effective answer is to work with a benchmarking service that obtains and updates that information. Of course, advisors and financial institutions should investigate the experience and quality of the benchmarking service, and the integrity and timeliness of its data.

Keep in mind that the reasonable compensation limits are in the prohibited transaction rules. As a result, the burden of proof is on the financial institution, and not on the retirement investor. In other words, it’s important to have market data and to develop compensation policies that are consistent with the data. Since it is likely that the levels of reasonable compensation will change over time, that information should be updated at reasonable intervals.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

 

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Interesting Angles on the DOL’s Fiduciary Rule #68


broker-dealers, DOL, fiduciary, General, prudent, registered investment advisers, SEC

Recommendations of Distributions: The SEC Joins the Fray

This is my 68th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In 2013, FINRA put its stake in the ground on recommendations of distributions and rollovers when it issued Regulatory Notice 13-45. The DOL has, with the development of its fiduciary regulation over the past few years—which became applicable on June 9 of this year—taken a similar, but more demanding position. However, the DOL’s guidance has more teeth than FINRA’s, because it is backed by a standard of care—the prudent man rule and duty of loyalty—and by the prohibited transaction rules in ERISA and the Internal Revenue Code. Recently, the SEC has joined the fray with the issuance of its ReTIRE initiative and its examination priorities over the past few years.

The SEC has completed the first phase of its ReTIRE initiative. This Angles article reports on the observations from the first phase and the current examination priorities.

Needless to say, recommendations and rollovers are issues of concern to the SEC and are, in fact, being examined. RIAs and broker-dealers who do not have well-developed practices and documentation for recommending rollovers and distributions may be surprised when the SEC raises those issues and faults their practices. However, my belief is that compliance with the DOL’s best interest standard of care (that is, the prudent man rule and the duty of loyalty) will satisfy the standard of care and conflicts of interest concerns of both the DOL and the SEC. As a result, broker-dealers and RIAs should focus on compliance with the DOL rules (especially in light of the SEC’s examination positions). Additionally, broker-dealers and RIAs should seriously consider affirmatively disclosing the conflicts of interest inherent in recommending distributions and rollovers.

Here is some additional information about the SEC examinations and their observations:

  • The SEC has conducted over 250 examinations under the ReTIRE initiative.
  • Specific areas of concern have been uncovered during the examinations. Those include:
  • Recommendations to investors/retirees of inappropriate share classes.
  • Misleading marketing materials regarding offerings and rollovers.
  • Lack of documentation to support the reasonableness of recommendations (including rollovers).
  • Vague or omitted disclosures related to fees, conflicts and services of affiliates.
  • Misleading touting of credentials.
  • Supervision and compliance breakdowns.

We expect that the SEC’s examinations will continue to focus on issues related to retirees and older investors, including distribution and rollover issues.

As an observation, in a recent SEC examination of a broker-dealer, the report specifically referenced practices which could violate FINRA Regulatory Notice 13-45. As a result, now is a good time for broker-dealers to review their practices, including advisor education, under 13-45, as well as the related policies, procedures and supervision.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

 

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Interesting Angles on the DOL’s Fiduciary Rule #67


BICE, DOL, fiduciary, prudent, SEC

Fiduciary Rule: From the DOL to the SEC

This is my 67th article about interesting observations concerning the Department of Labor’s (DOL) fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions, and related developments in the securities laws.

It now seems certain that the DOL will extend the applicability date of the final exemptions to July 1, 2019, or thereabouts. In any event, it will be a long extension. As a practical matter, that means that the transition rules under the Best Interest Contract Exemption (BICE) and Prohibited Transaction Exemption 84-24 will be extended until June 30, 2019 . . . in other words, the transition rules will continue until the applicability of revised final exemptions.

The extended time will be used for the DOL and the Securities and Exchange Commission (SEC) to cooperate in the development of new fiduciary rules by the SEC (and perhaps changes to the DOL’s fiduciary regulation) and for revised exemptions to be issued by the DOL for BICE and 84-24.

However, that coordination will probably not produce rules as favorable as some expect nor as unfavorable as others anticipate. Let me explain that comment.

The DOL’s new fiduciary regulation—which became fully applicable on June 9 of this year—defines the recommendations that cause an advisor and his or her supervisory entity to be fiduciaries. For example, if an advisor recommends an investment, an investment manager, an investment strategy or policy, a withdrawal from an IRA or a distribution and rollover from a plan, that is already fiduciary advice.

