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Best Practices for Retail Non-
Deposit Investment Programs
Louis Dempsey, RenaissanceBen Marzouk, Eversheds SutherlandDavid Porteous, Faegre Baker Daniels
Agenda
■ Regulatory Developments
• Focus on Fixed Income, Interest Rate Sensitive & Structured Products
■ Compensation Practices
■ Training
■ Compliance Oversight
Regulatory Developments
■ SEC Share Class Disclosure Initiative
• Background:
> SEC Division of Enforcement announced the Initiative on February 12, 2018.
> Encourages self-reporting of share class disclosure violations in exchange for favorable settlement terms.
> Applies to RIAs only.
• Initiative is squarely focused on comparatively more expensive share classes with 12b-1 fees selected for clients without adequate disclosure.
> Query: Does disclosure alone cure Section 206 violations for recommending a more expensive share class when less expensive option is available?
• SEC action against Ameriprise (Feb. 28, 2018)
Regulatory Developments
■ Offerings of ICOs and Cryptocurrencies
• SEC DAO Report (July 25, 2017)
> Status of ICOs as “securities” requiring SEC registration.
> Howey test.
> Impact for future ICOs?
• SEC Division of Investment Management Letter to ICI (Jan. 18, 2018)
> Mutual funds are ETFs pegged to cryptocurrency markets.
> Concerns regarding valuation, liquidity, and market manipulation.
> Request to halt cryptocurrency fund registration requests.
• Query: Allow reps to purchase? Allow customers to purchase?
Focus On Fixed Income Products
FINRA Comments and other enforcement actions indicate that FINRA believes firms should:
Have robust product review, approval, and monitoring process to assess product specific risks
and provide centralized guidance
Develop customized training/guidance for RRs, managers, and Principal Review that flow out
of the due diligence process
Inadequate to rely on sponsors + access to RRs must be supervised so:
• Know what sponsors are selling and advising RRs
• Control sponsor conflict of interest
• Ensure consistency with firm’s analysis of risks
Have product-specific suitability metrics including for Principal Review review
Have product expertise in Principal Review review process
Particular concern for bank-channel and older, less sophisticated or more
conservative customers who may be chasing rates or not understand risks
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FINRA Annual Examination Priority Guidance – Examiner Focus Areas Regarding
Interest Rate Sensitive Products
■ Concentration Risk –concentrated positions in interest rate sensitive products
■ Long Duration Risk re: FI Products & Bond Funds – if rates rise (including from changes in monetary policy),
such products could lose a substantial portion of their value regardless of credit quality of underlying portfolio assets
■ Long Holding Periods to Maturity –should match customer risk tolerance, time horizon, liquidity needs
■ High-Yield, Municipal, Other FI –may be particularly sensitive to rate changes
■ RR Training & Guidance –will look for firm training to ensure RRs
• Understand such products and risks
• Make suitable recommendations, and
• Have proactive conversations with customers about such risks
■ Customer Guidance & Disclosure –will look for quality of disclosures re: same
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Common SEC Exam Questions Regarding Product
Sales, Disclosures and Account TypesProvide any written disclosures and any scripts used during the Examination Period regarding:
■ a. distribution options (i.e., maintaining assets in a former employer’s plan, transferring assets to a new employer’s plan, rolling assets over to an IRA, or taking a lump sum distribution), the tax implications of those options, and other considerations (e.g., required minimum distribution requirements, availability of penalty-free withdrawals, protection of assets from lawsuits, and estate planning);
■ b. conflicts of interest or financial interests that Registrant or its representatives have in recommending any specific product or account type;
■ c. the various types of account options available to clients (i.e., IRA Rollover), including the account- level fees and expenses and services provided.; and
■ d. the various investment options available to clients (i.e., structured products, REITs, variable annuities, mutual funds, and ETFs), including information regarding product-specific fees and expenses, revenue sharing, loads, commissions, and other charges.
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SEC Data Analysis Of Structured Securities Product
Transactions By Investment Objective
■ Predominant types of customers that had purchased SSPs at each firm and branch office
■ Focused on branch offices and representatives that had highest numbers of sales that merited further review
■ Trends among customer investment objectives:
• More SSPs sold to customers in its most conservative investment objective (“Income”) than in the most aggressive (“speculation”) ($96mm “income” to $11 mm “speculative”)
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Regulatory Developments
■ SEC and State Fiduciary Developments
• SEC:
> June 1, 2017 – SEC Chairman Jay Clayton invites public comment on proposed rulemaking for uniform standard of conduct for BDs and IAs.
> Coordination with DOL?
• States:
> Certain states already impose fiduciary standards through either unethical business practices rules/regulations, or court decisions.
> Nevada “financial planner” amendment.
> Several other states taking steps to impose fiduciary duty on financial services providers (e.g., New York, New Jersey, Connecticut, Maryland).
> “Disclosure-based” fiduciary vs. “explicit fiduciary” standards.
Compensation Practices
■ Sales Contests [Loop in DOLFR treatment; Scottrade enforcement action by Massachusetts proves DOLFR still has teeth]
■ Referral Payments
■ Regulation R
■ Revenue Shares
■ Management Overrides
Training
■ Acceptable referral and sales practices
■ Who receives training?
• Reps
• Principal Review Desk
• Managers
■ Who performs training? (third party vendors / product sponsors)
• If training is provided by vendors / product sponsors, is it supervised?
• Know what sponsors are selling and advising reps
■ Supervision of training
• Product committee review and approval of marketing and advertising materials used
• Training should flow from customer profile identified for sale of product and making sure there is clear messaging regarding customer profile and interaction with management and PRD regarding questions
• Focus on messaging to bank-channel customers – how would this be understood by someone less familiar with market risk?
Compliance Oversight and Auditing
■ Titles [Note: Received attention from Clayton and others @ SEC Speaks; BDs calling themselves FAs etc…]
■ FINRA Regulatory Notice 18-08 re: OBA/PST streamlined new rule proposal
■ What how and when to examine investment program?
IDENTIFYING PRODUCTS FOR FURTHER ANALYSIS■ Materiality as measured as overall percentage of sales (e.g., rollover /
breakpoint cases) ■ Regulatory attention level■ Macroeconomic environment triggering heightened risk
• E.g., interest rate future guidance and potential impact on product performance and customer impact
■ Degree of unrealized losses in product class■ Underperformance or uneven performance■ Products that people may be using differently than intended (e.g., unsolicited
liquidations in specific products prior to term or recommended holding period)■ Complaint trending ■ Substantial Switch Activity (to/from) – documentation of comparison ■ Analysis of sales against higher-risk suitability factors including
• Age, risk profile, investment objective, other factors
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