If you’re an investment advisor, one of the quickest ways to run afoul of the Securities and Exchange Commission (SEC) is to make statements in your Form ADV that you fail to execute. When this happens in connection with investment-advisory fees, the SEC will be especially unhappy with you. To motivate advisors to not play games with their fees, the SEC recently published a Risk Alert detailing the most frequent advisory fee and expense compliance issues they encounter.

Based on a review of 1,500 examinations and resulting deficiency letters over the last two years, the SEC’s Office of Compliance Inspections and Examinations identified the most common compliance issues that arise out of sloppy or deceptive advisor billing of consumer fees and expenses. They include:

  • Inflating the value of an account in order to generate higher fees. This results from practices such as using a different valuation metric than what was defined in the advisory agreement; calculating the account value at the end of a billing cycle rather than using the average daily balance; or including asset types such as cash equivalents, alternative investments, or variable annuities in the value calculation in violation of the agreement.
  • Manipulating the timing and frequency of fee billing in order to benefit the firm. For example, advisors may bill advisory fees on a monthly basis instead of the required quarterly basis or bill new clients in advance for an entire cycle rather than making a pro-rata adjustment.
  • Applying an incorrect fee rate. This tactic may include applying a higher rate to the calculated account value than is stated in the advisory agreement or Form ADV or charging a non-qualified client performance fees based on a share of capital gains in violation of the Advisors Act.
  • Omitting rebates and applying discounts incorrectly. Here, OCIE staff said advisors sometimes fail to aggregate account values as promised for multiple family members in the same household or never reduce the fee rate when the account value reaches an agreed-upon benchmark. They also may charge clients brokerage fees when they are in the advisor’s wrap fee program.
  • Making disclosures in their Form ADVs that conflicted with actual practices. For instance, advisors sometimes charge a fee rate higher than the maximum promised in their advisory agreements. Or they may bill for expenses unmentioned in their agreements (example: billing for third-party execution and clearing services that exceed actual fees charged by an outside clearing broker).
  • Misallocating expenses to clients rather than to advisors. This occurs in connection with distribution and marketing expenses, regulatory filing fees, and travel expenses that advisors charge to clients rather than properly allocating to themselves.

What should you do with this information? The OCIE provides three pieces of advice:

  • Assess one’s advisory fee and expense practices (and disclosures) to make sure they comply with the Advisor’s Act and related rules.
  • Based on this review, change or enhance your practices and procedures to assure compliance.
  • Reimburse clients for the overbilled amount of advisory fees and expenses.

This may not be what you want to hear, but it’s good advice. Full compliance with the law and if not, mitigation of any problems, including refunds paid to consumers, will always be the smartest strategy. Questions? Contact your compliance officer or attorney as soon as possible so you can avoid problems in case the SEC comes calling.


To read more on ethical business practices, visit the Ethics Center at the National Ethics Association, sponsor of EOforLess. 

FINRA Shows Regulatory Hand: Brokers, Pay Heed or Watch Out!

One of the benefits of working in financial services is that regulatory agencies are usually transparent about their concerns. They communicate well in advance when they’re about to crack down on something, giving agents, advisors, and brokers more than enough time to respond. FINRA is an excellent case in point.

In early January 2018, the securities self-regulatory organization released its annual Regulatory and Examination Priorities Letter, which tells member firms and registered representatives what it intends to focus on during the year. The letter, in effect, is a great resource for resolving compliance issues before FINRA gets involved.  It also helps firm executives prepare for their FINRA examinations.

The regulator’s 2018 letter was wide-ranging. FINRA announced it will focus its efforts on fraud, high-risk firms and brokers, and operational and financial risks, including technology governance, cybersecurity, and market regulations. Other priorities will include:

  • Sales practice risks, especially recommendations of complex products to unsophisticated, vulnerable investors;
  • Protection of customer assets and the accuracy of firm’s financial data; and
  • Market integrity, including best execution, manipulation across markets and products, and fixed-income data integrity.

In the body of the letter, FINRA provided further details on each regulatory concern. Several that bear a strong relationship to broker sales activities follow.

Fraud: FINRA announced that once again, fraud will be a high enforcement priority. These include activities such as insider trading, microcap pump-and-dump schemes, issuer fraud, and Ponzi-type schemes. Also, a focus will be continuing to identify cases of potential insider trading, which FINRA refers to the U.S. Securities and Exchange Commissions (SEC). Reining in scams targeting senior investors will receive a strong emphasis, as well.

High-Risk Firms and Brokers: FINRA will focus on protecting investors from firms and brokers that take advantage of their customers. Specifically, it will look at practices such as hiring, supervision of high-risk brokers, supervision of point-of-sale activities, and branch inspection programs. Also a focus will be sales of advanced securities products to unsophisticated investors.

Sales Practice Risks: This is an especially wide-ranging area. In 2018, FINRA says it will pay serious attention to suitability violations, especially to the business practices and processes that produce suitable sales. Suitability in the context of employer-sponsored retirement plans and IRA rollovers will be hot-button issues too, as will be sales of initial coin offerings, cryptocurrencies, the use of margin loans in the sales process, and proper use of securities-backed lines of credit.

