SEC Issues AML Risk Alert for Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers

The SEC has warned broker-dealers to watch for compliance issues related to suspicious activity monitoring and reporting.

Seeking to improve compliance with federal anti-money laundering (AML) rules and regulations, the Division of Examinations encouraged firms “to review and strengthen their applicable policies, procedures, and internal controls” in an AML risk alert for broker-dealers.

“The SEC encourages broker-dealers to strengthen their policies and procedures for identifying and reporting suspicious activity as examiners have seen that many firms are not fulfilling their obligations under the law,” said Margie Webber, director of regulatory compliance for RegEd. 

The Examination Division has noticed several deficiencies related to broker-dealers’ obligations under the Bank Secrecy Act (BSA), specifically regarding the Financial Crimes Enforcement Network’s (FinCEN’s) AML Program Rule and SAR Rule. Examiners’ findings include the following observations, according to the risk alert issued on March 29.

AML Policies and Procedures

FinCEN’s AML Program Rule requires broker-dealers to establish and implement policies, procedures, and internal controls for identifying and reporting suspicious transactions. “A broker-dealer should look for indicators of illicit activities (generally referred to as “red flags”) and incorporate those red flags into its policies and procedures. Awareness by firm personnel of red flags and how to respond to those red flags, including escalating awareness of the red flags to appropriate firm personnel, will help ensure that a firm is in a position to identify the circumstances that warrant further due diligence and possible reporting,” the SEC explained in its risk alert.

Inadequate policies and procedures for AML

SEC examiners have found that some firms have not established “reasonably designed policies and procedures and internal controls” for identifying and reporting suspicious activity as required. Examiners noted the following examples.

  • No policies or procedures for raising “red flags” for suspicious activities
  • Setting SAR reporting thresholds at amounts “significantly higher” than the $5,000 regulations require
  • Relying on clearing firms to identify and report suspicious transactions in customer accounts

Failure to implement procedures

“Some firms that had reasonably designed written policies and procedures did not implement their procedures adequately and did not conduct adequate due diligence on or report suspicious activity that, per their own procedures, appeared to trigger a SAR filing requirement,” examiners wrote in their risk alert for broker-dealers.

Examples included:

  • Not filing SARs for transactions similar to ones that they previously reported
  • Not monitoring transaction reports and systems for suspicious activity
  • Failing to follow up on red flags that were raised

Suspicious Activity Reporting

The SAR Rule requires a broker-dealer to file a report of any suspicious transaction with FinCEN. The requirement applies to any transaction of $5,000 or more that meets any of the various criteria established by FinCEN, like it seems to be a transaction that the particular customer would not normally be expected to do.

Failure to respond to suspicious activity

“Weak policies, procedures, and internal controls, or the failure to implement existing policies and procedures, ultimately resulted in firms not conducting or documenting adequate due diligence in response to known indicators of suspicious activity especially with respect to activity in low-priced securities, which are particularly susceptible to market manipulation,” examiners wrote.

Examiners also noted that firms failed to act on information within customer accounts like records of liquidations of large volumes of high-risk, low-priced securities or trades of low-priced stock by customers affiliated with the issuer.

Filing inaccurate or incomplete SARs

Some broker-dealers make it difficult for regulators and law enforcement to follow up on suspicious activity by not including transaction-specific details in the SARs that the firm files. Rather, some firms have “filed hundreds of SARs or more containing the same generic boilerplate language, which failed to make clear the true nature of the suspicious activity and the securities involved,” examiners wrote.

Examiners noted the following examples of SARs that contained inaccurate information or lacked sufficient detail on key aspects of the suspicious activity.

  • Failing to include customer-identification information like Social Security numbers
  • Not reporting the liquidation of low-priced securities shortly after they were deposited
  • Not including details of a cyber-intrusion, like time, manner, and method of the incident

Improving AML compliance

“In fulfilling their important AML obligations, broker-dealers play a vital front-line role in assisting regulators and law enforcement in identifying and addressing suspicious activities to prevent our financial systems from being used for criminal purposes,” examiners wrote, in urging broker-dealers to strengthen policies, procedures, and internal controls for identifying and reporting suspicious activities.

“Strong policies, procedures, and internal controls protect broker-dealers and their customers by ensuring that any suspicious activity is quickly identified and properly reported,” RegEd’s Webber said. “Removing improper and illegal trading is key to maintaining the integrity of firms and financial markets.”

RegEd’s Policies and Procedures Management Solution helps broker-dealers comply with their AML obligations and other regulations. It enables comprehensive, end-to-end administration and oversight of all elements of a firm’s policies and procedures through an enterprise workflow, work-process, and task management platform. Broker-dealers can also incorporate AML into their Firm Element Continuing Education Program through RegEd’s learning management technology.

Schedule a consultation to learn more about how RegEd’s compliance solutions enable securities firms to improve efficiency, effectiveness, and transparency across the enterprise.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation, and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please schedule a consultation.

SEC’s Examination Priorities for 2021 Reflect Continued Concern for Retail Investors

The SEC’s Division of Examinations will continue to emphasize protection for retail investors in the coming year, particularly for seniors and individuals saving for retirement.

The Examination Division will evaluate whether registered investment advisers (RIAs) meet standards of conduct and will examine whether firms appropriately mitigate and disclose conflicts, regulators recently announced in releasing the SEC’s Examination Priorities for 2021. Examiners will also probe sales of retail investment products.

The priorities are a continuation of the SEC’s efforts to protect retail investors. In the fiscal year 2020, the Division of Examinations:

  • Issued more than 2,000 deficiency letters, which prompted many firms to take corrective actions, like by amending compliance policies and procedures or enhancing their disclosures.
  • Ordered firms to return more than $32 million to investors for fees that were improperly calculated and charged.
  • Referred more than 130 cases to the SEC’s Enforcement division, including referrals related to registered investment advisers selecting higher-cost mutual fund share classes for clients when lower-cost options were available; advisers failing to disclose conflicts of interest, and broker-dealers failing to supervise registered representatives who made unsuitable recommendations to retail customers.

“The SEC’s focus on retail investors speaks to the need for education and training for registered representatives, broker-dealers, and investment advisers,” said Margie Webber, director of regulatory compliance for RegEd. 

Firms can protect themselves by addressing the following SEC 2021 examination priorities through compliance action items.

Standards of Conduct

Examiners will focus on compliance with Regulation Best Interest (Reg BI), Form CRS, and whether RIAs have fulfilled their fiduciary duties of care and loyalty. With a compliance date of June 30, 2020, the standards have a “direct impact on the retail investor experience with broker-dealers and RIAs,” the SEC stated in its report on its 2021 examination priorities.

“Your policies and procedures should clearly define what standard applies to any given situation,” Webber said.

Firms and examiners have been adapting to the Reg BI and Form CRS standards since they were adopted in June 2019. In the past year, the SEC has developed new examination approaches for Reg BI and Form CRS “to both promote compliance and inspect firms in both our broker-dealer and investment adviser/investment company programs,” the SEC stated in its priorities report.

The SEC has also communicated with firms about Reg BI and Form CRS, beginning by publishing two risk alerts in April 2020: Examinations that Focus on Compliance with Regulation Best Interest and Examinations that Focus on Compliance with Form CRS. Regulators then shared preliminary observations from their initial examinations at a Roundtable on Regulation Best Interest and Form CRS in October 2020.

Regulation Best Interest

Reg BI requires a broker-dealer to put a retail customer’s interests first when recommending a securities transaction or an investment strategy involving securities. A broker-dealer must meet a four-part standard of conduct that includes obligations for Disclosure, Care, Conflict of Interest, and Compliance.