Since that’s a regulation, the DOL can amend it. However, I doubt that any of those recommendations will be removed from the category of fiduciary advice. On the other hand, an amended regulation could expand the circumstances in which selling is allowed without becoming fiduciary advice (perhaps with enhanced disclosures of non-fiduciary status) and could require a more personalized recommendation, e.g., a recommendation that is individualized to a plan, participant or IRA owner. However, I doubt that the changes will substantially alter the current landscape.

The second fiduciary issue is the standard of care—the dual duties of prudence and loyalty. For advice to plans and participants, those duties are statutory. They cannot be changed by regulation. And, they cannot be changed by the SEC. Only Congress can amend the law (and this Congress seems to have a difficult time doing anything).

However, the statutory prudent man rule and duty of loyalty only apply to advice to ERISA plans and their participants. For IRAs, those duties (which are referred to as the “best interest standard of care”) are imposed by the exemptions, for example, BICE. (As an aside, that means that advisors and their firms only need to comply with the best interest standard of care for IRAs if they are committing prohibited transactions by, e.g., receiving variable compensation or third party compensation. So, for example, a level fee advisor to an IRA would not be committing a prohibited transaction and, therefore, would not need to comply with the conditions of an exemption, e.g., the best interest standard of care.) However, the DOL can amend exemptions. So, BICE and 84-24 could be changed to a standard other than the best interest standard of care. Having said that, though, there may not be significant changes. If you look at the best interest standard, it requires that the advisor and his or her firm act prudently and loyally. It’s possible that the SEC could adopt the ERISA rule as the standard for retail advice for broker-dealers and RIAs. In any event, it’s difficult to imagine a new SEC standard that is much different than prudence and loyalty.

With regard to disclosures for exemptions, it’s possible—perhaps even likely—that the DOL will follow the SEC’s lead. Before the DOL does that, though, it must make an independent finding that the SEC’s disclosures are adequately protective of the interests of plans, participants and IRA owners. In that regard, the DOL needs to consider the effectiveness of the disclosures, as well as the facts to be disclosed. Nonetheless, I believe that the SEC will be leader on disclosures and the DOL will make every effort to use the SEC disclosures as conditions of the prohibited transaction exemptions. That will be more than is required under the transition exemptions, but it will probably be significantly less than is required under the current versions of the final exemptions.

We are working with clients to develop their strategies and comments for the SEC. I expect to have additional insights as those develop.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Interesting Angles on the DOL’s Fiduciary Rule #43


BICE, broker-dealers, DOL, fiduciary, prohibited transaction, registered investment advisers, SEC

BICE Transition: More Than the Eye Can See

This is my 43rd article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

As we all know by now, the new, and greatly expanded, definition of fiduciary advice becomes applicable on June 9. That means that almost any investment or insurance recommendation to a plan, participant, or IRA will be a fiduciary act. (The definition of investment recommendations is also very broad, including referrals to investment managers, recommendations to take distributions from plans, and recommendations to transfer IRAs.)

As a result, investment and insurance recommendations to participants and plans must be prudently developed and must be loyal to the plan or participant. But, recommendations to IRAs will not be subject to the prudent man standard of care. Instead, they would be subject to the SEC fiduciary duty for RIAs, FINRA’s suitability and know-your-customer standards for broker-dealers, and state law standards of care for both RIAs and broker-dealers.

However, this story does not end there. When investment recommendations cause a third party to pay compensation to the adviser (for example, commissions or 12b-1 fees), that is a prohibited transaction. Also, when the adviser makes a recommendation that causes the adviser to receive additional compensation (for example, a commission on a securities transaction), that is a prohibited transaction. Because of those prohibited transactions (for recommendations to plans, participants and IRAs), an adviser must satisfy the conditions of an exemption.

During the period from June 9 to December 31, the likely exemption will be “transition” BICE, that is, the transition rule under the Best Interest Contract Exemption. Fortunately, those conditions should be fairly easy to satisfy. In fact, there is only one condition, but it has three parts. The condition is that the adviser (and the adviser’s Financial Institution) comply with the Impartial Conduct Standards (ICS). The three parts of ICS are: (1) The best interest standard of care; (2) no more than reasonable compensation; and (3) no materially misleading statements.

Focusing on the best interest standard of care, that means that the adviser and the Financial Institution must engage in a prudent process to develop investment recommendations and must act with a duty of loyalty to the plan, participant or IRA owner.

