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Expect Reg BI Enforcement Actions, DOL Rollover Crackdown in 2022

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What You Need to Know

  • We’ll see a significant increase in Reg BI enforcement in 2022, attorney Susan Schroeder says.
  • The SEC issued a wake-up call on Form CRS.
  • In its new fiduciary rule, the Labor Department will propose clarifications regarding rollovers, Phyllis Borzi said.

Get ready: The Securities and Exchange Commission will be active this year in levying enforcement actions related to Regulation Best Interest (and more on Form CRS), while the Labor Department will push for a fiduciary rule that tightens rollover and insurance product recommendations, industry experts say.

“I think we’ll see a significant increase in Reg BI enforcement during 2022,” said Susan Schroeder, former head of enforcement at the Financial Industry Regulatory Authority who is now vice chair of the securities department at the law firm WilmerHale.

“Last year was the first year we could expect any enforcement activity and while the SEC brought a number of matters concerning Form CRS, those cases were not based on complex fact patterns and did not require significant investigation.”

The SEC, Schroeder continued, “has now had time to examine firm practices, and I think we’ll see a focus on enforcing” Reg BI.

Amy Lynch, founder and president of FrontLine Compliance, agreed that “more enforcement actions regarding Reg BI and Form CRS are sure to be released in 2022 against firms that simply failed to comply at all.”

How big will the Reg BI enforcement fines be? “Because Reg BI is still relatively new, there is less precedent that will govern the SEC’s penalty decisions — and SEC leadership has already stated that it may not be constrained by past penalties to determine new fines,” Schroeder said.

Cases “that solely involve compliance failures (such as insufficient policies and procedures) may not be accompanied by outsized fines,” she continued.

But “because Reg BI is such a priority for the SEC, I think we can expect very significant fines in matters where the staff alleges customers were harmed.”

Recent SEC deficiency letters related to Reg BI exams, Schroeder said, have focused on whether and how firms and their registered reps “consider reasonably available alternative investments, which is a new requirement imposed by Reg BI.”

So expect enforcement activity “related to that requirement, especially in cases where firms may be recommending higher-cost or complex securities to retail investors.”

Jim Lundy, partner in Faegre Drinker’s Chicago office and a former SEC attorney, expects to “start to see the first Reg BI enforcement actions” this year.

Exams taking place in late 2021 “were particularly focused and detailed,” he continued, and “it is reasonable to presume that the Division of Examinations has been looking for and will continue to look for good candidates to refer to the Division of Enforcement.”

Based on the enforcement division’s history, “the first enforcement actions will likely involve settlements and cases designed to send messages to the industry,” Lundy said.

Keep in mind, he noted, “that for violations of Reg BI that the Division of Enforcement need not establish scienter. That means that negligence-based violative conduct will be sufficient.”

Over the past five years or so, “the number of negligence-based cases (as opposed to scienter-based cases) has greatly increased. That is a trend that we should expect to continue” under SEC Chairman Gary Gensler.

Preparing for Heightened Reg BI Oversight

Schroeder recommends that firms focus on policies and procedures, “especially procedures to identify and mitigate conflicts of interest. The SEC can charge firms with Reg BI violations if their policies and procedures are insufficient, even if it has not identified specific problematic transactions.”

SEC leadership, she added, has also “talked about its focus on firm’s compliance systems; I think we can expect to see early cases focused on inadequacies in policies and procedures. And conflict-of-interest policies and procedures have been the focus on recent deficiency letters in Reg BI exams.”

Form CRS ‘Wake-Up Call’

The SEC’s Dec. 17 statement on Form CRS compliance “served as a wake-up call to advisors,” Lynch said, as it “let the industry know where the SEC sees firms running afoul of the requirements.”

The SEC, according to the statement, “saw a lot of poorly written Forms” while conducting targeted exams in 2021.

“Firms should use this time (as in Q1 of this year) to review and update their Form CRS so it meets all the requirements as described” in the SEC statement and instructions to the form, Lynch said. “Updated filings are due by March 31, so now is the time.”