The SEC says that its initial examinations for compliance with Reg BI showed “that firms generally responded” by updating their written supervisory procedures (WSPs) and conducting training. However, though some firms incorporated specific compliance processes into their WSPs, others “simply restated the standards, but did not provide any meaningful guidance as to how these should be implemented.”

In December, the SEC issued a Statement on Recent and Upcoming Regulation Best Interest Examinations that identified Reg BI components that could be included in future examinations, including how firms consider costs in making a recommendation and the processes firms use to recommend complex products.

And now, per its recently released priorities report, the SEC has advised firms that in 2021 it will also conduct enhanced transaction testing and “will evaluate firm policies and procedures designed to meet additional elements of Regulation Best Interest, the recommendation of rollovers and alternatives considered, complex product recommendations, assessment of costs and reasonably available alternatives, how sales-based fees paid to broker-dealers and representatives impact recommendations, and policies and procedures regarding how broker-dealers identify and address conflicts of interest.”

SEC Commissioner Caroline Crenshaw believes that examination and enforcement data “will illuminate whether the rule is working as promised, or whether changes may be required,” WealthManagement.com reported in an article about the SEC’s plans to assess Reg BI performance, which was based on an interview with Crenshaw.

Form CRS

Form CRS requires broker-dealers and RIAs to give retail investors a brief customer or client relationship summary. “The relationship summary is intended to inform retail investors about: the types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm.” Firms must also file their relationship summaries with the SEC and post them on their websites.

Firms filed more than 13,000 Form CRSs in the past year, the SEC noted in its report on 2021 examination priorities. The SEC stated, “We saw a wide variety of approaches that firms used to comply with the requirements of Form CRS, and generally observed firms complying with the Form’s requirements. Many firms appeared to make effective use of hyperlinks in their digital Form CRSs. We also observed that many firms are generally avoiding legalese and generic boilerplate language, but we also noted the readability of some Form CRSs could still be improved.

“Some firms did not adequately respond to the Form CRS disciplinary disclosure requirements, an area all firms should ensure they address. In addition, we identified and notified hundreds of firms that they had failed to timely file a Form CRS.”

The SEC will examine broker-dealers and RIAs to assess compliance with Form CRS in 2021.

RIA Fiduciary Duty

The Interpretation Regarding Standard of Conduct for RIAs that the SEC released in 2019 with Reg BI and Form CRS affirmed and clarified aspects of an RIA’s fiduciary duty that comprises duties of care and loyalty to its clients.

In evaluating RIAs for compliance in 2021, SEC examiners will assess, “among other things, whether RIAs provide advice, including whether account or program types continue to be, in the best interests of their clients, based on their clients’ objectives, and eliminate or make full and fair disclosure of all conflicts of interest which might incline RIAs—consciously or unconsciously—to render advice which is not disinterested such that their clients can provide informed consent to the conflict.”

Examiners will also focus on risks associated with fees and expenses, complex products, best execution, and undisclosed or inadequately disclosed, compensation arrangements.

Retail Investments and Sales Practices

In addition to evaluating broker-dealers and RIAs for meeting standards of conduct, the SEC has also prioritized determining whether transactions involving retail investors and advice provided to them are appropriate. Examiners will assess whether firms meet their legal and compliance obligations when providing retail customers access to complex strategies, such as options trading, and complex products in particular. They will also focus “on how firms are complying with the recent changes to the definition of accredited investor when recommending and selling certain private offerings,” according to the 2021 examination priorities report.

RegEd’s Webber suggested that firms address legal and compliance obligations related to retail investors in their education and training programs. She also recommended ensuring that standards, procedures, and solutions for conflicts of interest disclosure are in place.

Examiners are particularly concerned about conflicts of interest that could compromise a broker-dealer’s, RIA’s, or firm’s obligation to act in the best interest of retail investors. So, examiners have prioritized reviewing firms’ disclosures regarding their conflicts of interest, including those related to fees and expenses.

“Fee and compensation-based conflicts of interest may take many forms, including revenue-sharing arrangements between a registered firm and issuers, service providers, and others, and direct or indirect compensation to personnel for executing client transactions,” according to this year’s examination priorities report.

Strengthening Compliance for 2021 and Beyond

Securities firms that address the SEC’s 2021 examination priorities in their education and training programs will strengthen their compliance programs by doing so. Many companies will use technology to comply efficiently.

“The use of technology to facilitate compliance with regulatory requirements (RegTech) has experienced immense growth in recent years,” the SEC wrote, noting that examiners will focus on the implementation and integration of RegTech in firms’ compliance programs to ensure that the technology is configured correctly and used properly. “RegTech, when implemented appropriately, may increase the efficiency of compliance staff, reduce manual processes, and exponentially increase transaction review capabilities.”

As fit-to-purpose tools tailored to the needs of broker-dealers and investment advisers, RegEd’s compliance solutions for securities firms are highly effective as well as cost-efficient. Firms can seamlessly manage all aspects of their compliance programs, reducing risks and costs by automating and streamlining processes. And each solution is configured for optimal performance by RegEd’s implementation experts, who have worked with many of the nation’s largest securities firms.

RegEd’s compliance management platform includes the following solutions (among others).

  • Education and Training Solution Suite – Advanced learning management technology streamlines the creation of a firm’s annual compliance program, simplifies course enrollment, provides access to timely course materials, and efficiently tracks course completion.
  • Policies and Procedures Management Solution – An enterprise workflow, work-process, and task management solution enables comprehensive, end-to-end administration and oversight of all elements of a firm’s policies and procedures.
  • Conflicts of Interest Solution Suite – Automated end-to-end management of request processes, compliance monitoring and exception management associated with conflict of interest policies embeds best practices in a firm’s compliance program. 
  • Outside Business Activities Solution – Centralized, systematized management of OBA disclosures, attestations and amendments reduces review time and facilitates communication on specific requests to speed the decision process.
  • Gifts, Gratuities and Contributions Management Solution – Advanced software ensures that all transactions comply with regulations and firm policy, providing insight into violations, trends, conflicts of interest, reducing the risk of non-compliance.
  • Personal Securities Account Management Solution – Automating the management of personal trading activities delivers extraordinary efficiency and enhances the quality of supervision while dramatically reducing the risk of non-compliance and related consequences.

Schedule a consultation to learn more about how RegEd’s compliance solutions enable securities firms to improve efficiency, effectiveness, and transparency across the enterprise.

For additional ways to strengthen your firm’s compliance program, view our recent webinar on FINRA’s 2021 Examination and Risk Monitoring Program Report.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please visit www.reged.com.

Modernized Marketing Rule for Investment Advisers Takes Effect on May 4

The countdown to the implementation of the modernized marketing rule for investment advisers has begun.

After years in the making, the sweeping changes that the SEC made in modernizing marketing rules for investment advisers will finally take effect on May 4, 2021, 60 days after being published in the Federal Register on March 5.

Firms will have 18 months, until Nov. 4, 2022, to comply with the rules, Karen Barr, president and CEO of the Investment Adviser Association, told ThinkAdvisor for a story about the effective date for the changes.

A New Era in Compliance for Investment Advisers

“The marketing rule reflects important updates to the traditional advertising and solicitation regimes, which have not been amended for decades, despite our evolving financial markets and technology,” then-SEC Chairman Jay Clayton said in announcing the finalized reforms in December.

“This comprehensive framework for regulating advisers’ marketing communications recognizes the increasing use of electronic media and mobile communications and will serve to improve the quality of information available to investors.”

The SEC created a single marketing rule that modernizes the rules that governed investment adviser advertisements and compensation to solicitors under the Investment Advisers Act of 1940. Neither rule had been amended significantly since its adoption.

