More On Legal & Compliancefrom The Advisor's Professional Library
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
- Differences Between State and SEC Regulation of Investment Advisors States may impose licensing or registration requirements on IARs doing business in their jurisdiction, even if the IAR works for an SEC-registered firm. States may investigate and prosecute fraud by any IAR in their jurisdiction, even if the individual works for an SEC-registered firm.
Broker/dealers and RIAs alike should ready themselves for a number of initiatives being worked on by their regulators in the New Year. (See following page for a list of key lawmakers and some of the issues likely to be taken up by the new Democratically controlled Congress.) First, the merger of the regulatory arms of the NYSE and NASD will
hopefully be completed by the second quarter of this year, Robert Errico, executive VP at NASD, told a group of lawyers at ALI-ABA's broker/dealer regulation event in Washington January 11. Errico said the new SRO will yield a "synergy that should have happened a long time ago," and that the voting for changes in the bylaws has yet to be completed (the proxies likely will have been counted by the time you read this).
SEC Commissioner Annette Nazareth commented in a speech at the same event that the new SRO would be "responsible for member compliance for virtually all broker/dealer firms," adding that the SRO will also have "enforcement and mediation functions, as well as rulewriting, professional training, and licensing areas." Some NASD-only firms have expressed worries that NYSE-style regs will be imposed on them. However, Errico pledged that the combined SRO would be "issuing rules that take into consideration all firms." The NYSE would continue to oversee the NYSE market through its own market surveillance, enforcement, and listed company compliance groups, Nazareth said. "Thus, member regulation would be separated from the NYSE market under this [SRO] proposal."
Nazareth said the NASD/NYSE Regulation combination could "more effectively manage conflicts of interest" that are inherent in an SRO model, and an "NASD/NYSE Regulation combination potentially could achieve greater efficiencies and cost effectiveness than the current model." This consolidation, she argued, "should eliminate costly overlapping regulation and establish uniform rule sets within a single regulatory organization. Further, a single rule set and enforcement of such rules should reduce complexity and eliminate potential conflicts arising from multiple SROs."
Meanwhile, at the SEC . . .
What about the other regulator that oversees B/Ds and RIAs? Lourdes Gonzalez, assistant chief counsel in the SEC's Division of Market Regulation, told attendees at the ALI-ABA event that the regulator's study of broker and advisor regulation is underway, and that while a deadline for completing the study has never been formally stated, the SEC expects it to take about 18 months. The release announcing the study came out last September, so any results won't likely be seen until 2008.
Andre Owens, a lawyer with Wilmer Cutler Pickering Hale and Dorr in Washington, who sat on a panel with Gonzalez, said that he still devotes a lot of time to trying to help clients define what financial planning means under the SEC's broker/dealer exemption rule, also known as the Merrill rule. Hardy Calcott, a lawyer with Bingham McCutchen in San Francisco who moderated that same panel, commented that the "intersection between B/D and advisor regulation has gotten more difficult to navigate."
Owens asked Gonzalez if the SEC planned to issue further guidance defining what constitutes financial planning. She responded that the industry must first ask the SEC for clarification. "We have to get the questions before we can provide interpretive guidance," Gonzalez said.
Karen Barr, the Investment Adviser Association's general counsel, said another area of note for advisors is the CFP Board's controversial proposed revisions to its code of ethics, which many in the industry opposed because they said it watered down the definition of fiduciary. The CFP Board of Directors was to have met January 17-19, at which time the task force that was named to review the many comments to the proposed ethics revisions were to present its recommendations.
B/D Exam Priorities
As far as the SEC's examination priorities for broker/dealers in 2007, Mary Ann Gadziala, associate director of the SEC's Office of Compliance Inspections and Examinations (OCIE), told attendees the SEC will zero in on seven areas: supervision, sales practices, risk management, financial issues, anti-money laundering, books and records, and trading practices.
When it comes to written supervisory procedures, Gadziala said one of the most consistent infractions is that B/Ds' practices are not consistent with their written policies. Branch office supervision is another issue of concern, she said, since the number of B/D branches has ballooned to 172,000.
A senior sweep is now underway of B/Ds in states with large retirement populations, like California, Florida, North Carolina, and Texas, Gadziala said. The SEC has noticed some firms are using "aggressive" marketing and advertising materials targeted to seniors when selling variable annuities and other products. Gadziala also warned that exam officials will be scrutinizing sales of 529 plans, fee-based accounts, breakpoints, hedge funds, and structured products.
Another area of scrutiny will be affiliate relationships. The SEC will focus on the "overall operations" of B/Ds' affiliates, Gadziala said. "Firms have become so diversified that lots of activity is going on," she said, noting that the comment period on Regulation R, which addresses whether an affiliate is properly registered, ends March 11.
On risk management, Gadziala said B/D firms should be keeping up with their business continuity planning. As for financial issues, the SEC has a proposal pending that would give B/Ds the ability to do portfolio margining, she said. Anti-money laundering, too, she said, continues to be a top priority. She said when outsourcing background checks, B/Ds should make sure the checks actually get done.