This week the Enforcement Section of the Massachusetts Securities Division of the Office of the Secretary of the Commonwealth filed an administrative complaint to commence an adjudicatory proceeding against Scottrade, Inc., for violations of the Massachusetts Uniform Securities Act and the regulations promulgated thereunder.
In particular, the enforcement section alleges in its complaint that Scottrade—a Massachusetts-registered broker/dealer—engaged in acts and practices in violation of Section 204 of the Uniform Securities Act and related regulations.
The enforcement section claims “Scottrade knowingly violated its own internal policies designed to ensure compliance with the United States Department of Labor (DOL) Fiduciary Rule by running a series of sales contests involving retirement account clients.”
The alleged details and timeline of the wrongdoing are tied to the Department of Labor’s (DOL) ongoing fiduciary rule expansion. As readers will recall, on April 6, 2016, the DOL issued its re-minted fiduciary rule, which expanded dramatically the investment advice fiduciary definition under the Employee Retirement Income Security Act (ERISA) of 1974. At issue here, according to the Massachusetts regulators, the new fiduciary rule significantly expanded the circumstances in which broker/dealers, investment advisers, insurance agents, plan consultants, and other intermediaries are treated as fiduciaries.
“In part, the fiduciary rule, which requires that material conflicts of interest be disclosed to clients, intends to stem the tide of unethical sales practices in the brokerage business,” the regulators argue. “On June 9, 2017, the impartial conduct standards of the fiduciary rule went into effect. The impartial conduct standards require all financial advisers who manage retirement accounts or provide retirement advice to act as fiduciaries, placing the interests of their customers ahead of their own.”
As the complaint seeks to establish, prior to the fiduciary rule reforms, Scottrade “employed a firm-wide culture characterized by aggressive sales practices and incentive-based programs.”
“For example, between December 2015 and April 2017, Scottrade ran a series of call nights and sales contests, in part to drum up additional business in light of an upcoming merger with TD Ameritrade,” regulators claim. “In response to the fiduciary rule reform, Scottrade added identical provisions to both its brokerage and investment adviser compliance manuals. These provisions, titled ‘Impartial Conduct Standards Applicable to Covered Recommendations in Retirement Accounts,’ provide that: The firm does not use or rely upon quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or reasonably expected to cause associates to make recommendations that are not in the best interest of retirement account clients or prospective retirement account clients.”
According to regulators, Scottrade made these appropriate and necessary changes in anticipation of its obligations under the upcoming fiduciary rule.
“However, Scottrade subsequently failed to enforce the above provisions, rendering these policies meaningless,” regulators claim. “Despite its addition of policies related to the fiduciary rule, Scottrade expanded the scale and scope of the very sales practices its policies were designed to curtail.”
Full details of the alleged wrongdoing are available in the text of the complaint. The basic story is that, notwithstanding the implementation of relevant elements of the fiduciary rule on June 9, 2017, Scottrade launched two sales contests between June and September 2017 that ran in violation of its own internal policies designed to ensure compliance with the fiduciary rule. The firm has not yet returned a request for comment.
“Scottrade launched the first of these two contests, the Q3 Win and Retain Sales Contest, on June 5, 2017,” regulators suggest. “The Q3 Sales Contest came on the heels of predecessor sales contests, placed an explicit emphasis on generating net new assets, including retirement assets, and offered $285,000 in cash prizes. Almost immediately after the Q3 Sales Contest ended on July 31, 2017, Scottrade launched the Q4 Dials and Referral Contest, which was nearly identical in scope and structure. The Q4 Sales Contest offered weekly cash prizes in the amounts of $500 and $2,500. Both the Q3 and Q4 contests perversely incentivized Scottrade agents to bring in new assets from customers, including through the rollover of retirement assets.”
The regulators argue that, during both the Q3 and Q4 Sales Contests, Scottrade knowingly included retirement account clients in the scope of the contests.
“As a result, the Q3 and Q4 Sales Contests, which focused on gathering additional assets, including those of Massachusetts retirement account clients, ran in direct contravention of Scottrade policy,” regulators claim. “Scottrade encouraged its customers to bring new assets to the firm, while failing to inform them of the conflicts arising from the sales contests. To appraise the performance of its agents, Scottrade frequently circulated internal metrics and rankings during the Q3 and Q4 Sales Contests. Under the Q3 Sales Contest, Scottrade required its agents to achieve a call penetration of at least 80% in order to qualify for particular prizes. Under the Q4 Sales Contest, Scottrade required its agents to make recommendations and referrals to its investment advisory program in order to qualify for particular prizes.”
Regulators argue these contests could reasonably be expected to cause Scottrade agents to make recommendations in their own best interests rather than the best interests of their customers, including those with retirement accounts.
Important to note, the DOL announced that until July 2019, it “will not pursue claims against fiduciaries working diligently and in good faith to comply with the new fiduciary rule or treat those fiduciaries as being in violation of the fiduciary rule.” But the regulators argue Scottrade is abusing this temporary non-enforcement policy and went too far with these ongoing sales contests: “Although it had in place policies designed to ensure compliance with the fiduciary rule, Scottrade failed to take any meaningful steps to implement and enforce such policies.”
Readers should note that the Massachusetts regulators obviously cannot enforce ERISA, and so, instead, they seek to tie these violations of the DOL fiduciary rule to various state-based laws, making the case that Scottrade patently failed to reasonably supervise agents, investment adviser representatives and other employees to assure compliance with its own internal conflict of interest policies that were required to be established to bring prior sales practices into line with ERISA.