The SEC first proposed amendments to modernize the advertising and cash solicitation rules in November 2019. Regulators revised their proposed changes based on public comments before announcing the final rule a year later.  When the SEC announced the new rule, it said it would take effect 60 days after being published in the Federal Register.

Compliance Management for the Present and the Future

The SEC has achieved a “Herculean task” by collecting hundreds of pages of piecemeal guidance that have accumulated over decades as well as “accounting for all of the information technology, social media, and marketing practice advancements over more than half a century, and fusing them into a modern, principles-based, evergreen, workable framework,” IAA President Barr wrote in a note to members in January, according to a ThinkAdvisor article on how advisor advertising rules are entering the 21st century.

The “principle-based provisions” include:

  • A two-prong definition of “advertisement”;
  • Prohibitions of certain general practices;
  • Requirements for using testimonials and endorsements in advertisements;
  • Criteria for the use of third-party ratings; and
  • Restrictions on promoting performance information in advertisements.

The SEC adopted amendments to the books and records rule and amended Form ADV to require advisers to provide additional information regarding their marketing practices to help facilitate the Commission’s inspection and enforcement capabilities as well.

Also, the staff of the Division of Investment Management will withdraw no-action letters and other guidance addressing the application of the advertising and cash solicitation rules as those positions are either incorporated into the final rule or will no longer apply, the SEC announced, noting that a list of the letters will be available on the commission’s website.

Addressing the New Investment Adviser Marketing Rule

“Anyone can read the rule but putting it into play and understanding what’s in and out, that’s really the work to be done,” said attorney Genna Garver, a partner at Troutman Pepper, during a RegEd webinar about understanding and preparing for the modernized marketing rule.

Webinar panelist Suzan Rose expects the SEC to provide additional guidance on some of the rule’s provisions during the transition period. “We have plenty of time to work out the kinks but there’s lots to cover,” said Rose, a senior advisor to the Alternative Investment Management Association (AIMA).

For example, the new “principles-based” approach includes undefined concepts like “fair and balanced.” “It will be a while before anyone can get a grasp on what the SEC truly feels ‘fair and balanced’ means,” Rose said. “And you want to be sure that ‘fair and balanced’ in your judgment does not equate to ‘misrepresentation’ in their judgment.”

Still, there are welcome changes, Garver said. One of the biggest is that the new rule permits testimonials.

“This will be welcome relief for many, especially on the social media front,” Garver said. “This is massive.”

Additional highlights of the rule include flexibility for the continual evolution and interplay of technology and advice, and easing restrictions on references to past investments, Garver and Rose noted.

“Part of this transition period needs to be used to look at everything that’s interfacing with clients and making a decision if this is an advertisement or is it not and having the training and policies and procedures in place to identify things that might be outliers in the types of communication that you have,” Garver said.

Adopting the Modernized Marketing Rule

Some investment advisers may adopt the new marketing rule before the 18-month transition period ends, said Margie Webber, director of regulatory compliance for RegEd. “They may consider rolling it out sooner so that they could use testimonials in their marketing materials as soon as possible after the May 4 effective date.”

Though advisers can voluntarily adopt the new rules before the compliance date, they would be subject to them in full if they do. “If you’re going to do it, make sure that you have policies in place and that you’ve trained your teams,” Garver suggested.

Rose recommended waiting for the SEC to clarify any provisions that could use additional guidance, like those related to the usage of hypothetical performances. “Ask your questions before deciding to adopt the rule as it is and before the compliance date because once it’s in effect that’s what you’ve got,” she said.

Rose expects the SEC to respond to industry comments during the transition period.

But the countdown to Nov. 4, 2022, has begun. Advisers have until then to comply.

RegEd has reduced non-compliance risk for hundreds of financial services firms by providing them with proven, scalable compliance management solutions, including our market-leading Advertising Review software.

View our most recent Advertising Regulation Webinar to learn more about the new modernized marketing rule for investment advisers, its impact on the industry, and what firms can do now to prepare.

About RegEd

RegEd is the market-leading provider of RegTech enterprise solutions with relationships with more than 200 enterprise clients, including 80% of the top 25 financial services firms.

Established in 2000 by former regulators, the company is recognized for continuous regulatory technology innovation with solutions hallmarked by workflow-directed processes, data integration, regulatory intelligence, automated validations, business process automation and compliance dashboards. The aggregate drives the highest levels of operational efficiency and enables our clients to cost-effectively comply with regulations and continuously mitigate risk.

Trusted by the nation’s top financial services firms, RegEd’s proven, holistic approach to RegTech meets firms where they are on the compliance and risk management continuum, scaling as their needs evolve and amplifying the value proposition delivered to clients. For more information, please visit www.reged.com.

Insurance Compliance Lifecycle: A Closed-Loop Process to Managing Regulatory Change Successfully

Each year, thousands of regulatory changes are made that could materially affect the insurance industry, and the number is rising. In any given year, more than 40,000 regulations—including legislative bills, administrative rules, bulletins, advisories, alerts, directives, and interpretive guidance—must be vetted to determine if they affect the business of insurance. According to RegEd’s internal research, there were about 2,400 new or revised state regulations enacted or adopted that directly affected the insurance industry in 2013. In 2019, there were about 3,600, an increase of 53%. As the number escalates, new regulations themselves are becoming more complex, especially around risk management, corporate governance, cyber-security, and privacy, with wider-ranging effects that reach further across geographies, business lines, products, and processes.

Managing the regulatory change process can be complicated and time consuming. Simply to identify a new regulation is a monumental task, to say nothing of methodically analyzing each one to determine how—and whether—it could affect an insurance company’s sales operations, actuarial procedures, product features, financial obligations, or any number of other areas of the business. When a new regulation does affect the organization, an organization must take steps to bring itself into compliance. Finally, a company must demonstrate compliance to regulators.

A Repeatable Closed-Loop Process

If an organization has implemented an established and repeatable closed-loop process to manage regulatory change, it can avoid missing key regulations, determine how new regulations affect the organization with more precision, take measures to bring itself into compliance more efficiently, and demonstrate proof of compliance with comprehensive documentation and reporting. There are five steps: Be aware of new regulations; determine relevance to your organization; identify areas of ownership and translate changes into business requirements; execute, monitor, and validate a workflow plan to bring the company into compliance; and demonstrate compliance to regulators and internal stakeholders.

1. BE AWARE

An organization must be aware of what new, revised, and amended regulations have been made, and each year, there could be thousands of rule changes. As insurance regulation is decentralized, the process can be enormously challenging. There are at least 50 separate insurance jurisdictions, and it’s necessary to monitor each state legislature and agency that has the authority to regulate the business of insurance—there is no central clearinghouse. An organization’s compliance department has to know where to look.

Myriad state and local agencies are authorized to regulate the insurance industry. State departments of insurance are an obvious place to start, but it’s critical not to overlook others that may not regulate as often or as widely, including departments of transportation, departments of labor, and departments of health and human services. Equivalent regulations in different states may have different requirements, and if the company offers numerous lines of insurance in different markets, the company is subject to each rule for each product in each state.

Once aware of new regulations, it’s best to have a central system to manage them actively. Regulations that are handled through different departments within the organization with different methodologies, workflow practices, and levels of accountability can easily be lost or addressed inconsistently, creating a risk of noncompliance and inefficiencies throughout the organization.

2. DETERMINE RELEVANCE

Once in the door, a regulation must be reviewed and evaluated for relevance to an organization’s business, its spirit and intent, the areas and processes it may affect, and the types of changes necessary to comply. It’s a time-consuming and laborious process that can take months for a single regulation, and it involves a great deal of research and dialogue. In many instances, a new regulation’s relevance may not be obvious, and although a regulation ultimately may be deemed not applicable to the organization, the process to make this determination can represent a great deal of staff time, effort, and other resources.