Cybersecurity: 2018 will continue to see high FINRA involvement in protecting customer assets and information against hacking and other cyber-crimes. As in prior years, FINRA will continue to evaluate the effectiveness of firms’ cybersecurity protocols—specifically their preparedness, technical defenses, and resiliency measures.

To further help member firms and their brokers, FINRA released a Report on FINRA Examination Findings. Based on what it finds when it visits firms at least once every four years, this document can also be a helpful resource in assuring firm compliance with FINRA rules in 2018 and beyond.

For further information about FINRA’s 2018 priorities, please visit its website here.

Continue to keep up to date with ethical practices by reading the latest news on  National Ethics AssociationFor information on affordable E&O insurance for low-risk insurance agents, investment advisors, and real estate broker/owners, please visit EOforLess.com.

Advisor Alert: Sell in New York? A Best-Interest Standard is Coming for You

The state of New York is bucking the federal anti-fiduciary trend by introducing a best-interest standard for life insurance and annuities. The proposal, which was announced on December 27, 2017, would require agents to serve a customer’s best interests first, not their own financial interests.

The measure, from the New York Department of Financial Services, aligns with the now delayed full implementation of the DOL Fiduciary Rule, which has encountered headwinds from the Trump Administration. The latter regulation has been delayed until 2019.

“Consumers who purchase life insurance and annuity products deserve to have financial services providers act in their best interest when providing advice,” says NY Financial Services Superintendent Maria Vullo. “Given the key role insurance products play in providing financial security to middle-class New Yorkers, it is essential that a provider adhere to a higher standard of care and only recommend insurance and annuity products that are in the consumer’s best interests.

The department said that the proposed amendments to its current suitability regulation will mandate a best-interest standard for all life products, not just annuities, and to products sold in any context, not just under ERISA. It would also apply to the provision of advice at any point in the customer/agent relationship.

The proposed rule is now open for 60 days of public review and comment.

According to the law firm Carlton Fields, the amendment to the existing Suitability in Annuity Transactions (11 NYCRR 224) would usher in sweeping changes to how New York licensed life/health agents sell their wares. Key points in their analysis follow:

  • The amendment broadens the existing law by applying a best-interest standard to life insurance policies, as well as to in-force policies, not just proposed offerings. In other worlds, all customer communications must take the person’s best interests into account. This pertains to any advice or act “intended to result in a consumer entering into or refraining from entering into a transaction.”
  • It also broadens suitability analysis in two ways. First, it applies it to “all available products, services, and transactions,” as well as to specific issues such as duration of liabilities and obligations and to tolerance of non-guaranteed contractual elements.
  • It applies a prudent person standard of care to all transactions.
  • It expands required consumer disclosures, including potential client consequences, tax implications, and compensation methods pertaining to the action, among several other new disclosure mandates.
  • It prohibits agents from saying or implying that a transaction is part of a financial or investment management service without having proper expertise.
  • It expands applicability of the new rule to all agents involved in the matter, not just to those with direct customer contact.
  • It requires that agents and agencies establish and maintain procedures to prevent financial exploitation and abuse.
  • It allows all compensation amounts and types that are currently permitted under New York insurance statutes.

Perhaps the most significant change is scope expansion, says law firm Carlton Fields. For example, the new Life & Annuity Suitability Rule would not only apply to advice given at the point of initial sale or annuity but also to subsequent recommendations. For example, it would apply to discussions about whether to increase a life insurance policy’s face amount or to receive early death benefits. In terms of annuities, the new regulation would apply to any discussions about electing a step-up to a benefit base for an income benefit or greater death benefits or even to deciding to pay additional premiums.

For further information on the new measure, contact your compliance officer or visit the New York Financial Service Department’s rule-making page. For information on errors and omissions insurance, visit EOforLess’s EO HQ.

Three Compliance Developments: Or Why An Advisor’s Work is Never Done!

Financial professionals face a daunting challenge: stay on top of their clients’ needs, track product-portfolio changes, AND stay current on regulations.

Several news items crossed our desks in late 2017 that brought this reality home. One report dealt with FINRA’s proposed ban on expungements. Another promised SEC action on insurance and securities professionals using the term “advisor.” The third announced that the SEC is creating a searchable database of bad brokers.

Clearly, none of these items was blockbuster news. But the three together would demand a block of advisor time and attention. We’re not complaining, mind you. Each of these initiatives appears to be sensible and probably overdue. Yet, they reinforce how compliance-driven this business has become. And it suggests that each new rule brings with it opportunity costs—for product manufacturers, agents and advisors, and regulators themselves.

To help minimize your costs, here’s a brief review of each item, which hopefully will reduce the amount of time you need to spend on it.

