2018 SEC Examination Priorities

Art by Tim Bower

QUESTION: I provide investment advice to ERISA [Employee Retirement Income Security Act] plan participants and IRA [individual retirement account] owners. Based on the 2018 SEC [Securities and Exchange Commission] examination priorities, what issues do I need to consider, and how should I address them?

ANSWER: Protecting retirement investors and seniors—who in many cases are one and the same—continues to be a priority for the SEC. Based upon that agency’s areas of focus, you should review and update your disclosures to identify all conflicts of interest, particularly those affecting retirement investors, and make sure there are appropriate policies and procedures in place to safeguard their interests.

The SEC’s principal priority for 2018 examinations is “protecting retail investors, particularly seniors and those savings for retirement, and pursu[ing] examinations of firms that provide products and services directly to them.”

While the SEC and the Department of Labor (DOL) share the same objective of protecting retirement investors, they each address this goal in different ways. Unlike the DOL, the SEC does not generally characterize financial conflicts of interest as “prohibited.”

Instead, the SEC’s focus is on disclosing such conflicts and whether advisory practices appropriately address them. As stated by the SEC: “It is also important for financial professionals to inform investors of any conflicts of interest that might provide incentives for the financial professionals to recommend certain types of products or services to investors, including any higher cost or riskier products.”

While the examination priorities do not specifically mention recommendations of distributions and rollovers, these are the most important services that can be provided to retirement investors, given how those recommendations potentially can affect their lives. In fact, we are seeing SEC examinations of distribution/rollover recommendations made by broker/dealers (B/Ds) and registered investment advisers (RIAs) to plan participants. FINRA [Financial Industry Regulatory Authority] and the DOL are also looking into these activities.

Adviser communications with retirement investors about distributions and rollovers fall into two categories: education and recommendations. Policies and procedures are needed to support and oversee both. For example, in the case of a distribution/rollover recommendation, the policies and procedures should address the need to gather information about the plan’s investments, expenses and services and compare those with the investments, expenses and services in, for example, a proposed IRA, based upon the investor’s investment objectives, financial circumstances and needs.

For education, the policies should cover the communications that do not rise to the level of being recommendations. Whether the adviser provides educational activities or a recommendation, supervisory controls should be in place to oversee the implementation of the policies. Advisers should also consider that a distribution/rollover recommendation results in a conflict of interest if the adviser receives additional compensation as a result of the recommendation—i.e., the IRA advisory fee. This conflict of interest should be disclosed in the Form ADV Part 2A.  

The SEC is particularly focused on the “increased risks” of inadequate disclosure, including “advisers that changed the manner in which fees are charged from a commission on executed trades to a percentage of client assets under management [AUM].” And it’s not the only agency concerned about this conflict of interest. The DOL considers such recommendations a fiduciary act that results in a conflict of interest if the adviser receives additional compensation as a result of the recommendation. Also, FINRA, in its 2018 examination priorities, noted its intention to review registered representatives’ recommendations to switch from a brokerage account to an advisory account where that switch clearly disadvantages the customer.

Given this heightened scrutiny by all three agencies, advisers should insure they have policies and procedures in place that support compliant recommendations of account changes from commission-based to advisory fee. More specifically, the policies should describe the process that advisers should use in determining whether the recommendation is acceptable for the retirement investor. We know of an examination where the SEC took the position that any recommendation to move from a commissioned account to a fee account within 24 months of the commission payment should be closely scrutinized.

In conclusion, the SEC, the DOL and FINRA all appear to be circling some conflicts of interest. Advisory firms should be aware that conflicts of interest and DOL prohibited transactions (PTs) are similar, if not identical.

Fred Reish is chair of the financial services ERISA practice at the law firm of Drinker Biddle & Reath LLP. A nationally recognized expert in employee benefits law, Reish has written four books and many articles on ERISA, pension plan disputes, and audits by the Internal Revenue Service and Department of Labor. Joan Neri is counsel in the firm’s financial services ERISA practice, where she focuses on all aspects of ERISA compliance affecting registered investment advisers and other plan service providers.