3. TRANSLATE CHANGES INTO BUSINESS REQUIREMENTS

When it’s determined that a new regulation affects the business, an organization must identify the areas of ownership—claims department, underwriting, or actuarial, for example—and the individuals who are responsible to bring the company into compliance. As some legislative bills and administrative rules can reach hundreds of pages with a high degree of complexity, it is critical to review, interpret, package, and deliver—in plain English—a new or revised regulation to the different affected parts of the organization. This can represent a lot of work, but someone on the receiving end may not be able to interpret legal or legislative language in an effective way that’s actionable and makes sense for the business.

Many companies, especially those that haven’t established a strong compliance management cycle, don’t have the staff and resources to translate new regulations effectively. When left to individual divisions to interpret a new regulation and take measures to comply, the effort often can be like a fire drill: reactive, incomplete, and inconsistent with other areas of the company. Without a central, managed closed-loop process, this step is almost impossible to do; merely hoping for the best outcome rarely results in the best outcome.

4. EXECUTE, MONITOR, AND VALIDATE

An organization’s compliance department must assign the recommended tasks and requirements to the correct departments to make sure the changes needed to bring the company into compliance are in fact made within the required time frame. This should include guidance and a complete framework of workflow, with processes for oversight, monitoring, and accountability built in. Organizations that don’t have an established, closed-loop process can find this difficult—email usually can’t handle the job.

5. DEMONSTRATE COMPLIANCE

It’s not uncommon for regulators to ask an insurance company to show what it did to comply with a new regulation. After all, it’s the law, there are consequences for not being compliant, and the entire process is useless unless an organization can provide positive proof. In addition to providing legitimacy to regulators, it serves as valuable risk management data to senior management and other internal stakeholders.

A closed-loop process makes managing regulatory change vastly easier. Without one, complications can arise when regulators arrive, such as during a market conduct examination, that can result in a fire drill—tracking down the people involved, looking through email correspondence, searching for documents, and wading through files—that can be chaotic. If done correctly, running a quick report can provide proof by highlighting the details of how and when an organization complied.

REGULATORY CHANGE MANAGEMENT

RegEd’s Regulatory Change Management incorporates a complete, workflow-enabled, closed-loop process to be aware, determine relevance, create and execute a compliance strategy, and demonstrate compliance with all regulatory changes.

Subject Matter Experts and Specialists

A full staff of subject matter experts with deep, hands-on experience in the insurance industry, monitors the regulatory landscape, documents changes, and evaluates each new or revised regulation for relevance and applicability.

Regulatory specialists interpret, summarize, and translate legal language to business-appropriate plain English before distributing them through RegEd’s system to clients based on their lines of business. Streamlined tools enable the tasks necessary to achieve compliance and reporting functions demonstrate to executive management and regulators that an organization was aware of a regulatory change and steps were taken to comply along with a current status report and a full audit trail.

About the Author

Merlinda Johnson

Merlinda Johnson is the Director of Insurance Regulatory Compliance at RegEd, Inc.

The New Best Interest Standard for Annuity Sales: An Overview of Revisions to the NAIC’s Model Regulation #275

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In February 2020, the National Association of Insurance Commissioners (NAIC) approved revisions to its Suitability in Annuity Transactions Model Regulation (#275). The revised regulation requires that all annuity recommendations by producers and insurers meet a “best interest” standard.

Under the new model regulation, insurance producers and carriers may not place their financial interests ahead of the consumer’s interest when recommending an annuity product. Furthermore, insurers are required to establish and maintain a system to supervise producer recommendations, so the insurance needs and financial objectives of consumers are addressed effectively. The new model also prohibits an insurer from issuing an annuity product to a consumer unless the insurer has a reasonable basis to believe the annuity would address the consumer’s insurance needs and financial objectives effectively.

The NAIC’s new best interest standard uses the Securities and Exchange Commission’s recent Regulation Best Interest as a model. For the past 10 years, insurance regulators have used a “suitability” standard, similar to the Financial Industry Regulatory Authority’s (FINRA), to regulate annuities sales. The best-interest standard on sales and recommendations of annuity products by insurance producers is a higher standard than the 2010 model regulation’s suitability requirements, but it does not reach the level of a fiduciary duty.

A producer would be deemed to have acted in the consumer’s best interest if the producer meets the obligations of care, disclosure, conflict of interest, and documentation that are detailed in the model regulation. Insurance companies are required to supervise producer compliance with this rule and to maintain compensation systems that will not undermine the best interest of clients.

Like the 2010 model regulation, the new model regulation requires that producers be trained in its requirements. For producers new to selling annuities, the new model calls for a four-hour training course. For veteran producers who were trained under the old model regulation, the new model regulation allows for a one-hour update course, although the regulation makes this option available only for the first six months after their state adopts the new rule (states may vary this time period).

The new model regulation applies only to the recommendation or sale of an annuity. It also provides for various exemptions from its requirements, such as exemptions for certain group annuities. The model also provides a safe harbor for sales and recommendations made in compliance with “comparable standards,” for example, those that comply with applicable SEC or FINRA securities requirements for broker-dealers and registered investment advisers.

The NAIC recommends that states amend their annuity sales regulations in response to the new model regulation. The NAIC’s 2010 Model Regulation was adopted by 45 states and the District of Colombia in the wake of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act. Previous projections suggested that half the states could adopt the model regulation in some form by the end of 2020,  but may be delayed due to the COVID-19 pandemic.

An Important Note

This following content summarizes and highlights key revisions made to the NAIC’s model regulation #275—it is not the complete version of the model regulation itself. Please see the full text of the revised and complete model regulation here. Additional information on Model Regulation #275 is available here.

Best Interest Obligation: Reasonable Diligence, Care, and Skill

Under the NAIC’s revised Suitability in Annuity Transactions Model Regulation (#275), producers must now “exercise reasonable diligence, care, and skill” when recommending an annuity and shall act in the best interest of the consumer, under the circumstances known at the time the recommendation is made, without placing the producer’s or the insurer’s financial interest ahead of the consumer’s interest.

A producer’s obligations regarding care, disclosure, conflict of interest, and documentation include making appropriate recommendations that consider the consumer’s financial situation, insurance needs, and financial objectives, and reasonable efforts must be made to obtain consumer profile information from the consumer before making a recommendation.

Thus, a producer must be familiar with the annuity options available. Of those annuities the producer is authorized and licensed to sell, the producer must have a reasonable basis to believe the consumer would benefit from certain features of the annuity, such as annuitization, death or living benefit, or other insurance-related features. The producer must also be able to communicate the basis of the recommendation.

Consumer profile information; characteristics of the insurer; and product costs, rates, benefits, and features are generally relevant factors in determining whether an annuity addresses a consumer’s financial situation, insurance needs, and financial objectives. While each factor’s importance may vary depending on a consumer’s circumstances, each factor may not be considered in isolation.

Producers must make an effort to gather customer profile information to determine whether a recommendation addresses the consumer’s financial situation, insurance needs, and financial objectives, including age, income, assets and liabilities, financial experience, objectives, time horizon, use of the annuity, liquidity needs, risk tolerance, and tax status.

When exchanging or replacing an annuity, a producer must consider the whole transaction, factoring in surrender charges, commencement of a new surrender period, loss of existing benefits, increased fees, and other exchanges or replacements made within the previous five years. The new product must substantially benefit the consumer in comparison to the replaced product for its duration.

Disclosures

The model regulation requires specific disclosures of the customer relationship between the producer and consumer, the products the producer is authorized or licensed to sell, and the producer’s compensation. The model regulation requires the use of a disclosure form (“Insurance Agent [Producer] Disclosure for Annuities”)signed by both the producer and customer; an example is provided as an appendix.

