Category Archives: Form ADV

DOL Proposes 60-Day Delay of Fiduciary Rule

The DOL has proposed an initial 15-day public comment period on the issue of whether to delay the April 10 implementation date of the DOL fiduciary rule, which, if ever effective, would subject large amounts of IRA rollover advice, and other retirement advice, to a fiduciary standard. After the 15 days, the DOL has proposed another 45 days during which the DOL is to analyze the economic impact of the Rule on investors and the marketplace.

Specifically, in his February 3, 2017 memorandum, President Trump directed the the DOL “to examine the Fiduciary Duty Rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.” Accordingly, it is likely that the Rule, as is or amended, will not become effective for some time. Meanwhile, many broker dealers, registered investment advisers, and the representatives they employ have already spent thousands of hours in training and millions of dollars preparing to comply with the Rule.

Stay tuned.

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Trump Administration May Suspend DOL Fiduciary Rule

The DOL Fiduciary Rule, effective April 2017, is among the items that the new administration may put on hold upon taking office in January 2017. Once effective, the Rule makes all financial advisers providing rollover and other advice to retirement investors “fiduciaries” required to put retail customers’ interests before the advisers’ interests in getting compensated. Broker-dealers, investment advisers, and mutual fund complexes have already sunk millions of dollars into upgrading and changing their compliance and business models in anticipation of the Rule.

At the center of the Rule is the so-called “Best Interest Contract” Exemption or BIC. It permits fiduciaries to enter into prohibited transactions (e.g., accepting commissions in connection with providing rollover and other investment advice) if the financial firm and professional enter into a BIC with the customer, provide certain disclosures, adhere to Impartial Standards of Conduct, charge only “reasonable” compensation, and acknowledge fiduciary status.

Due to its complexity and related compliance costs, some firms have announced that they will not be opening new commissions-based retirement accounts. Others have said that they will continue to open such accounts but will make continuous efforts to review accounts for the appropriateness of commission-based versus fee-based compensation based on a number of factors (e.g., the amount of trading in the account).

The new administration may ask the SEC to step in and issue a unifying rule covering investment advice to retirement accounts. Currently, the SEC’s regime for registered investment advisers under the 1940 Investment Advisers Act provides that investment advisers (who typically charge a percentage of assets under management) are fiduciaries. Such advisers may enter into conflicted transactions if adequate disclosures are made to the customers and if not otherwise prohibited by law.

By contrast, SEC Rules do not impose a fiduciary duty on brokers who provide rollover and other advice to retirement accounts in return for a commission. Brokers charging a commission for transactions are not considered fiduciaries and are instead held to the lesser “suitability” standard.

Regardless of whether the DOL Rule survives, the kinds of changes and industry introspection that have occurred are probably not a complete waste of time and money. FINRA and the SEC are already monitoring investment advisers and broker-dealers for conflicted transactions and policies with respect to compensation. For example, FINRA tends to take a very broad view of whether an investment recommendation, including a rollover recommendation, is “suitable”. Further, the plaintiffs’ litigation bar has long been asserting claims for breach of fiduciary duty in FINRA arbitrations even in the technical absence of such a duty.

Bottom line: regardless of the durability of the DOL Rule, advisers and their firms should continue evaluating their business practices to conform to a “best interests” standard.

For further discussion, here is a recent article from The Hill:

http://thehill.com/policy/finance/305287-financial-adviser-rule-could-be-in-trumps-crosshairs

 

 

 

 

 

 

SEC Laser-Focused on Conflicts Disclosures by Advisors and Broker-Dealers

In two recent cases, the SEC ordered JP Morgan Chase to pay over $270 million for what it deemed inadequate disclosures about certain conflicts of interest. When closely examined, these two cases illustrate just how detailed and granular the Commission can be when evaluating and prosecuting conflicts non-disclosure issues.

The Proprietary Funds Case

On December 18, 2015, the SEC announced that two J.P. Morgan wealth management subsidiaries had admitted wrongdoing (though no intentional violations) relating to the firm’s investment advisory business and agreed to pay $267 million.[1] Specifically, J.P. Morgan Securities LLC (JPMS) and JPMorgan Chase Bank, N.A. (JPMCB), preferred to invest clients in the firm’s proprietary mutual funds without properly disclosing this preference to clients. In addition, JPMS breached its fiduciary duty to certain wealthy clients when it did not inform them that they were being invested in a more expensive class of J.P. Morgan mutual funds shares than other available classes, or that JPMS preferred third-party-managed hedge funds that made certain “retrocession” payments to a J.P. Morgan affiliate.

The level of scrutiny applied in this case is striking. The SEC was initially focused on a possible charge that JPMS was improperly steering clients to house products so that it and its affiliates could make additional fees. JPMS’s Form ADVs, however, disclosed that JPMS “may have a conflict of interest in including affiliated [Mutual] Funds…because [JPMS] and/or its affiliates will receive additional compensation.” Further, in advance of opening an account, JPMS clients were specifically informed how much of their assets were to be allocated between proprietary mutual funds and third-party funds. Because of such disclosures, the SEC pivoted to the theory that there should have been an additional disclosure that JPMS “preferred” to invest client assets in proprietary products.

Holding the bank to this level of scrutiny seems severe; as noted, JPMS disclosed its incentive to put client money into house funds and these were discretionary accounts. Its “preference” for house funds seems axiomatic. All things considered, however, the penalty could have been far worse. Perhaps because of its cooperation and proactive remedial measures, J.P. Morgan was permitted to continue to provide these kinds of investment advisory services and was able to avoid the so-called automatic “bad actor” disqualification, which would have blocked it from the lucrative business of raising money for private companies, including hedge funds and startups. In addition, while the penalties and disgorgement are certainly significant, they amount to roughly one month of JPMS’s operating profits.

The Broker Compensation Case

In the second settlement, JPMS agreed to pay $4 million to resolve charges that it falsely stated on its private banking website and in marketing materials that individual advisors were compensated based on the performance of client investments, not on commission.[2] As it turned out, advisor compensation was not tied to investment performance; it consisted of a salary plus a bonus determined by a number of factors, none of which were performance based. Although it appears that no investor was harmed, the SEC believed that sanctions were warranted: “JPMS misled customers into believing their brokers had skin in the game and were being compensated based upon the success of customer portfolios.”[3]

Bottom Line

Based upon recent developments, it is clear that the SEC intends to look under every rock to see if all conflicts of interest, regardless of their severity, have been disclosed. Accordingly, firms should take a close look at their business practices and make sure their Form ADVs, websites, marketing materials and other disclosure documents accurately reflect those business practices.

[1] http://www.sec.gov/litigation/admin/2015/33-9992.pdf. The $267 million consisted of penalties, disgorgement and interest.

[2] https://www.sec.gov/litigation/admin/2016/33-10001.pdf. JPMS neither admitted nor denied any wrongdoing.

[3] https://www.sec.gov/news/pressrelease/2016-1.html.