More On Legal & Compliancefrom The Advisor's Professional Library
- Where Are We Headed? The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.
- Pay-to-Play Rule Violating the pay-to-play rule can result in serious consequences, and RIAs should adopt robust policies and procedures to prevent and detect contributions made to influence the selection of the firm by a government entity.
In its annual list of hot exam items, the Financial Industry Regulatory Authority warned broker-dealers that it would be zeroing in on a host of areas this year, namely brokers’ recommendations on IRA rollovers, private placements, complex products as well as products sold to older investors.
Two of the most prominent exam priorities are IRA rollovers and FINRA’s intention to create a dedicated enforcement team under its High-Risk Broker initiative to prosecute brokers who have a pattern of sales practice abuses. FINRA barred 16 such recidivist brokers in 2013.
FINRA said that reviewing firms’ qualified plan rollover practices will be a priority in 2014, and that staff will examine firms’ marketing materials and supervision in this area. FINRA will also evaluate securities recommendations made in rollover scenarios to determine whether they comply with suitability standards under FINRA Rule 2111.
A recent Investment Company Institute study found that from 1996 to 2008, more than 90% of funds flowing into traditional IRAs came from retirement plan rollovers.
FINRA said that it shares the Government Accountability Office’s concerns that investors may be misled about the benefits of rolling over assets from a 401(k) plan to an IRA. In its Regulatory Notice 13–23, FINRA warned firms and associated persons not to make claims of “free IRAs” or “no-fee IRAs” where investors do pay costs associated with these accounts.
In Regulatory Notice 13–45, released in December, FINRA reminded firms of their responsibilities concerning IRA rollovers. FINRA said that it issued the notice to remind firms of their responsibilities when recommending a rollover or transfer of assets in an employer-sponsored retirement plan to an IRA, or when marketing IRAs and associated services.
IRAs and Conflicts of Interest
Dale Brown, president and CEO of the Financial Services Institute, said that FINRA’s increased focus on IRA rollovers “is tied to their interest in the industry’s management of conflicts of interest.” FINRA, he said, “is not prohibiting advisors from rollovers into an IRA that pays fees to the advisors, but rather reminding firms to be diligent in monitoring those situations and ensuring advisors inform investors of all their rollover options.”
Brown said FSI’s broker-dealer members are already aware that the conflicts associated with rollovers is an issue and have been monitoring it. FSI itself, he said, supports FINRA rules and guidance that “effectively increases investor protection without limiting access to financial advice.” Brown said FSI doesn’t think investors “should have to be regulatory experts to know that their advisor is working in their best interest.”
Susan Axelrod, FINRA’s executive VP of regulatory operations, said in a statement that the 2014 exam letter provides “insight to the industry on specific areas of concern for our regulatory programs in the coming year.” Axelrod encouraged firms to use the guidance “along with their own analysis” to enhance their compliance programs as FINRA “will be examining for strong controls and robust compliance efforts in these areas.”
Richard Ketchum, FINRA’s chairman and CEO, said that by providing detailed guidance to firms, “we hope to not only support firms’ compliance efforts but also to alert firms to the issues we have identified as the most salient risks to investors and the integrity of our markets.”
Structured Products, Private Placements
As for structured products, FINRA said that it will examine the suitability of recommendations to retail investors for complex products, including structured products with interest rate sensitivity, private REITs, frontier and emerging-market funds, mortgage-backed securities, long duration bond funds and municipal securities.
Private placements will also be on FINRA’s radar, with the self-regulator saying that it will not only be monitoring general solicitation and advertising of private placements under the recently adopted amendments to Rule 506 of Reg D, but it will also assess the due diligence suitability of private placements. FINRA will also focus on offerings of securities through private placements.
Crowdfunding portals will also be a focus. As part of the JOBS Act, which became law in 2012, retail investors would be able to purchase unregistered securities through crowdfunding websites. However, to maintain investor protections, the Act limits the amount they can invest over a 12-month period based on their income and net worth.
The SEC and FINRA proposed rules on Oct. 23, 2013, and comments are due by Feb. 3.
FINRA notes that the objective of its proposed rules is to ensure that the capital-raising objectives of the JOBS Act are advanced in a manner consistent with investor protection.
Pending adoption of the SEC’s proposed rules, no JOBS Act crowdfunding is lawful.
FINRA notes that as its rules become effective and funding portals become FINRA members, the self-regulator will implement a regulatory program designed to protect investors while recognizing the distinctions between funding portals and broker-dealers.
Municipal advisors will be another exam focus. In September 2013, the Securities and Exchange Commission (SEC) issued final rules regarding municipal advisors, including definitions of what constitutes municipal advisory activity requiring registration with the SEC. The SEC also designated FINRA as the examination and enforcement authority for municipal advisors that are regulated by FINRA. The final rules were to become effective Jan. 13, 2014. Accordingly, FINRA said, “municipal advisory activity will be an area of focus in sales practice examinations in 2014.”
In mid-January, the Municipal Securities Rulemaking Board issued a rule proposal, Rule G-42, which sets forth standards of conduct—including fiduciary requirements—and duties of municipal advisors when engaging in municipal advisory activities other than the undertaking of solicitations. Comments on the proposed rule are being taken until March 10.
On a call with reporters announcing the proposal, the MSRB’s executive director, Lynette Kelly, said that the proposed rule “strikes an appropriate balance and is workable for municipal advisors of all sizes.”
Given the fact that there are ongoing cybersecurity issues being reported across the financial services industry, FINRA said that it will also monitor this issue closely. The “frequency and sophistication of attacks” on many of the nation’s largest financial institutions appear to be increasing, FINRA said.
“In light of this ongoing threat, FINRA continues to be concerned about the integrity of firms’ infrastructure and the safety and security of sensitive customer data. Our primary focus is the integrity of firms’ policies, procedures and controls to protect sensitive customer data.” FINRA said its focus on controls may take the form of examinations and “targeted investigations.”