Customer relationship: Before making a recommendation or selling an annuity, a producer must disclose in writing the scope and terms of the relationship with the consumer and the producer’s role in the transaction.

Products: The producer must state which products the producer is licensed and authorized to sell (fixed, fixed-indexed, and variable annuities; life insurance; mutual funds; stocks and bonds; and certificates of deposit).

Insurers: The producer must provide a statement describing the insurers for which the producer is authorized, contracted, appointed, or otherwise able to sell insurance products by indicating one insurer, from two or more insurers, or from two or more insurers although primarily contracted with one insurer.

Compensation: The producer must also describe the sources and types of cash and non-cash compensation received, including whether the producer is to be compensated for the sale of a recommended annuity by commission as part of a premium or other remuneration received from the insurer, intermediary or other producer or by a fee as a result of a contract for advice or consulting services; and a notice of the consumer’s right to request additional information regarding cash compensation. Upon request, the producer must disclose a reasonable estimate of the amount of cash compensation to be received, which may be stated as a range of amounts or percentages; and whether it’s a one-time or multiple occurrence amount, and if a multiple occurrence amount, the frequency and amount, which may be stated as a range of amounts or percentages.

Conflicts of Interest: A producer shall identify and avoid or reasonably manage and disclose material conflicts of interest, including material conflicts of interest related to an ownership interest.

Documentation: At the time of recommendation or sale, a producer must document any recommendation and its basis in writing. Should a customer refuse to provide consumer profile information, the producer must obtain a statement signed by the consumer that documents the customer’s refusal and the customer’s understanding of the implications of not providing consumer profile information. The model regulation provides a sample form (“Consumer Refusal to Provide Information”) as an appendix. Furthermore, a producer must obtain a statement signed by the consumer acknowledging that the annuity transaction is not recommended if a customer decides to buy an annuity that is not recommended by the producer.

Application of best interest: Any requirement that applies to one producer must apply to each producer who was involved in the recommendation and has received direct compensation as a result, regardless of consumer contact. Providing marketing or educational materials, product wholesaling or other back office product support, and general supervision of a producer do not, in and of themselves, constitute material control or influence.

Transactions not based on a recommendation: A producer shall have no obligation to a consumer if no recommendation is made, if a recommendation was made and was later found to have been based on materially inaccurate information provided by the consumer, if a consumer refuses to provide relevant consumer profile information and the annuity transaction is not recommended. If a consumer decides to purchase an annuity transaction that is not based on a recommendation, a disclosure must be made in writing and signed by both the producer and consumer. The model regulation provides a sample form (“Consumer Decision to Purchase an Annuity NOT Based on a Recommendation”) as an appendix.

Reasonable basis: Except as described under transactions not based on a recommendation, an insurer may not issue a recommended annuity unless there is a reasonable basis to believe it would effectively address a consumer’s financial situation, insurance needs, and financial objectives, based on the consumer’s consumer profile information.

Supervision System

An insurer must establish and maintain a supervision system that is reasonably designed to achieve the insurer’s and its producers’ compliance with model regulation #275, including:

Review

The insurer shall establish and maintain procedures for the review of each annuity recommendation prior to issuance that are designed to ensure that there is a reasonable basis to determine that the recommended annuity would effectively address the particular consumer’s financial situation, insurance needs and financial objectives.

Non-compliance detection

The insurer shall establish and maintain reasonable procedures to detect recommendations that are not in compliance, including confirmation of the consumer’s profile information, systematic customer surveys, producer and consumer interviews, confirmation letters, producer statements or attestations, and internal monitoring. The insurer shall establish and maintain reasonable procedures to identify and address suspicious consumer refusals to provide consumer profile information.

Verification

The insurer shall establish and maintain reasonable procedures to assess, prior to or upon issuance or delivery of an annuity, whether a producer has provided to the consumer the required information.

Sales incentives

The insurer shall establish and maintain reasonable procedures to identify and eliminate any sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sales of specific annuities within limited periods of time. The insurer is not required to make its compensation system incentive-neutral with those of other carriers that may have different system. (But differences between carriers are still subject to the rule that prohibits placing the producer’s or insurer’s interests ahead of the consumer’s.)

Effectiveness of supervision program

The insurer shall annually provide a written report to senior management, including to the senior manager responsible for audit functions, which details a review, with appropriate testing, reasonably designed to determine the effectiveness of the supervision system, exceptions found, and any corrective action recommended or taken.

Safe Harbor

Recommendations and sales of annuities made by registered broker-dealers, investment advisers, or a plan fiduciary in compliance with business rules, controls, and procedures that conform to a comparable standard, such as the SEC’s Regulation Best Interest, shall satisfy the requirements under this regulation as long as the insurer monitors the relevant conduct of the financial professional or the entity responsible for supervising the financial professional.

Compliance Mitigation, Penalties, Enforcement

Insurers are responsible for compliance with this regulation. If a violation occurs, the commissioner may order an insurer or agency to take reasonably appropriate corrective action for any consumer harmed by an insurer’s failure to comply or that of a producer or contracted agent for the insurer. Appropriate penalties and sanctions may apply as well. Applicable penalties for a violation may be reduced or eliminated if corrective action is taken for the consumer is taken promptly and if the violation is not part of a pattern or practice.

Recordkeeping

Insurers, general agents, independent agencies, and producers must maintain records of information collected from the consumer; disclosures made to the consumer, including summaries of oral disclosures; and other information used in making the recommendations that were the basis for insurance transactions. Each state will specify the required number of years after the annuity transaction is completed that records are to be kept.

Producer Training

A producer who has completed an annuity training course approved by the department of insurance prior to the effective date of the amended regulation must complete either a new four-credit training course approved by the department of insurance or an additional one-time, one-credit training course approved by the department of insurance and offered by an approved education provider. The training must focus on appropriate sales practices, replacement transactions, and disclosure requirements in the amended regulation. An insurer must verify that a producer has completed the required annuity training course before allowing the producer to sell an annuity product.

RegEd offers the two courses that meet the requirements of the NAIC’s revised model regulation #275, which will be submitted for approval and continuing education (CE) credit in each state as their versions of this regulation become effective:

Recommending Annuities Under the NAIC Best Interest Standard (490)

This is the standard four-hour training course required of insurance agents before they may sell annuities. It details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation. In addition, the course reviews the operations of different types of annuities and how they are used to meet different client needs.

Recommending Annuities Under the New NAIC Best Interest Standard—One-Hour Update Course (491)

Veteran insurance agents who previously qualified to sell annuities under their state’s version of the NAIC annuity suitability regulation may take this one-hour update course to qualify to sell annuities under the new NAIC best-interest standard. This course details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation.

RegEd is ready to assist insurance companies manage the process of revising the standards of the Suitability in Annuity Transactions Model Regulation (#275), including tracking recommendations, managing disclosures, documentation, and other compliance obligations, supported by efficient and enabling technology and people with deep experience in the process. For more information: sales@reged.com, www.reged.com, or 800-334-8322.

About the Authors

Brandi Brown

Brandi Brown is the Senior Vice President of Regulatory Affairs at RegEd, Inc.

Margie Webber

Margie Webber is the Director, Regulatory Compliance BD/IA at RegEd, Inc.

Regulatory Insights Regarding Compliance Assessments of Regulation Best Interest and Form CRS

These are certainly interesting days.  So much is taking the attention of compliance professionals.  By now everyone has implemented their business continuity plans (BCP) and likely made modifications to them here and there as the true test of these plans has been realized.  BCP has now become yet another compliance ball to juggle for the foreseeable future.  BCP recordkeeping will be important so be sure to track as you go.  Regulators are certain to ask about this in upcoming exams.

