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Regulation and Compliance > State Regulation

5 New Compliance Headaches for Advisors, BDs

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Pressures on compliance professionals at advisory firms and broker-dealers continue to mount as the Securities and Exchange Commission, the Obama administration, the Financial Industry Regulatory Authority and the Department of Labor are gearing up to usher in new requirements.

While compliance is increasingly becoming a core function at advisory firms and broker-dealers, with firms hiring more personnel to help in this area, a recent Cipperman Compliance survey found that firms still aren’t devoting enough manpower or funds to their compliance programs.

A recent poll conducted by the Investment Adviser Association found that firms continue to try and keep up with ongoing compliance challenges such as cybersecurity, custody of client assets, advertising/marketing, fraud prevention and compliance with the Foreign Account Tax Compliance Act — but new compliance challenges are lurking around the corner.

Regulators treat the industry as if “we are moonshiners,” said BD recruiter Jon Henschen, in response to recent news that FINRA was scrutinizing brokers’ pay practices for conflicts of interest. “They allow us to continue to operate as long as we pay their extortion money, i.e. FINRA fines. Between compliance rules and company policies becoming so complex and convoluted, many times advisors have difficulty discerning if they are doing something wrong.”

Read on to see five new chores that will only add to firms’ compliance checklist.

Succession Planning 

1. Mandatory Succession Planning

The SEC’s Division of Investment Management is developing mandatory succession plan rules for RIAs.

The rules, which could come out by year-end, would require investment advisors to plan for market stress and other events that may prevent an advisor from serving its clients – including addressing the risks of losing key personnel, according to Karen Barr, president and CEO of the Investment Adviser Association.

The rules, Barr says, are part of SEC Chairwoman Mary Jo White’s five-part initiative to enhance the SEC’s monitoring of the industry. “Advisors typically already have business continuity plans, but we anticipate that this proposal will go beyond those plans and specify other areas that must be addressed.”

The North American Securities Administrators Association recently adopted its own model rule for business and succession plans, which, while not mandatory, provides a roadmap for those states that choose to regulate succession planning for advisors.

NASAA’s model rule became effective on April 13, and can now be adopted by individual states well as the Canadian provinces, Mexico, the District of Columbia and Puerto Rico. The effective date will depend on the adopting state or region.

Changes to Form ADV

Form ADV Changes

The SEC wants advisors to not only provide more information about their use of derivatives in separately managed accounts, but also about their branch office operations and their use of social media.

Tom Giachetti, chairman of Stark & Stark’s Securities Practice Group, says that while Form ADV currently requires an advisory firm to identify its website, the proposed amendment would require an advisor to include any social media platforms it uses.

Requiring more info about firms’ social media will make it easier for SEC examiners to “locate and scrutinize online RIA advertisements,” Giachetti says, while also potentially having a “profound effect upon advisory firms whose representatives are using social media to advertise on behalf of the RIA without properly notifying management.”

The IAA urged the SEC in its recent comment letter on the rule, which was proposed in late May, to not only amend confusing questions about custody, but to also focus a “particularly keen eye” on the disproportionate costs that would be imposed on smaller advisors if the agency moves ahead with its plan to require firms to provide more information about their use of derivatives in SMAs.

Treasury’s AML Rules for Advisors

Treasury’s AML Rules for Advisors

While the Treasury Department’s Financial Crimes Enforcement Network’s recently issued (and long-awaited) proposed rules apply to SEC-registered investment advisors, state-regulated advisors aren’t off the hook.

FinCEN also says that future rulemaking may affect other types of investment advisors, such as state-regulated or SEC-exempt advisors.

The proposal would require all RIAs to develop and implement a written anti-money laundering program, and as needed, report suspicious activity to FinCEN under the Bank Secrecy Act via Suspicious Activity Reports. The proposed rules would also require advisors to file Currency Transaction Reports and maintain various records relating to the transmittal of funds.

The law firm Dechert explained in a recent notice on the AML rules that FinCEN is proposing including RIAs in the definition of “financial institutions” under BSA regulations, which “would impose a number of specific filing and recordkeeping requirements” on those advisors. 

BSA regulations require financial institutions to file CTRs for transactions involving the transfer of more than $10,000 in currency by, through or to an investment advisor, Dechert says. “This would replace the current requirement that investment advisors file Form 8300s upon receipt of more than $10,000 in cash and negotiable instruments.” Also, the proposed rules would require advisors to observe “Recordkeeping and Travel Rules” and related requirements, Dechert explains, “which mandate that financial institutions create and retain records pertaining to transmittals of funds and that this information generally ‘travel’ with the funds to the next financial institution in the payment chain.”

BD Conflict of Interest Sweep

BD Conflict of Interest Sweep

While not a rule — yet — FINRA wants BDs to answer 19 questions in writing by Sept. 18 regarding conflicts of interest they have related to their compensation practices.

The scope of FINRA’s review is limited to a firm’s retail accounts, and will cover activity from August 2014 through July.

FINRA wants to know how compensation policies for registered reps and supervisors are reviewed and approved and what role the board has, for both individual packages and the firm as a whole. It also asks about how firms identify compensation-related conflicts of interest and the controls used to manage those conflicts (e.g., neutral grid, fee-capping, compensation penalties). It asks firms to describe how pay policies balance short-term incentives for brokers with clients’ long-term interests.

FINRA wants BDs to describe how products approved for sale are displayed or otherwise communicated to registered reps. For example, are products presented by product category (e.g., mutual fund or annuity)? Is an internal search feature available?

Jon Henschen, owner of the broker-dealer recruiting firm Henschen & Associates, says that advisors are “scrambling to find products that are not a conflict of interest with some reps leaving commissionable mutual funds and going to [unit investment trusts] as a way of annuitizing their business.”

Because “every area of our industry is getting drilled down on,” Henschen says, reps are “having a difficult time coming up with a product mix that will not be problematic. The transactional active stock trader model is quickly dying on the vine and rightly so, but many other commission-based models are becoming a playground for securities attorneys and FINRA audits.”

DOL Fiduciary Rule 

DOL Fiduciary Rule

 The Department of Labor’s rule to amend the definition of fiduciary under the Employee Retirement Income Security Act is being hailed as perhaps the biggest regulatory change to come down the pike in decades.

Five years in the making, the controversial rule has faced fierce lobbying by broker-dealer and insurance industry opponents.

While industry officials anticipate the final rule will come by May, the rule must first survive defunding attempts that are included in House and Senate appropriations bills.

The House Financial Services Capital Markets and Oversight and Investigations Subcommittees plan to hold a joint hearing Sept. 10 on DOL’s proposed rule, which will likely lead to a markup of Rep. Ann Wagner’s bill, H.R. 2374, the Retail Investor Protection Act, which requires the DOL to wait to repropose its rule until the Securities and Exchange Commission issues its own fiduciary rulemaking.

But even if it passes the House Financial Services Committee, Wagner’s bill has little chance of being taken up in the Senate.

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