While the Department of Labor was busy putting the finishing touches on its rule to retool the definition of fiduciary under ERISA and sending it off to the Office of Management and Budget for review in late January, regulators for the BD and advisory industries unleashed their exam priorities for the new year.
Like DOL, the Financial Industry Regulatory Authority said that it would focus on reining in brokers’ conflicts, while the Securities and Exchange Commission said it would zero in on the retirement planning services that advisors and BDs offer their clients.
“We completely agree with DOL that those [BD] conflicts are real and they need to be addressed, and that firms have failed in managing their conflicts on too many occasions,” Richard Ketchum, FINRA’s chairman and CEO, told IA in an early January interview to discuss the release of the self-regulator’s 2016 regulatory and exam priorities.
Once at OMB, industry officials anticipate DOL’s fiduciary rule (also known as the conflicts of interest rule) could likely be put through an expedited review — not the typical 90-day OMB review — which means that the final rule could be out before April.
While Ketchum noted that FINRA “disagreed in details” with the DOL’s proposed fiduciary rule and “tried to provide constructive comments that identified potential changes, [FINRA] certainly agrees with the basic concern that firms have to be able to manage their conflicts that relate to compensation incentives,” he said. “That’s a huge focus of our program.”
Specifically, brokers’ conflicts as they relate to “both the provision of advice and the recommendation of products to customers,” as well as the differential commissions and incentives that their registered reps receive, “are a real concern,” said Ketchum, who could retire from FINRA as early as this summer (see sidebar, page 12).
He noted that potential problems can crop up in the sale of proprietary products as well as in the sale of “higher-commission products, whether that be in higher-cost mutual funds or the traditionally higher-cost products like direct REITs and private placements.”
Meanwhile, Back at the SEC …
The SEC’s Office of Compliance Inspections and Examinations also said in releasing its 2016 exam priorities that examiners will continue their multi-year initiative dubbed ReTIRE, launched last June, which focuses on SEC-registered investment advisors and broker-dealers and the services they offer investors with retirement accounts.
The ReTIRE exams focus on the “reasonable basis” for recommendations made to investors, conflicts of interest, supervision and compliance controls, and marketing and disclosure practices.
Fred Reish, head of the ERISA team at the law firm Drinker Biddle & Reath, added that the ReTIRE exams focus on “suitability, conflicts and disclosures for plan distributions and rollovers, as well as on management” of qualified default investment alternatives, or QDIAs.
BDs’ conflicts are “front and center for a lot of reasons,” Susan Axelrod, FINRA’s executive vice president of regulatory operations, agreed during the interview with IA. Since releasing its priorities list in 2013, conflicts of interest — particularly as they relate to the sale of products and compensation — have been a focus for FINRA.
She noted that FINRA expects to complete this year its targeted exams launched in late 2015 of brokers’ incentive structures and conflicts of interest in connection with firms’ retail brokerage business.
The review encompasses firms’ conflict mitigation processes regarding compensation plans for registered reps, firms’ approaches to mitigating conflicts of interest that arise through the sale of proprietary or affiliated products, or products for which a firm receives third-party payments (e.g., revenue sharing).
The SEC also said in releasing its priorities that examiners will focus this year on several new areas — liquidity controls, public pension advisors and product promotion as well as exchange-traded funds and variable annuities.
Amy Lynch, founder of FrontLine Compliance and a former SEC staff accountant, says the agency’s focus on ETFs, pension advisors and liquidity controls are to be expected given the recent market events in these areas as well as SEC staff’s “strong focus” on retirement issues.
“ETFs continue to gain popularity with the average retail investor as well as financial advisors working within the retail retirement space so it’s understandable the SEC would be taking a look at these products both from the sales side as well as the issuer,” Lynch said.
Pay-to-Play and Cyber
Pension advisors will also be under scrutiny from the “pay-to-play rule perspective,” Lynch said, since the SEC brought its first case against an advisor for pay-to-play violations last year. The SEC is “looking for more” violations in this area, she said.
Both FINRA and the Municipal Securities Rulemaking Board recently filed their proposed pay-to-play rules with the SEC, which starts the clock ticking on when advisors must start complying with the third-party solicitor provision of the SEC’s pay-to-play rule, added Karen Barr, president and CEO of the Investment Adviser Association.
Cybersecurity will also be a priority for both regulators this year.
OCIE also said that examiners would “advance” in 2016 the second round of cybersecurity exams launched by the agency last September by including testing and assessments of firms’ implementation of procedures and controls.
Ketchum said that while he didn’t see FINRA issuing a formal cybersecurity rule, the self-regulator does expect brokerage firms to continue their efforts to raise the cybersecurity compliance bar “just as the efforts of attacks have increased.”
Axelrod agreed during the interview that issuing formal rules is unlikely because the constantly evolving nature of cybersecurity would likely render such rules obsolete. “It’s much more important for us to continue to be engaged with firms on the [cyber] topic, understand their infrastructure and their cyber programs and continue to articulate best practices as they evolve.”
— Read “FINRA, SEC to Get New Execs in 2016” on ThinkAdvisor.