Now that everyone is settled into their temporary work environments and any BCP gaps have been shored up, the looming June 30, 2020 compliance date for Regulation Best Interest (Reg BI) and Form CRS (client/customer relationship summary) is once again the primary focus for most broker-dealers (BDs) and investment advisers (IAs).  SEC Chairman Jay Clayton has recently signaled there will be no regulatory relief around the June 30th compliance date. 

On April 7th, the Office of Compliance Inspections & Examinations (OCIE) released two Risk Alerts providing BDs and IAs with insight around initial regulatory examinations to assess implementation of Reg BI and Form CRS.  OCIE’s implementation assessment exams will likely occur within one-year of the June 30th compliance date.  FINRA also released a statement that they will take the same approach as OCIE on their initial examinations of firms’ compliance with Reg BI and Form CRS. 

OCIE Risk Alert: Examinations that Focus on Compliance with Regulation Best Interest

OCIE (and FINRA) will assess whether firms made good faith efforts to implement policies and procedures that are reasonably designed to achieve compliance with the general obligation of Reg BI to make recommendations that are in the best interest of the retail investor before or at the time the recommendation is made.  You demonstrate compliance with the general Reg BI obligation by complying we each of the four (4) component obligations of Reg BI.  The Disclosure Obligation, the Care Obligation, the Conflict of Interest Obligation and the Compliance Obligation. 

The Disclosure Obligation requires BDs, prior to or at the time of a recommendation to a retail customer, to provide written, full and fair disclosure of all material facts relating to the scope and terms of the relationship with the retail customer; and all material facts relating to conflicts of interest that are associated with the recommendation being made to the retail customer.  BDs can expect regulators to review the content of their disclosures as well as ‘other firm records’ to make a compliance assessment. 

  • Do your disclosures define the capacity in which the recommendation is being made? 
  • Do your disclosures provide applicable material fees and costs?
  • Are any material limitations on the securities or investment strategies involving securities that may be recommended to the retail customer included in your disclosures?
  • Are you making your disclosures ‘timely’ (prior to or at the time of recommendation)?

The Care Obligation requires BDs to exercise reasonable diligence, care, and skill when making a recommendation to a retail customer.

  • Does the BD understand potential risks, rewards, and costs associated with the recommendation?
  • Were these factors considered in light of the retail customer’s investment profile?
  • Was the recommendation made in the retail customer’s best interest?

BDs can expect regulators to review the information collected from retail customers to develop their investment profiles (i.e. new account forms, correspondence, agreements between customer and BD).  Regulators will want to understand:

  • The process taken by the BD to determine a reasonable basis exists to believe that the recommendations are in the best interest of the retail customer. 
  • Factors considered by the BD to assess potential risks, rewards, and costs of the recommendations in light of the retail customer’s investment profile.
  • BD’s process for having a reasonable basis to believe that it does not place its financial or other interests ahead of the interest of its retail customers.
  • How the BD makes recommendations related to significant investment decisions, such as rollovers and account recommendations, and how the BD has a reasonable basis to believe that such investment strategies are in a retail customer’s best interest.
  • How the BD makes recommendations related to more complex, risky or expensive products and how the BD has a reasonable basis to believe that such investments are in a retail customer’s best interest.

The Conflict of Interest Obligation requires BDs to establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest associated with its recommendations to retail customers. Of course regulators will review the BD’s policies and procedures to determine compliance. 

  • Do your policies and procedures address conflicts that create an incentive for an associated person to place its interest or the interest of the BD ahead of the interest of the retail customer?
  • Do they include material limitations such as only limited product menu, only offering proprietary products, or products with third-party arrangements?
  • Has the BD eliminated sales contests/quotas/bonuses/non-cash compensation based on the sale of specific securities or specific types of securities within a limited period of time?
  • Do the policies and procedures establish a structure for identifying the conflicts that the BD or its associated person may face?
  • Do they provide for disclosing, mitigating or eliminating conflicts?

The Compliance Obligation requires BDs to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.  Regulators will assess compliance with this obligation by reviewing policies and procedures and evaluating controls, remediation for noncompliance, training, and periodic review and testing of the BD’s policies and procedures.

Included in this Risk Alert is an Appendix that should be reviewed as it provides a sample list of information the regulators may request in order to determine compliance with Reg BI.

OCIE Risk Alert:  Examinations that Focus on Compliance with Form CRS

Unlike with Reg BI, the Form CRS obligation applies to IAs as well as BDs.  BDs and IAs are required to deliver to retail investors a brief relationship summary (Form CRS) providing information about the firm. By June 30, 2020, the Form CRS must be filed with the SEC through Web CRD for BDs, or IARD for IAs (both Web CRD & IARD for dual registrants using one Form CRS for both brokerage and advisory services).  In addition, if the firm has a public website, the Form CRS must be posted there.  After the June 30th compliance date, regulators will assess for a good faith effort to comply with the Form CRS obligation. 

  • Has the firm filed its Form CRS including any amendments?
  • Does the firm have a public website and if so, has the Form CRS been posted there?
  • What is the process for delivering Form CRS to existing and new retail investors?
  • Does the firm’s policies and procedures address the delivery process and dates?
  • Does the Form CRS include all required information; does it contain true and accurate information; does it omit material facts?
  • How does the firm describe the relationship and services it offers, including statements regarding account monitoring and investment authority?
  • How does the firm describe fees and costs?
  • How does the firm describe its conflicts of interest, including incentives related to proprietary products, third-party payments, revenue sharing, and principal trading?
  • Does the firm accurately disclose if the firm or its financial professionals have legal or disciplinary history?
  • Is the Form CRS formatted in accordance with Form CRS instructions?
  • Do policies and procedures provide for Form CRS updating?
  • Has the firm retained applicable records related to its delivery of the Form CRS?

Firms should expect regulators to review records of the dates that each relationship summary was provided to retail investors to validate whether the firm has complied with the delivery obligations. 

  • For existing retail investors, firms must deliver the summary by July 30, 2020 and before or at the time of:
    • Opening a new account that is different from existing accounts held by the retail investor;
    • Recommending a rollover of assets from retirement accounts into a new or existing accounts; or
    • Recommending a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account.
  • For new retail investors, Form CRS must be delivered before or at the earliest of:
    • Entering into an investment advisory contract with the retail investor;
    • Recommending to a retail investor an account type, a securities transaction, or an investment strategy involving securities;
    • Placing an order for the retail investor; or
    • Opening a brokerage account for the retail investor.

A thorough review of these two (2) risk alerts should enable firms to be ready for the initial compliance assessments expected by OCIE and FINRA within one year of the June 30, 2020 compliance date.

Note: RegEd is not engaged in rendering legal, accounting or other professional services. If legal or other professional advice is warranted, the services of an appropriate professional should be sought.

About the Author

Margie Webber is the Director, Regulatory Compliance BD/IA at RegEd, Inc.

CE Council Fall 2019 Firm Element Advisory Topics

Every year, RegEd reviews the latest guidance on CE Council Firm Element topics.  Several times a year, the CE Council, established by FINRA to oversee the continuing education rules, writes the regulatory element exams and issues guidance on what they consider appropriate FE training topics.  

Following are some highlights of new or updated topics as they appear in the recent Fall Advisory.

