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.
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
The SEC has just ended its comment period for a proposed rule requiring disclosure and reporting of recruitment deals. While several wirehouse and large independent broker-dealers have mixed views on the potential regulation — and suggest major changes — a group of about 150 independent advisors has given the proposal, referred to as Rule 2243, a big thumbs-down.
A key objection of the advisors is that the rule would “stifle competition and threaten succession planning,” according to a letter that was sent separately by 150 advisors and entities to the SEC before Friday.
“If this rule is enacted as proposed, it will have a chilling effect on financial advisors moving to new broker-dealer firms,” they said. “This requirement will cause financial advisors to remain at a firm so as to avoid professional embarrassment and an invasion of privacy, even if leaving would serve their clients’ interests.”
The SEC has until mid-May to act on FINRA’s proposal, though it can chose to extend this period to the end of June or later. The SEC must approve Rule 2243, reject it or hold proceedings regarding the rule’s potential rejection.
As the independent advisors stated in their letter, Rule 2243 would “have the unintended consequence of threatening advisors’ succession planning in instances where a firm provides transition assistance to an advisor taking over the clients of a retiring colleague. This will have a severely negative impact on clients who have advisors nearing retirement.”
The advisors sending the common letter to the SEC, like many broker-dealers writing to the regulatory group, generally support moves to protect investors, such as requiring disclosure of material conflicts of interest.
However, they say, FINRA’s proposed rule could easily “create problems that will outweigh its benefits and will give investors the mistaken assumption that a material conflict of interest exists in every situation where an advisor accepts recruitment compensation.”
As several broker-dealers noted in their own separate letters to the SEC, many of which were received on Thursday, the requirement that upfront or future payments of more than $100,000 be disclosed, fails to consider the common industry practice of reimbursing advisors for the transition costs of moving from one broker-dealer to another.
“While I may receive a payout for switching firms, the money does not go into my pocket as income, but rather goes toward supporting my business and my clients,” the advisors noted. “While the proposed rule language would allow advisors to subtract direct costs from the calculation of compensation, the language must be clearer with respect to lost revenue and the indirect costs incurred by advisors during a transition.”
Another complaint of the independent reps concerns privacy. Many reps live in the same community as their clients. Thus, they say, FINRA’s recruitment-compensation disclosure rule “would force me to disclose part of my income to them, putting me and my clients into a personally and professionally uncomfortable and unnecessary position.”
Rather than sharing the compensation details with clients, the advisors would prefer to give this information to regulators instead. “This way FINRA could examine potential conflicts of interest and enhance investor protection without causing me potential professional and personal embarrassment,” they explained.
Overall, the reps argue that Rule 2243 is “overly broad” and “will have a negative impact on clients without providing them with enhanced investor protections.” They ask FINRA — and by extension the SEC — to reject it.
The wirehouse broker-dealers such as Morgan Stanley (MS), Wells Fargo (WFC) and UBS (UBS), as well as some IBDs like LPL Financial (LPLA), generally support Rule 2243 but ask FINRA to carefully rework some to its details. LPL Financial, for instance, points out that the proposed rule does not specifically address advisors who are dually registered.
Other IBDs, however, ask for Rule 2243 to be completely dropped.
“Even if a customer would consider the [registered rep’s] recruitment compensation material information, it is entirely far-fetched that a customer would care how the compensation is calculated,” wrote Andrew Daniels, managing principal of business development for Commonwealth Financial Network“Moreover, the proposed requirement to disclose the basis for the upfront or future payments will only lead to investor confusion,” Daniels explained.
The ranges for financial disclosure outlined by FINRA, he adds are “very broad and could give customers the mistaken impression that [reps] who received $100,000 may have received as much as $500,000.”
The Commonwealth Financial executive reminds the SEC that FINRA Rules 2111 and 3010 already address the issue of how to best regulate and supervise reps to deter the “churning” of customer accounts and the use of unsuitable investment recommendations in order to hit certain commission targets.
A different tactic toward the issue is shared by Lincoln Financial Network, which suggests a pilot program for the disclosure of recruitment deals.
In its letter, the IBD’s chief counsel — Carrie Chelko — points out that there have been no investor alerts issued by FINRA “to prompt investors to have a dialogue about their recruitment compensation.” Plus, there are have been few —“if any” — enforcement actions related to “the very conduct that FINRA believes needs to be regulated.”
The IBD does not question FINRA’s aim to give investors full details of why advisors switch firms and to reduce conflicts of interest, but Lincoln Financial does argue that there has been no “demonstration of customer harm or an industry-wide misconduct that would substantiate the need for rulemaking.”
Instead, it recommends “that FINRA conduct a pilot program with the wirehouses, who have uniformly supported proposed Rule 2243, and those smaller firms and independent broker-dealers who have argued that Rule 2243 will ‘level the playing field.’ ”