Compliance guidelines concerning money laundering and 1035 exchanges are taking center stage these days, and advisors should make sure they’re brushing up on the steps needed to protect themselves and their practices from potential wrongdoing.
The Patriot Act of 2001, which was passed in the aftermath of the attacks on the World Trade Center and the Pentagon, requires financial institutions–including securities firms and financial advisors–to come up with an anti-money-laundering program by April 24.
The Treasury Department, which is charged with devising formal regulations by April 24, has already stated it will miss that deadline; the official deadline now for a final regulation is July 1. This gives broker/dealers and advisors some lag time in setting up their own policies; however, it’s probably best to err on the side of caution and start the ball rolling now.
The Securities Industry Association came out in February with its “Preliminary Guidance For Deterring Money Laundering Activity,” which is designed to help broker/dealers and advisors comply with the Patriot Act provisions. The guidelines can be downloaded for free at www.sia.com. At a minimum, the Patriot Act requires securities firms to develop internal policies and controls to detect money laundering activity, including designating a compliance officer, implementing an ongoing employee training program, and maintaining identification records for future audits.
Fred Fram, VP of compliance and chief compliance officer at National Planning Corporation, says for advisors that have a broker/dealer relationship, the anti-money-laundering guidelines “will clearly change how they do business.” While specific requirements are sketchy at best since formal rules haven’t been established yet, there are a couple of issues that merit advisors’ attention, Fram says. First is the requirement to file suspicious activity reports (SARs), not just for suspicious transactions, but for attempted suspicious transactions, he says. “If somebody walks into an advisor’s office and says, ‘I have $10,000 in cash, can you help me invest this?’ does that then become suspicious activity that needs to be reported? We don’t know yet,” he says. “But the requirement to report an attempted transaction is going to be challenging.”
Advisors are also going to face increased pressures to verify the identity of their clients. “We don’t yet know what that means,” Fram says. “Does that mean I have to look at your driver’s license before I can do business with you? Do I have to photocopy your driver’s license? Or do I have to require more than just your driver’s license, more like a citizenship [certificate], passport, or birth certificate?”
While the Securities and Exchange Commission has historically been instrumental in developing money-laundering rules, it’s up to the Treasury Department to set up a regulation that complies with the Patriot Act. Fram thinks this is a bit worrisome. “The Treasury Department is not as familiar with the brokerage industry as some of the other regulatory bodies, and we need to be prepared that this may be difficult, especially in the early stages” of the rule’s development, he says.
A compliance issue that’s receiving renewed scrutiny by the SEC and NASD of late is 1035 exchanges. The increasing popularity of bonus annuities over the last couple of years has sparked a proliferation of 1035 exchanges, and the SEC and NASD have been slapping securities companies, broker/dealers, and insurance companies with disciplinary actions because these exchanges often benefit brokers more than they do the contract holders.
With bonus annuities, the insurer adds an up-front bonus, usually ranging from 1% to 5% of the existing value of the contract. Brokers who handle these transactions usually receive hefty commissions, while contract holders end up forking over more dollars because bonus annuities often have higher surrender and asset-based charges and longer surrender charge periods.
Mike DeGeorge, a spokesman for the National Association for Variable Annuities, says that while there are abuses in 1035 exchanges, there are legitimate reasons for these exchanges as well. “NAVA, the NASD, and the SEC recognize that an exchange can be appropriate if someone has an older contract that doesn’t offer the features and guarantees available today,” he says. “Or perhaps the investment choices are limited in the older contract. Today, with the newer contracts, the average number of funds to choose from is 30 to 35.”
Fram says advisors should adopt clear policies to ensure everything goes smoothly. Besides sticking with suitable recommendations, he says, advisors should “get documentation that disclosure was made to the client of all of the relevant issues regarding the switch.” That means the advisor should not only go over the relevant issues orally, but he should secure written approval from the client as well. “It’s good to tell the client that there will be a surrender charge, to tell them what the maximum surrender charge would be, and how long the surrender charge period runs,” he says. “Tell them there are fees and expenses; it’s better to tell them specifically that there are mortality and expense charges, and fund management expenses.” In short, give the client as many details as possible, he suggests.
Advisors should also ensure “that when they sell an annuity, the subaccounts that are selected are appropriate and that they can document why they are appropriate,” Fram says.–Melanie Waddell
Reaction to Enron has been swift, but action on Capitol Hill has been glacial
Although we’ve all heard the stories of the Enron employees done out of their retirement money, and many non-Enron employees are wondering how secure their own nest eggs are, there has been little change on Capitol Hill to protect benefits.
Various proposals limiting the amount of company stock allowed in 401(k) plans to 20%, 10%, or some other mandatory proportion are wending their tortuous way through the halls of Washington, yet support for such measures seems to have waned. In fact, according to Mark Niziak, VP and senior counsel at New York Life Benefit Services LLC in Norwood, Massachusetts, the bill co-sponsored by Senators Barbara Boxer (D-CA) and Jon Corzine (D-NJ) no longer sports the stock-limiting provision. A bill sponsored by Senator Ted Kennedy (D-MA) is considered a compromise, according to Niziak; an employer can offer a match in the form of stock or as an investment option, but not both for deferral of income unless a substantial pension plan is also offered. Niziak points out that overly stringent restrictions on the use of company stock, such as mandatory caps, could be “a disincentive for an employer to continue a match.” Instead, he sees a rule requiring diversification as more likely to become law.
Two studies have offered contradictory views of employee opinions on owning company stock within their 401(k) plans. The first, from TowersGroup, a New York public relations firm, is based on the responses of 363 investors with retirement plans who had also invested outside their plans during the last two years. The poll found 70% of respondents were “comfortable with the amount of company stock” they own in their 401(k) plans; in fact, 9% “would prefer to own more company stock.” Company President Alan Towers is quick to note that not all respondents could answer these questions, however, since only 171 participated in plans allowing company stock ownership.