Alternative Investments

  • Digital Assets: Updated for Reg. Notice 19-24: Encourages firms to keep FINRA abreast of their activities related to digital assets.
  • Cryptocurrencies: An alert to warn investors to be cautious when considering shares of companies that tout the high returns associated with cryptocurrency-related activities without the business fundamentals and transparent financials to back up such claims. (RegEd Course 912)
  • Supervision: Complex Products: FINRA Notice 12-03. Identifies characteristics that may render a product “complex” for purposes of determining if a product is subject to heightened supervisory and compliance procedures and gives examples of heightened procedures. (RegEd Course 916)

Anti-Money Laundering

  • Suspicious Activity Reporting: Updated for Reg. Notice 19-18 on red flags. (2020 AML Update course, 35AU20)

Communications   

  • FINRA Regulatory Notice 19-31 (September 19, 2019): Disclosure Innovations In Advertising And Other Communications With The Public.
  • Communications Related To Departing Registered Representatives: Updated for Reg. Notice 19-10. FINRA Provides Guidance on Customer Communications Related to Departing Registered Representatives.

Cybersecurity

  • Imposter Websites: Updated for Info Notice April 29, 2019. FINRA Provides Guidance to Firms Regarding Suspicious Activity Monitoring and Reporting Obligations. (We will add this info to our existing Cybersecurity courses 876_2 and 897)
  • FINRA Information Notice: October 2, 2019: Cybersecurity Alert: Cloud Based Email Account Takeovers.
  • Fraudulent Phishing Emails: Updated for Info Notice February 13, 2019.  FINRA Warns of Fraudulent Phishing Emails Targeting Member Firms.

Financial Responsibility Rules for Broker-Dealers

  • Capital, Margin and Segregation Requirements: New. Discusses SEC Rel. No. 34-86175. The SEC adopted capital and margin requirements for security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs), segregation requirements for SBSDs, and notification requirements with respect to segregation for SBSDs and MSBSPs. (We will update course 922, which addresses the current status of Dodd-Frank.)

Fixed Income

  • Supervision: Municipal Advisors: Updated for FINRA Reg. Notice 19-28 on Guidance Regarding Member Firms’ Supervisory Obligations When Participating in Investment-Related Activities with Municipal Clients. (Covered in the 2020 Supervision Update.)

Margin

  • Exchange Traded Notes: New. Discusses FINRA Reg. Notice 19-21 on new higher strategy-based margin requirements for ETNs and options on ETNs.

Municipal Securities

  • General: New. Discusses MSRB Reg Notice 2019-15. SEC Approves Amendments to MSRB Rules and Data Collection Related to Primary Offering Practices. (2020 Municipal Securities Update)
  • General: Advertising Rule Changes: New. Discusses amended Rule G-21 on advertising by brokers, dealers, or municipal securities dealers. (2020 Municipal Securities Update.)
  • General: Best Execution Rule: Updated to discuss MSRB Reg Notice 2019-5 amending implementation guidance on MSRB Rule G-18. (2020 Municipal Securities Update)

Obligations to Customers (New)

  • Regulation Best Interest: New. The SEC is adopting a new rule, Reg BI, establishing a standard of conduct for broker dealers and natural persons who are associated persons of a broker-dealer when they make a securities recommendation to a retail customer. Enhances the standard of conduct beyond existing suitability obligations, and aligns it with retail customers’ reasonable expectations. (Course 923, Regulation Best Interest & Form CRS)
  • Suitability: Know-Your-Customer and Suitability Obligations.  Same discussion of Rules 2090 and 2111 as contained in the last FE Advisory.

Observations From FINRA’s January 2020 Disciplinary Actions Report

Outside business activities and private securities transactions were a focus of FINRA’s January 2020 Disciplinary Actions Report with at least nine (9) cases being cited within the report.  Several registered persons were sanctioned for failure to notify and obtain prior written approval from their member firm before engaging in an outside business activity or private securities transactions.  

Those who failed to cooperate with FINRA’s investigation by refusing to provide on-the-record testimony have been barred from the industry. 

For those who did cooperate in the FINRA investigation, all but one received fines.  Fines ranged from $10,000 to $30,000.  (A fine was not issued in one case due to the registered representative’s financial status.)  All received suspensions ranging from three (3) months to eighteen (18) months.  The most egregious case resulted in a $30,000 fine and an eighteen (18) month suspension.  This case involved outside business activities that took place at the member firm branch office and involved customers of the member firm, private securities transactions as well as false statements on annual compliance and branch office questionnaires.   Several other cases also involved false statements on compliance questionnaires.

Sanctions around outside activities vary based on facts and circumstances.  FINRA’s 2019 Sanctions Guidelines provides information on principal considerations and sanctions:

Outside Business Activities

  • Principal considerations in determining sanctions include:
    • Whether the outside activity involved customers of the firm.
    • Whether the outside activity resulted directly or indirectly in injury to other parties, including the investing public, and, if so, the nature and extent of the injury.
    • The duration of the outside activity, the number of customers and the dollar volume of sales.
    • Whether the respondent’s marketing and sale of the product or service could have created the impression that the employer (member firm) had approved the product or service.
    • Whether the respondent misled his or her employer member firm about the existence of the outside activity or otherwise concealed the activity from the firm.
    • The importance of the role played by the respondent in the outside business activity.
  • Monetary fines range from $2,500 to $77,000 (disgorgement could also be considered).
  • Suspensions range from ten (10) days up to two (2) years (or could include a complete bar in lieu of suspension). 

Private Securities Transactions

  • Principal considerations in determining sanctions include:
    • The dollar volume of sales.
    • The number of customers.
    • The length of time over which the selling away activity occurred.
    • Whether the product sold away has been found to involve a violation of federal or state securities laws or federal, state or SRO rules.
    • Whether the respondent had a proprietary or beneficial interest in, or was otherwise affiliated with, the selling enterprise or issuer and, if so, whether respondent disclosed this information to his/her customers.
    • Whether respondent attempted to create the impression that his or her member firm sanctioned the activity, for example, by using the employer’s premises, facilities, name and/or goodwill for the selling away activity or by selling a product similar to the products that the member firm sells.
  • Monetary fines range from $5,000 to $77,000 (disgorgement could also be considered).
  • Suspensions range from ten (10) days to twelve (12) months based on extent of selling away (dollar amount of sales, number of customers, length of time over which selling away occurred).

Although FINRA’s 2020 Risk Monitoring & Examinations Priorities Letter did not flag outside activities specifically as an examination priority (other than a digital asset footnote), their January 2020 Disciplinary Actions Report certainly evidences an ongoing regulatory focus on outside activities.

How confident are you in your compliance program around outside business activities and private securities transactions?  When was the last time you trained your registered persons on how to report such activities to your firm for approval?  Are you adequately supervising the activities you do approve or condition? How are you documenting your supervision of these activities?  If you’ve denied activities, do you monitor to ensure activities aren’t taking place?  Do you have best practices in place to validate the information you receive in response to your annual compliance questionnaires and branch office questionnaires?  Do you require your non-registered persons to report such outside activities as a best practice?

RegEd is ready to assist with your compliance challenges.  Our solutions deliver proven, robust, compliance-optimized capabilities that enable extraordinary efficiency and strong compliance oversight, dramatically reducing the risk of non-compliance.  If you’d like to learn more, schedule a personalized consultation with our solution and subject matter experts. We’ll provide an overview of how RegEd’s enterprise platform enables our clients to improve efficiency, effectiveness and transparency across the enterprise.

BREAKING: NAIC Adopts a Best-Interest Standard for Annuity Sales

February 13, 2020—This afternoon, the National Association of Insurance Commissioners (NAIC) voted to recommend that the states amend their annuity sales regulations to require insurance agents to “act in the best interest of the consumer when making a recommendation of an annuity.”

The action came in the form of an amendment to the NAIC’s 2010 Suitability in Annuity Transactions Model Regulation, which was adopted by 45 states and the District of Colombia in the wake of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

The new best-interest standard requires insurance agents to exercise a greater degree of care in selecting annuities for their clients, to avoid conflicts of interest, to make certain disclosures to clients, and maintain adequate documentation to show that they have acted in the best interest of the client. Insurance companies are required to supervise agent compliance with this rule and to maintain compensation systems that will not undermine the best interest of clients.