However, the purpose of this article is to discuss requirements that aren’t obvious on the face of the ICS. In other words, there is more to the rule than meets the eye. That’s because, in the DOL’s final regulation extending the applicability date of the fiduciary rule, the Department said:

Also note that even though the applicability date of the exemption conditions have been delayed during the transition period, it is nevertheless anticipated that firms that are fiduciaries will implement procedures to ensure that they are meeting their fiduciary obligations, such as changing their compensation structures and monitoring the sales practices of their advisers to ensure that conflicts in interest do not cause violations of the Impartial Conduct Standards, and maintaining sufficient records to corroborate that they are adhering to Impartial Conduct Standards.

In other words, while the explicit compensation requirement of the ICS is that advisers and Financial Institutions cannot receive more than reasonable compensation, the DOL is saying that a Financial Institution’s compensation structures cannot promote investment recommendations that are not in the best interest of the investor. Think about that. One possible interpretation is that, even though the compensation of the adviser can vary, both for similar products (e.g., mutual funds) and among product categories (e.g., mutual funds vs. variable annuities), the variation cannot be so great as to unreasonably promote advice that is inconsistent with the best interest standard of care.

That raises the obvious question, how much is too much?

It’s difficult, if not impossible, to answer that question. Having said that though, I think that the answer will be somewhat like the famous Supreme Court position . . . “You know it when you see it.”

In any event, broker-dealers, RIA firms, and other Financial Institutions should evaluate their compensation practices and consider whether they align with the quoted language.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Interesting Angles on the DOL’s Fiduciary Rule #38


broker-dealers, DOL, registered investment advisers, SEC

SEC Examinations of RIAs and Broker-Dealers under the ReTIRE Initiative

This is my 38th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions.

As explained in my last post (Angles #37), the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a National Exam Program Risk Alert concerning examinations about services offered by RIAs and broker-dealers to investors with retirement accounts. One of the areas specifically identified for those examinations is “Reasonable Basis for Recommendations.” The OCIE described that issue as:

“Registrants have important obligations under the federal securities laws and SRO rules (with respect to broker-dealers) when making recommendations or providing investment advice. To the extent applicable and required, the staff will assess the actions of registrants and their representatives for consistency with these obligations when: (i) selecting the type of account; (ii) performing due diligence on investment options; (iii) making initial investment recommendations; and (iv) providing on-going account management.”

At the end of the language about “selecting the type of account,” the SEC included a footnote that referenced FINRA guidance on rollovers to IRAs. That footnote said:

“See FINRA, Rollovers to Individual Retirement Accounts, Regulatory Notice 13-45 (December 2013) (FINRA Regulatory Notice 13-45) (“A recommendation concerning the type of retirement account in which a customer should hold his retirement investments typically involves a recommended securities transaction, and thus is subject to Rule 2111. For example, a firm may recommend that an investor sell his plan assets and roll over the cash proceeds into an IRA. Recommendations to sell securities in the plan or to purchase securities for a newly-opened IRA are subject to Rule 2111.”)”

Combining the language in the Risk Alert with the language in the footnote, the OCIE is saying that recommendations to participants to take distributions from plans (that is, from one type of account), and rolling over to an IRA (that is, to another type of account) will be scrutinized. It also suggests that the OCIE favorably views FINRA’s analysis in Regulatory Analysis 13-45.

In my next post, I will discuss the rollover discussion in FINRA Regulatory Notice 13-45.

For the moment, though, as a word to the wise, broker-dealers and RIAs should review their procedures and policies, as well as their supervisory programs, to ensure that their advisers are complying with the expectations of the OCIE and with the provisions of Regulatory Notice 13-45.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Interesting Angles on the DOL’s Fiduciary Rule #37


DOL, fiduciary, prudent, SEC

SEC Retirement-Targeted Examinations

This is my 37th article about interesting observations concerning the Department of Labor’s fiduciary rule and exemptions. These articles also cover the DOL’s FAQs interpreting the regulation and exemptions and related developments in the securities laws.

In 2015, the Office of Compliance Inspections and Examinations (OCIE) of the SEC issued a National Exam Program Risk Alert describing its “Retirement-Targeted Industry Reviews and Examinations Initiative” (ReTIRE). The Initiative announces that the OCIE “will conduct examinations of SEC-registered investment advisers and broker-dealers (collectively, registrants) under the ReTIRE Initiative that will focus on certain high-risk areas of registrants’ sales, investment and oversight processes, with particular emphasis on select areas where retail investors saving for retirement may be harmed.”

