Compliance February 22, 2016

FINRA Turns Up Focus on the Values of a Firm

Broker/dealers urged in FINRA letter to define and strengthen their firms’ ethical business practices.
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Firm culture—the attitudes that affect client interests and shape ethical considerations—has a profound impact on investor outcomes and market integrity, according to the Financial Industry Regulatory Authority (FINRA). Broker/dealers will be receiving letters that request a self-exam on the firm’s own values, as well as the practices and processes the firm uses to conduct itself.

In January, FINRA posted a letter about culture, conflicts of interest and ethics. While definitions of “firm culture” can depend on an organization’s specific definition, the self-regulatory organization explains that they use the term to refer to “explicit and implicit norms, practices, and expected behaviors that influence how firm executives, supervisors and employees make and implement decisions in the course of conducting a firm’s business.” One initiative FINRA has set for this year is formalizing its assessment of firm culture, while continuing its focus on conflicts of interest and ethics. 

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On Thursday, FINRA outlined its priority for 2016: scrutinizing firm culture at broker/dealers, stating that how they conduct business, including managing conflicts of interest, is a direct outcome of the firm’s own culture. Ethic failures put both investors and the markets at risk, not to mention the firms themselves, FINRA says in “Establishing, Communicating and Implementing Cultural Values.” Failures in these areas can impose significant harm on investors and the markets as well as firms themselves. One estimate places fines and litigation costs to firms, or their parent companies, related to cultural failures at more than $300 billion since 2010—underscoring how critical it is for firms to establish and implement their own strong cultural values. 

FINRA says it will be reviewing how firms establish, communicate and implement cultural values, and whether cultural values are guiding business conduct. The self-regulatory organization plans to meet with executive business, compliance, legal and risk management staff at broker/dealers to discuss cultural values. FINRA also wants to discuss how the firm communicates and reinforces those values directly, implicitly and through its reward system.Of particular interest: how firms measure compliance with its cultural values; what metrics, if any, are used; and how they monitor for implementation and consistent application of those values throughout the organization.

This inquiry is not an indication that FINRA has concerns about a firm’s culture or has determined that the firm violated any rules or regulations, the self-regulator says. Rather, FINRA says, “our goal is to better understand industry practices and determine whether firms are taking reasonable steps to properly establish and implement their own cultural values within the firm. Knowing firms’ practices in this area, and the challenges they face, will help FINRA develop potential guidance for the industry and determine other steps that could be taken.”

NEXT: Here’s what FINRA wants broker/dealers to share

FINRA requests firms to supply the following summaries and descriptions by March 21:

  • A summary of the key policies and processes by which the firm establishes cultural values. In the summary, include whether this is a board-level function at the broker/dealer or at the corporate parent of the firm. If it is a board-level function, describe the board’s involvement. Also, provide a description of any steps initiated or completed in the past 24 months to promote, strengthen or change the firm’s culture.
  • A description of the processes employed by executive management, business unit leaders and control functions in establishing, communicating and implementing the firm’s cultural values. Include a description of how executive management communicates, promotes and establishes a “tone from the top” as it relates to cultural values (to the extent not covered by the previous question). Include a description of the firm’s approach to ensure that its cultural values are adopted and applied by middle management.
  • A description of how the firm assesses and measures the impact of cultural values (to the extent assessments and measures exist) and whether they have made a difference at the firm in achieving desired behaviors. Provide a summary of the policy statements, procedures, mission statements or other related documents that reflect the firm’s assessments and measures.
  • What processes the firm uses to identify policy breaches, including the types of reports or other documents the firm relies on, in determining whether a breach of its cultural values has occurred. The summary should focus on those activities the firm considers directly related to reinforcing its culture.
  • How the firm addresses cultural value policy or process breaches, once they are discovered. How are policy or process breaches addressed? What is the escalation process to surface and resolve such breaches?
  • The firm's policies and processes, to identify and address subcultures in the firm that may depart from or undermine the cultural values articulated by the board and senior management.
  • The firm's compensation practices and how they reinforce the firm’s cultural values.
  • The cultural value criteria used to determine promotions, compensation or other rewards. Describe opportunities for promotion to the managing director or equivalent level available to personnel of the compliance, legal, risk and internal audit functions.
Compliance February 22, 2016

Lawsuit Accuses Chevron of Not Using Negotiating Power for 401(k) Fees

The lawsuit also questions Chevron's failure to use a stable value fund, collective trusts or separate accounts.
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A new lawsuit claims that by providing participants the Vanguard Prime Money Market Fund instead of a stable value fund, as represented by the Hueler Index, from February 2010 to September 30, 2015, Chevron Corporation caused its 401(k) plan, participants and retirees to lose more than $130 million in retirement savings. 

