Conventional wisdom would hold that regulators with enforcement jurisdiction over retail and institutional investment markets would loosen their grip under a pro-business, Republican presidential administration.
But attorneys with Drinker, Biddle and Reath report that both the Labor Department and Securities and Exchange Commission are leveraging enforcement initiatives at a historic level of tenacity.
“Now that the fiduciary rule has been terminated, I think the focus at DOL is more on enforcement,” said Fred Reish, a partner at Drinker Biddle and chair of the firm’s Financial Services ERISA Team.
“There’s been a realization over the years that in the 401(k) world, service providers play critical roles in the operation of plans, unlike with defined benefit plans, where everything happened in-house,” added Reish.
One recent Labor investigation of a registered investment advisory firm that Reish defended focused on the RIA’s relationship with the custodian of the assets. The RIA in question actively managed a retirement plan’s assets, which were placed with the custodian without fees charged to plan participants. But the RIA and custodian had a revenue sharing agreement. Labor’s investigation found that to be a prohibited transaction under ERISA.
In other cases, Labor is investigating trust companies that are setting up collective investment trusts for sponsors. Reish said such investigations represent a new domain for Labor’s enforcement arm. “We are seeing a more focused investigation regiment,” said Reish.
“They start with ‘hello, we are the DOL, show us how you do ERISA,’ and from there take a very broad based approach,” said Brad Campbell, a partner in Drinker Biddle’s Washington D.C. office.
In a webinar, Campbell said he too is defending several plan service providers in DOL investigations.
“We would expect them to look into proper disclosures, but they are getting into more complex interpretations that reflects some of the experience they gained throughout the fiduciary rule process,” said Campbell.
Complicating matters is that the newfound experience with internal industry mechanics is grasped at varying levels among Labor’s exam and enforcement teams. ERISA’s complex provisions and exemptions “are not universally understood” among examiners, said Campbell.
“Just because DOL has asserted a breach doesn’t mean there was one,” he added.
In one investigation of a broker dealer, front-end sales loads were collected when they could have been waived for charitable organizations.
The SEC referred the case to Finra and Labor, meaning the broker dealer was subject to two investigations at once, something Reish thinks was inappropriate.
Labor was asked to defer to Finra, but they would not concede. “It’s the first time I’ve seen DOL take a position on share classes in an investigation of a broker dealer,” said Reish.
Hundreds of RIAs self-report under SEC’s disclosure initiative
Last February, the SEC launched the Share Class Selection Disclosure Initiative, which was intended to rein in potentially widespread violations of the Investment Advisors Act of 1940.
The program targeted advisors’ failure to disclose 12b-1 fees on mutual funds, and recommendations of higher cost share classes when lower cost shares of the same fund were available.
Firms that self reported by a June deadline will not be subject to civil penalties under the program, but will be responsible for returning ill-gotten gains from fees to investors.
An SEC spokesperson said the agency has not disclosed results from the initiative, but James Lundy, a partner at Drinker Biddle and head of the firm’s SEC and Regulatory Enforcement Team, suggested the number of self-reporting RIAs has been substantial.
“Hundreds of RIAs self-reported under this initiative,” Lundy said. “It will be a significant, impactful outcome for the entire industry.”
SEC enforcement staff are working with mutual fund experts to cull through the cases, and taking “aggressive and critical views” of how firms defend their capture of 12b-1 fees, said Lundy.
“It feels like an enforcement initiative, not self-reporting,” added Lundy, who is representing several firms under the program.
The initiative descends from SEC Chair Jay Clayton’s insistence on making protecting the retail investor a top priority of the agency. Lundy expects the comingling of more disclosure and enforcement initiatives in the future.
“Self-reporting initiatives are here to stay,” said Lundy. “The SEC believes in them, and thinks they can accomplish what they want, which is regulation by enforcement.”
The attorneys also noted that the SEC is scrutinizing language in advisory firms’ Form ADV filings in unprecedented ways.
References to conflicts of interest that “may” exist—a disclaimer common in ADV filings—are getting new attention from examiners.
That has been “incredibly frustrating” for industry, says Lundy.
“What were well accepted industry practices have essentially become outlawed by the enforcement division,” said Lundy.
The SEC’s more muscular focus on language in Form ADVs is sending a clear message to RIAs, thinks Lundy.
“You should be writing your ADV for the SEC,” he said, as opposed for the investor client. “You should be assuming they (SEC) are going to look at it closely, and the exact disclosures of conflicts of interest, specifically with revenue sharing.”