Like the 2010 model regulation, the new model regulation requires that agents be trained in its requirements. For agents new to selling annuities, the new model calls for a 4-hour training course. For veteran agents who were trained under the old model regulation, the new model regulation allows for a 1-hour update course, but the regulation makes this option available only for the first 6 months after their state adopts the new rule.

RegEd has two courses completed that meet these requirements (which will be submitted for approval and continuing education (CE) credit in each state as their version of this regulation comes on line):

Recommending Annuities Under the NAIC Best Interest Standard (490)
This is the standard 4-hour training course required of insurance agents before they may sell annuities. It details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation. In addition, the course review the operations of different types of annuities and how they are used to meet different client need.

Recommending Annuities Under the New NAIC Best Interest Standard—1 Hour Update Course
Veteran insurance agents who previously qualified to sell annuities under their state’s version of the NAIC annuity suitability regulation may take this 1-hour update course to qualify to sell annuities under the new NAIC best-interest standard. This course details the standard of care agents must adhere to when recommending annuities to clients. It discusses the fact finding and analysis required to make a recommendation that is in the best interest of the client. It discusses conflicts of interests, disclosures to clients, and documentation.

These courses will be available in each state upon approval.

The state of Arizona has already announced that it is going ahead with its process for adopting its version of the NAIC model regulation.

Form CRS: An Overview of the SEC-Mandated Customer Relationship Summary Due June 30, 2020

About Form CRS

In June 2019, the SEC adopted requirements (SEC Release 34-86032) for registered investment advisers, broker-dealers, and dual-registrants that do business with retail investors to file Form CRS (customer relationship summary). Form CRS is intended to inform retail investors about:

  • The types of client/customer relationships and services the firm offers;
  • Fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services;
  • Whether the firm and its financial professionals currently have reportable legal or disciplinary history;
  • How to obtain additional information about the firm.

Form CRS applies to registered investment advisers, broker-dealers, and dual registrants that do business with retail investors. See page 189 of SEC Release 34-86032 for the definition specific to Form CRS and more information.

  • For investment advisers, Form CRS is known as Part 3 of Form ADV.
  • For broker-dealers, Form CRS is known as such and has no association with Form BD.
  • Form CRS does not apply to those who do business only with institutional investors.
  • Form CRS is an additional disclosure requirement. It does not eliminate any existing disclosures.
  • Form CRS may be delivered as part of a disclosure packet, but it must be the first document. For example, some investment advisers are considering a disclosure packet approach to include Form ADV Part 2B disclosure supplements.
  • Dual registrants may have particular challenges. For example, if the firm is a dual registrant, but the financial professional engaging with the retail investor is qualified only as a registered representative, it must be made clear in the relationship summary.

The deadline for firms to be compliant with Form CRS is June 30, 2020.

Form CRS is designed to help retail investors better understand the nature of the relationship and what services they can expect from a financial firm and its individual professionals, primarily in terms of a fee-based account with an investment adviser, a transaction-based account with a broker-dealer, and the significance, roles, and duties of an investment advisory representative versus those of a registered representative.

Formatting and presentation instructions are specific (See general instructions for Form CRS).

  • Firms must respond to each item and must provide responses in the same order as the items appear in the instructions.
  • The relationship summary must not exceed the equivalent of two pages, for standalone investment advisers or broker-dealers, or four pages, for dual registrants, using reasonable paper size, font size, and margins. If delivered electronically, the relationship summary must be the equivalent of the paper formatting.
  • The relationship summary should be concise and direct, using short sentences and paragraphs. It  must be written in plain English (see the SEC’s A Plain English Handbook: How to Create Clear SEC Disclosure Documents), taking into consideration retail investors’ level of financial experience. Responses to each item must be written as if speaking to the retail investor, using “you,” “us,” “our firm,” etc. Responses must be factual and provide balanced descriptions to help retail investors evaluate services.
  • White space, charts, graphs, tables, and other graphics design features should be included to make the relationship summary easy to read. For a relationship summary posted on a website or otherwise provided electronically, online tools are encouraged, including links to video or audio messages, mouse-over windows, chat functionality, and hyperlinks to information that enhances a retail investor’s understanding of the material in the relationship summary.
  • Conversation starter questions must be formatted to make them more noticeable and prominent than the standard surrounding text.

Conversation starter questions must be included in Form CRS. They are intended to engage retail investors in a discussion about the differences between an investment adviser and a broker-dealer and their relationship with a financial professional, including legal obligations, conflicts of interest, and reportable disciplinary history. For example:

  • “As a financial professional, do you have any disciplinary history? For what type of conduct?”
  • Firms must answer “yes” or “no” accordingly and, regardless of the answer, refer retail investors to Investor.gov/CRS, for additional information.
  • Firms with disciplinary history should be prepared to answer follow up questions and direct clients to additional information.

Other conversation starter questions pertain to conflicts of interest. (Item 3. Fees, Costs, Conflicts, and Standard of Conduct; see page 550 of SEC Release 34-86032 for more information.) For example:

  • “What are your legal obligations to me when providing recommendations as my broker-dealer or when acting as my investment adviser? How else does your firm make money and what conflicts of interest do you have?”
  • Firms will be required to distinguish firm-level from financial professional–level conflicts.

Initial Filing Requirements

Investment advisers must file Form ADV, Part 3 (Form CRS) electronically through IARD. Broker-dealers must file Form CRS electronically through CRD. Dual registrants are to file both. See page 544 of SEC Release 34-86032 for more information.

IARD and CRD systems should be available to accept filings on May 1, 2020; initial filings must be made no later than June 30, 2020.

Delivery Requirements to Clients

Initially, Form CRS must be delivered to current and prospective retail investor clients within 30 days of the regulatory filing deadline of June 30, 2020.

Investment advisers must send Form CRS to clients and prospective clients before or at the time they enter an investment advisory contract with the retail investor. This includes oral agreements. Broker-dealers must send Form CRS to clients and prospective clients before a recommendation of account type, securities transaction, or a recommendation of investment strategy involving securities is made or before placing an order for a retail investor, whichever is earliest. Dual registrants must send Form CRS in accordance with the earliest triggering event of an investment adviser or a broker-dealer.

Form CRS must be amended or revised and filed with IARD or CRD within 30 days of any information becoming materially inaccurate. Amended or revised versions of Form CRS must be delivered within 60 days of change to each retail investor who is a client or considered a prospect of the firm.

Compliance and Recordkeeping

The SEC may use the information provided in Form CRS to manage its regulatory and examination programs, and firms will need to integrate the relationship summary into their compliance controls, including policies and procedures, supervisory controls, testing, tracking, training, and recordkeeping.

  • Investment advisers must retain copies of each relationship summary and each amendment or revision, and they must retain a record of the dates that each relationship summary and any amendments or revisions were given to any client or prospective client who subsequently becomes a client. Records must be retained for a minimum of five years. (Amends Rule 204-2 of the Investment Advisers Act of 1940.)
  • Broker-dealers must retain a record of the date each relationship summary was provided to each retail investor, including any summary provided before the retail investor opens an account. Records must be maintained for a minimum of six years after the relationship summary is created. (Amends Rule 17a-3 of the Securities Exchange Act of 1934.)
  • Dual registrants must retain records in accordance with which role they adopt as a financial professional.
  • See page 499 of SEC Release 34-86032 for more information.

RegEd is ready to assist investment advisory firms, broker-dealers, and dual registered firms with various compliance issues related to Form CRS, including managing various disclosures, training, versioning, managing client delivery, and more. For further information, schedule a consultation with RegEd representative.

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