While Form CRS, often referred to as Form ADV, Part 3, is not required to be updated annually, the form’s “update status is dependent upon material changes to its disclosures.”

Since firms are now also completing updates to Form ADV for Q1 “and customer statements also go out at end of Q1, now would be a good time to assess Form CRS disclosures and update if changes needed,” Lynch advised. “The new Form CRS could be delivered to customers along with the Q1 statements.”

Schroeder added that according to the SEC’s guidance, “attempts to streamline/tailor the Form CRS requirements to a firm’s business model will not be met with approval.”

While it is a “very real challenge to include all the information that Form CRS requires in an easy-to-read, concise format,” Schroeder said, “the SEC has signaled that it will not tolerate omitting information, modifying prescribed language, changing the order or format of the disclosures, or referring to more detailed disclosures outside the document.”

DOL Fiduciary Rule

President Joe Biden on Jan. 4 renominated ERISA attorney Lisa Gomez to head the Labor Department’s Employee Benefits Security Administration, the agency overseeing retirement plan rules.

If confirmed by the full Senate, Gomez will be the point person on helping Labor shepherd a new fiduciary rule.

Phyllis Borzi, former head of EBSA, told me in a recent email message that she believes EBSA “is pretty far along in its thinking about (if not drafting) the structure” of the new fiduciary rule.

Fred Reish of Faegre Drinker said that ”the release of a new proposed fiduciary definition and related prohibited transaction exemptions is imminent, perhaps within 60 days.”

However, “that could only refer to submitting those proposals to the White House” for review by the Office of Management and Budget, which could take another 60 to 90 days.

What Will the New Fiduciary Rule Say?

Borzi said she expects Labor to propose amendments “to the basic fiduciary definition to correct the obvious defects/loopholes in the five-part test [on who’s a fiduciary] that have clearly emerged since the initial reg was issued in 1975.”

Labor will also likely propose clarifications “in the rollover context, limited by the legal constraints they face based on the odd statutory structure where DOL has interpretive and administrative jurisdiction over the fiduciary definition and interpretations regarding IRA rollovers, but [the Department of the] Treasury has the enforcement authority through imposition of the excise tax” for prohibited transaction exemptions, or PTEs.

“Undoubtedly,” Borzi said, “we will see proposed tightening via the imposition of new limits and conditions on some existing PTEs,” such as PTE 84-24, which applies to insurance sales (life insurance and variable, fixed indexed and fixed rate annuities) and to receipt of commissions.

Labor has also indicated that it intends to revisit the conditions of PTE 2020-02, dubbed “Improving Investment Advice for Worker & Retirees,” Borzi said. That exemption, intended to align with the SEC’s Regulation Best Interest, was allowed to take effect by the Biden administration last February.

Labor may also “even propose an additional PTE,” Borzi said.

Level the Playing Field

EBSA, as a general matter, Borzi said, “is concerned about the unlevel playing field between conflicted recommendations regarding insurance products and securities.

“As flawed as many of us believe Reg BI is, at least it imposes some limits on conflicted advice when investments in securities are recommended,” Borzi said.

In marked contrast, she continued, the National Association of Insurance Commissioners’ “model law (which is only applicable when and to the extent each state adopts it and with no apparent enforcement mechanism) makes it quite clear that it is merely a codification of the pretty useless [FINRA] suitability standard.”

How will Labor “propose to impose greater accountability for conflicted recommendations of insurance products than is currently the case?” Borzi wondered.

“I wouldn’t be surprised if the proposed expansion of PTE 2020-02 includes bringing some or all insurance products within its purview, but at the very least, I expect they will impose adding the impartial conduct standards to PTE 84-24 and some of the other older PTEs,” she said.

With respect to Reg BI, “I believe that the staff of the two agencies has been continuing to talk about how to better coordinate the two standards so that key terms in Reg BI are more clearly defined and are more consistent,” she said. “That doesn’t mean that either agency would defer to the other, but rather the regulatory structures would be more complementary and consistent than may currently be the case.”


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