- The SEC Division of Examinations is focused on advice to older investors and retirement investors. Advisors and their firms should review their practices for those investors.
- Among the concerns of the Division of Examinations is whether conflicts are adequately disclosed so that investors can provide informed consent. Off-the-shelf disclosures may not have sufficient information to pass that test.
- The starting point for making an investment recommendation or providing investment advice is to develop a profile of the investor that considers the information relevant to the investor’s needs and circumstances. The information needed for the profile for retired investors may be different than for accumulation investors. Questionnaires and other information gathering materials should be reviewed to ensure their adequacy for purposes of investors who will regularly withdraw cash for lifelong retirement income from their accounts.
The SEC Division of Examinations recently released its 2024 Examination Priorities (2024-exam-priorities.pdf (sec.gov)). While the Priorities cover a range issues, this article focuses on the Priorities that could impact advice and recommendations by investment advisers and dual registrants (both referred to as advisors in this article) to retirement investors. “Retirement Investors” is DOL terminology for investors in retirement plans and IRAs. My interchangeable use of SEC and DOL language is justified by their shared interest in protecting people who are saving and investing for retirement and who are investing and spending in retirement.
The Examination Priorities begin with a discussion of examinations of investment advisers. The first paragraph of that section establishes the context for the Priorities that follow:
As a fiduciary, an investment adviser owes a duty of care and a duty of loyalty to its clients. An adviser must, at all times, serve the best interest of its clients and not subordinate its clients’ interest to its own. In other words, an investment adviser cannot place its own interests ahead of the interests of its clients. In addition, an adviser is required to eliminate or make full and fair disclosure of all conflicts of interest which might incline the adviser—consciously or unconsciously—to render advice which is not disinterested such that a client can provide informed consent to the conflict. Examining for advisers’ adherence to their duty of care and duty of loyalty obligations remains a priority for the Division. In reviewing advisers’ adherence to this fiduciary standard, the Division continues to focus on:
The next paragraph lists the first set of Priorities:
Investment advice provided to clients with regard to products, investment strategies, and account types, particularly those regarding: (1) complex products, such as derivatives and leveraged exchange-traded funds (ETFs); (2) high cost and illiquid products, such as variable annuities and non-traded real estate investment trusts (REITs); and (3) unconventional strategies, including those that purport to address rising interest rates. Examination focus may be emphasized for investment advice provided to certain types of clients, such as older investors and those saving for retirement. (The bolding is added by me.)
My interpretation of those statements is that some investments and strategies will be more closely examined (for example, high cost and illiquid products and unconventional strategies) for all investors, but they will be particularly scrutinized for older invertors and retirement investors. It probably goes without saying (but to be safe, I will say it anyway), there is considerable risk in recommending or managing volatile, risky and illiquid investments for retirees. From a legal perspective, a large loss in a retiree’s IRA would raise questions about the prudence of the advisor’s strategy.
The next paragraph says that the Division of Examinations will focus on an advisor’s:
Processes for determining that investment advice is provided in clients’ best interest, including those processes for (1) making initial and ongoing suitability determinations, (2) seeking best execution, (3) evaluating costs and risks, and (4) identifying and addressing conflicts of interest. Such assessments will also review the factors advisers consider in light of the clients’ investment profiles, including investment goals and account characteristics. Examinations will review how advisers address conflicts of interest, including (1) mitigating or eliminating the conflicts of interest, when appropriate, and (2) allocating investments to accounts where investors have more than one account (e.g., allocating between accounts that are adviser fee-based, brokerage commission-based, and wrap fee, as well as between taxable and non-taxable accounts). (Again, the bolding is mine.)
While most of those priorities are obvious (e.g., costs and risks), I think that two of them warrant special consideration. First, my suspicion is that the SEC Divisions of Examination will be placing emphasis on gathering the relevant information for the investor profile and then making recommendations and managing investments in a manner consistent with those characteristics. That would be particularly true for retirees who are living on the income provided by their investments for their uncertain lifetimes. The second is the reference to “mitigating” conflicts. Mitigation of conflicts is a requirement in Reg BI for the advisors of broker-dealers but investment advisers are more commonly required to “manage” conflicts. Query, does this language suggest that there is a legal requirement for investment advisers to mitigate their conflicts “when appropriate” and, if so, when is that? Advisors should consider when it would be appropriate to mitigate a conflict. The expectations may be heightened.