FINRA Expungement Ban: No, FINRA isn’t doing away with all expungements . . . just certain ones that are more than a year old.  As reported in Financial Advisor magazine, the action follows a dramatic increase in securities professionals applying to have very old complaints erased from their records.

In theory, requesting an expungement shouldn’t be a problem when a complaint is inaccurate or factually unsupported. The trouble is, defense attorneys have been recruiting advisors in droves to purge their BrokerCheck files of complaints dating back 10 or 15 years, even those without factual errors. Reason: they figure that after such a long period, consumers probably won’t dispute the request, and advisors will get an easy win.

This, in fact, is what typically happens. According to Financial Advisor, arbitrators grant expungements 90 percent of the time. As a result and in response to heavy criticism from the plaintiffs’ bar, FINRA wants to ban expungements on requests made a year or longer after a case closed. This would “ensure that the expungement hearing is held close in time to the underlying customer case, when information . . . is available and in a time frame that would increase the likelihood for the customer to participate” in the hearing.

Our takeaway? That now may be the time to apply for an expungement if you believe an old client complaint is flawed. That’s because FINRA is taking comments on its proposal until February 5, 2018. After an ensuing period of rule making, it will issue a final regulation, after which you may lose the ability to remove old complaints.

If you don’t have old complaints with issues, then ponder the importance of preserving your clean record through ethical and compliant business practices. As with many regulatory developments over the years, the agencies have not only raised the bar in terms of what they consider appropriate conduct, they have made the negative impact of getting sanctioned more severe. So take a look at your business practices to make sure you’re doing everything possible to prevent a FINRA complaint. Once it hits your CRD file, it will likely become much harder to remove.

Use of term “advisor.” The second item relates to an SEC official announcing that the investment-advisor regulator will be taking another look at the titles advisors and brokers used to describe their businesses. According to Financial Advisor, the executive told an industry meeting that the SEC is concerned about securities brokers who call themselves “advisors,” thereby implying they are fiduciaries under the Investment Advisors Act of 1940, when in fact they operate under the less stringent suitability standard.

The SEC also is concerned about brokers holding themselves out as advisors (and thus as fiduciaries) at one point in their client relationships, but then acting as a commissioned salesperson at other times. “If I’m the client, does it really work if I pick up the phone and call you and you’re my fiduciary while we’re talking and when we hang up you’re not my fiduciary any more?” asked Rick Fleming, head of the SEC’s Office of the Investor Advocate, at the TD Ameritrade’s Advocacy Leadership Summit in early November 2017.

However, Fleming stressed that regulating use of the term “advisor” shouldn’t be “worse than the disease” or something that weakens an advisor’s fiduciary role. “What we have to make sure of is that the rule has to be no less stringent than the (Investment Advisors Act of 1940). You have to build in exceptions to accommodate brokers’ business model,” Fleming said. “You have to allow them to sell a limited line of products and proprietary products, and fiduciary duty as written doesn’t allow that.”

This compliance item actually is quite serious, as it may force life insurance agents or securities brokers to change what they call themselves. If this involves reprinting business stationery and revising marketing materials, the headaches and costs involved could be significant. Implication? If you’re planning to enter the industry, think hard about what to call yourself and make sure your title doesn’t encourage a prospect to think you’re something that you’re not.

The regulatory risk is even greater for insurance-licensed producers who not only use the word “advisor,” but also titles such as “financial planner” and “wealth manager.” Not only do they not provide the broad-based financial advice such fee professionals provide, state insurance regulations require them to not mislead consumers about the scope of their work. For example, the NAIC advertising model regulation says that, “No insurance producers may use terms such as ‘financial planner,’ ‘investment advisor,’ ‘financial consultant,’ or ‘financial counseling’ in such a way as to imply that he or she is generally engaged in an advisory business in which compensation is unrelated to sales unless that actually is the case.”

Barred-broker database. The last compliance item relates to the SEC creating a searchable database of barred brokers and advisors. SEC Chairman Jay Clayton announced this at a Practicing Law Institute meeting in early November 2017. “Clearly, there are fraudsters in our marketplace who are seemingly unafraid of, or undeterred by, the risks of being caught,” Carney said. “The SEC can target the underlying conduct of those fraudsters—and we do—but we also can and should arm investors with information that makes it more difficult for them to be defrauded.”

According to a report in Financial Advisor magazine, the SEC plans to create a new website and database that will allow consumers to search for records of individuals the SEC has barred or suspended for violating federal securities law. The agency hopes this will shed light on the activities of barred or suspended brokers or advisors, helping consumers to wisely select a financial professional.

As with FINRA’s proposed expungement ban, the SEC’s banned broker database is another example of regulators raising the bar for financial professionals. In this case, though, it primarily affects bad actors who’ve already been thrown out of the business, making it harder for them to travel to a new jurisdiction after being sanctioned elsewhere. This is a positive development for ethical agents and advisors, who presumably will face less competition from rogue players who are simply out to scam the public.

To read more on ethical business practices, visit the Ethics Center at the National Ethics Association, sponsor of EOforLess.