Since at least February 2010, Chevron has provided plan participants as their sole capital-preservation, conservative investment option the Vanguard Prime Money Market Fund, initially in the higher-cost Investor class, and as of April 1, 2012, in the lower-cost Institutional class. During that time, the Vanguard Prime Money Market Fund provided an annual return that was 0.07% at its highest and as low as 0.04%. The lawsuit says “that microscopically small return did not even beat the rate of inflation during that time period.” 

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In the complaint, the Hueler Analytics Pooled Fund Comparative Universe (Hueler Index) data was used to show the returns of the funds in the Hueler Index have far exceeded the returns of the Vanguard Prime Money Market Fund in the plan. The Hueler Index shows stable value funds dramatically outperformed the plan’s money market fund—up to 67 times the return of the Vanguard Prime Money Market Fund.

NEXT: No consideration of collective trusts and separate accounts

The lawsuit also questions Chevron’s lack of investigation into non-mutual fund alternatives, such as collective trusts and separately managed accounts. “Holders of large pools of assets know that these investment vehicles are readily available to them and can be used for the same investment style and with the same portfolio manager, but are much less expensive,” the compliant says. Each mutual fund in the plan charged fees far in excess of the rates Chevron could have obtained for the plan by using these comparable products, according to the lawsuit.

The complaint quoted the United States Department of Labor’s Study of 401(k) Plan Fees and Expenses, which says separate accounts can “commonly” reduce “[t]otal investment management expenses” to “one-fourth of the expenses incurred through retail mutual funds.”

The complaint also notes that collective trusts also provide much lower investment management fees than the plan’s mutual funds, and in some instances, separate accounts. “Collective trusts are a common investment vehicle in large 401(k) plans, and are accessible even to midsize plans with $100 million or more in total plan assets, an amount which is a tiny fraction of the size of the Chevron plan,” the compliant says, stating that the Chevron plan has assets around $19 billion. The complaint notes that Vanguard offers low-cost collective trust funds to qualified retirement plans in several asset styles, including large-cap domestic equities, small-cap equities, international equities, and target-date funds.

The lawsuit also claims the plan’s recordkeeping fees were excessive in part because Chevron failed to monitor and control the amount of asset-based revenue-sharing fees Vanguard received. From February 2010 through March 31, 2012, Chevron caused the plan to compensate Vanguard for its recordkeeping services with assed-based revenue sharing of the annual expenses of the plan’s investment options instead of a fixed recordkeeping fee. “Chevron could have and should have capped the amount of revenue sharing to ensure that excessive amounts were returned to the plan but failed to do so. As a result, the plan therefore paid millions of dollars in excessive recordkeeping fees from February 2010 through March 31, 2012” the complaint contends.

The lawsuit also accuses Chevron of failing to conduct a competitive bidding process for the plan’s recordkeeping services within the past six years, which it says would have produced a reasonable recordkeeping fee for the plan.

NEXT: Failure to bargain for lower fees

Jumbo retirement plans, such as Chevron’s, have much more bargaining power to negotiate low fees for investment management services than even large plans, the complaint contends. Lower-cost institutional share classes of mutual funds compared to high-priced retail shares are readily available to giant institutional investors or even smaller asset holders that meet minimum investment amounts for these share classes.

According to the lawsuit, from February 2010 until on or about April 1, 2012, Chevron imprudently and disloyally provided participants the more expensive share class of Vanguard mutual funds, even though the identical investment was available to the plan at a much lower cost. The lower-cost shares of these mutual funds were available to the plan many years before Chevron moved to lower-cost share classes for the Vanguard mutual funds in 2012.

In addition, from February 2010 to April 1, 2014, Chevron provided the Artisan Small Cap Value Fund as a plan investment option. As of February 1, 2012, Artisan provided the exact same investment in an Institutional class share, which charged 99 to 100 bps in annual fees, compared to 122 to 124 bps for the Investor class shares, which were the shares in the plan. The lawsuit lists similar complaints with the Artisan Mid Cap Fund and Neuberger Berman Genesis Fund.

“Even though Chevron switched to the less expensive but otherwise identical share class of the plan’s Vanguard mutual funds on April 1, 2012, …inexplicably, and to the plan’s detriment, Chevron failed to do the same with the non-Vanguard funds when cheaper share classes continued to be available to the plan,” the lawsuit alleges.

The lawsuit charges that participants paid far higher fees than they should have, which resulted in receiving lower returns on their retirement investments, and fewer retirement assets to build for the future, than they would have obtained had Chevron performed its fiduciary duties. It contends that because Chevron imprudently and disloyally provided participants the much more expensive versions of the plan’s same mutual fund options during these dates, plan participants lost more than $20 million of their retirement savings through unnecessary expenses.

The lawsuit seeks to enforce defendants’ personal liability to make good to the plan all losses resulting from each breach of fiduciary duty and restore to the plan any profits made through the defendants’ use of the plan’s assets. In addition, the plaintiffs seek to reform the plan to comply with the Employee Retirement Income Security Act (ERISA) and to prevent further breaches of ERISA’s fiduciary duties and other such equitable or remedial relief for the plan as the Court may deem appropriate.

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