Two paragraphs after that, the Priorities say:
Disclosures made to investors and whether they include all material facts relating to conflicts of interest associated with the investment advice sufficient to allow a client to provide informed consent to the conflict.
Investment advisers should review their ADVs to ensure (1) that all conflicts of interest are disclosed, and (2) that the disclosures include “all material facts.” I have several concerns about this. First, in reviewing ADVs for compliance with the disclosure requirements under the DOL’s PTE 2020-02, I noticed that, in some cases, conflicts were not disclosed. Two notable examples are: A rollover recommendation and a recommendation to transfer an IRA from another firm. Advisors need to consider any recommendations that they make that could affect their compensation (or the revenues of an affiliate) and ensure that the disclosures are made and that they are adequate.
The Priorities point to economic incentives to recommend products, services or account types:
Such economic incentives may exist when there is revenue sharing, markups, or other incentivizing revenue arrangements. Examinations will focus on the economic incentives and conflicts of interest associated with advisers that are dually registered as broker-dealers, use affiliated firms to perform client services, and have financial professionals servicing both brokerage customers and advisory clients to identify, among other things: (1) investment advice to purchase or hold onto certain types of investments (e.g., mutual fund share classes) or invest through certain types of accounts when lower cost options are available; and (2) investment advice regarding proprietary products and affiliated service providers that result in additional or higher fees to investors. (The bolding is mine.)
These economic incentives are conflicts of interest for SEC purposes. However, they are prohibited transactions under the Internal Revenue Code and ERISA. For both IRAs and plans (including participant accounts), where the advisor is a fiduciary under DOL regulations, the conflicts must be eliminated or, alternatively, the conditions of an exemption can be satisfied (if an exemption is available). For nondiscretionary investment advice, PTE 2020-02 is generally available, but has conditions that must be satisfied. On the other hand, for discretionary investment management, PTE 2020-02 is not available and there are only a few circumstances under which any exemption is available.
Later in the Priorities, the Division of Examinations adds:
Disclosure assessments to review the accuracy and completeness of regulatory filings, including Form CRS, with a particular focus on inadequate or misleading disclosures and registration eligibility. (Emphasis added by me.)
As a word of warning, when advisors provide investment services to plan participants, they are required to deliver the Form CRS (unless they are selected and monitored by the plan sponsor to provide those services). That includes rollover recommendations. As explained in the Instructions to the Form CRS:
You must deliver the most recent relationship summary to a retail investor who is an existing client or customer before or at the time you: (i) open a new account that is different from the retail investor’s existing account(s); (ii) recommend that the retail investor roll over assets from a retirement account into a new or existing account or investment; or (iii) recommend or provide a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account,…
In the case of a rollover recommendation, a participant must be given the Form CRS even if it has been provided previously, e.g., if the advisor has another account with the participant outside of the plan. The CRS delivery requirement also applies if the advisor is, e.g., providing advisory services to the participant’s account in the plan.
Broker-dealers and investment advisers are now on notice that the SEC Examination Division is focusing on advice provided to “older investors and those saving for retirement.” There is significant overlap with the ERISA and Code rules for fiduciary advice to participants and IRA owners— “retirement investors.” Both the SEC and the DOL require that investment advice be prudent and in the best interest of the retirement investor. Conflicts of interest must be disclosed, and the conflicts should be mitigated. The disclosures should provide enough detail such that a retirement investor can reasonably understand the conflicts and consider their magnitude in order to provide informed consent.
I think these Priorities could be a warning of change in attitudes. I think that the SEC Examination Division is signaling that there are higher expectations than in the past. Now is a good time for advisors to review their disclosures, management of conflicts, and processes for advising retirement investors.
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