In its Risk Alert, the OCIE says:

“The staff intends to use data analytics, information from prior examinations, and examiner-driven due diligence to identify registrants to examine under this Initiative. As part of the examinations or the selection of examination candidates, the staff may focus on the activities of investment advisory representatives and/or broker-dealer registered representatives (collectively, representatives). The risk-based examinations conducted under the ReTIRE Initiative will focus on the services offered by the registrants to investors with retirement accounts in the following areas:

Reasonable Basis for Recommendations. . . .

Conflicts of Interest. . . .

Supervision and Compliance Controls. . . .

Marketing and Disclosure. . . .”

The purpose of this post is to emphasize that there are agencies, in addition to the Department of Labor, that are focused on advisers’ practices for retirement investing and related activities (for example, the recommendation of rollovers). In future posts, I will discuss the OCIE’s focus for those examinations.

For the moment, though, a good approach is to make sure that recommendations regarding plan distributions and rollovers are in the best interest of the participants and that investment practices for IRAs should be consistent with prudent investing in retirement (and should reflect practices such as appropriate portfolio investing, diversification, and mitigation of conflicts of interest).

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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Interesting Angles on the DOL’s Fiduciary Rule #36


DOL, fiduciary, SEC

Retirement Advice and the SEC

While the DOL’s fiduciary regulation and prohibited transaction exemptions have occupied everyone’s attention over the last year, other regulatory agencies have been focusing on retirement plan issues, as well.

For example, in its “Examination Priorities for 2017,” the SEC has indicated that it will focus on “Senior Investors and Retirement Investments.” Specifically, the SEC says:

As the U.S. population ages and investors become more dependent than ever on their own investments for retirement income, we are devoting increased attention to issues affecting senior investors and those investing for retirement.

  • ReTIRE. We will continue our multi-year ReTIRE initiative, focusing on investment advisers and broker-dealers along with the services they offer to investors with retirement accounts. This year, these examinations will likely focus on, among other things, registrants’ recommendations and sales of variable insurance products as well as the sales and management of target date funds. We will also assess controls surrounding cross-transactions, particularly with respect to fixed income securities.
  • Senior Investors. Today’s Americans are more reliant on returns from their investment portfolios to fund their retirement compared to previous generations. We will evaluate how firms manage their interactions with senior investors, including their ability to identify financial exploitation of seniors. Examinations will likely focus on registrants’ supervisory programs and controls relating to products and services directed at senior investors.

With regard to retirement investments, the most impactful “focus” will be on recommendations and sales of variable insurance products. In the context of individual retirement accounts and annuities, that refers to individual variable annuities. (Also see Retirement-Targeted Industry Reviews and Examinations Initiative, June 22, 2015. Note that the SEC references FINRA’s guidance on rollovers, Regulatory Notice 13-45.)

However, unlike the DOL, the SEC will not focus on the fiduciary process and prohibited transaction exemptions. Instead the SEC will examine for violations of rules that are, in some ways, similar to the fiduciary rule, such as the best interest of the investor, the suitability of the product for the investor’s needs, and disclosures. However, unlike the DOL rule, the securities laws do not include prohibited transactions.

With regard to senior investors, it’s important to keep in mind that the terms “Senior Investors,” “Retirees,” and “IRA Owners” are, in many cases, synonymous. For these investors, the SEC will focus on:

  • The ability of advisers to identify financial exploitation of seniors;
  • Registrants’ supervisory programs and controls related to products and services directed at senior investors.

In terms of qualified assets, this means that the SEC will be looking at the products and services recommended to retirees who are IRA owners. Are the services and products recommended to those IRAs suitable for retirees and were the recommendations in the best interest of the IRA owners? In my opinion, increasing attention will be given to the recommendations of particular investments and strategies to older investors. Those recommendations should be consistent with retirement investing, including appropriate asset allocation.

Forewarned is forearmed.

POSTSCRIPT: Some readers may think that, since this article is about SEC examinations, it is limited to registered investment advisers. However, when the SEC uses the term “registrants,” it is referring to the “more than 4,000 broker-dealers (including approximately 162,000 branch offices and 640,000 registered representatives), more than 12,000 investment advisers (with nearly $67 trillion in assets under management) . . .” (See footnote 2 in Examination Priorities for 2017.)

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Drinker Biddle & Reath.

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