The Division of Trading and Markets of the U.S. Securities and Exchange Commission (SEC) recently published a no-action letter in response to an inquiry by Banc West Investment Services (BWIS), which may be helpful to retirement plan focused advisers and broker/dealers.
Back in September 2018, BWIS requested that the staff of the Division of Trading and Markets “not recommend enforcement action to the Securities and Exchange Commission if BWIS transmits checks submitted by customers to rollover funds from a retirement plan into an individual retirement account to BWIS’s carrying broker/dealer in a manner consistent with the Commission’s exemptive order for checks received for purchases of deferred variable annuities.”
As detailed in the letter, BWIS felt it needed to seek SEC clarification of how to act in circumstances in which a BWIS customer formerly participated in a tax-qualified plan made available by his or her employer, such as a 401(k) plan, and now desires to roll assets held in such plan to an IRA, for the purpose of purchasing annuities. More specifically, although the assets to be rolled over may consist of investments in stock, mutual funds, employer securities and other investment types, the request for no-action relief was made “only with respect to distribution checks issued by a tax-qualified plan.”
The BWIS letter stated that a customer’s decision to roll assets to an IRA involves a number of considerations, which require, among other things, an examination of the services, investment options, fees and expenses that may be involved with a particular individual retirement account (IRA). As such, BWIS wrote, FINRA has cautioned its members that they must have policies and procedures in place reasonably designed to comply with FINRA rules applicable to rollovers. In particular, FINRA has reminded member firms that they have an obligation of fair dealing with respect to customers planning for retirement, and that if a recommendation is made, member firms must consider certain attributes unique to the individual customer, such as the customer’s age, other investments, financial situation and needs, and investment objectives.
Furthermore, BWIS said, FINRA rules prohibit member firms and their associated persons from making a recommendation unless they have sufficient information about the customer to believe that the recommendation is suitable for that customer. Even if a recommendation is not made, FINRA member firms are required to follow “know your customer” procedures. BWIS noted that member firms also must comply with the anti-money laundering obligations of FINRA Rule 3310, not to mention Internal Revenue Code requirements applicable to rollovers, including the requirement that individuals have only a 60-day window in which to roll over the distribution to another eligible retirement plan or IRA in order to avoid negative tax consequences.
In its letter, BWIS represented that the request for relief by is based on a compliance conflict resulting from its obligation to comply with the FINRA rules discussed above and its obligation to comply with the requirements of Exchange Act Rule 15c3-3, vis a vis the rule’s “prompt transmission” exemption requirement, which generally requires the transmission of customer funds and securities to a firm’s clearing broker or dealer by noon of the next business day after receipt.
By way of context, for customer cash, Rule 15c3-3(e) requires a broker/dealer to maintain a reserve of funds or qualified securities in an account at a bank that is at least equal in value to the net cash owed to customers. The amount of net cash owed to customers is computed pursuant to a formula contained in Exhibit A to Rule 15c3-3. In effect, if a broker/dealer owes more to its customers than its customers owe to it, the broker-dealer must set aside at least an amount equal to that difference so that it is readily available to repay customers. Put simply, an exemption to this requirement is available for “introducing brokers” who “promptly transmit” customer cash to the carrying broker/dealer entity.
In its letter, BWIS stated that it “cannot in all circumstances” make the fair dealing or suitability determinations called for by a rollover decision and at the same time ensure that a customer’s distribution check is forwarded to the firm’s carrying broker/dealer by noon of the next following business day.
The BWIS letter offered substantial detail about the firm’s check processing. In sum, BWIS centralizes check processing in its main office in Omaha and directs registered representatives and customers to send checks to that office. The Omaha office, BWIS said, cannot always comply with the prompt transmission requirement because the firm must consider whether it has met its obligations under applicable FINRA rules.
The SEC’s no-action letter, responding to these representations, reminds readers that, indeed, pursuant to paragraph (k)(2)(ii) of Exchange Act Rule 15c3-3, an SEC-registered broker/dealer is only exempted from the requirements of that rule “provided that it serves as an introducing broker or dealer (i.e., does not hold customers’ funds or securities), clears all transactions with and for customers on a fully disclosed basis with a clearing broker or dealer, and promptly transmits all customer funds and securities to the clearing broker/dealer which carries all of the accounts of such customers and maintains and preserves such books and records pertaining thereto pursuant to the requirements of Exchange Act Rules 17a-3 and 17a-4 as are customarily made and kept by a clearing broker/dealer.”
According to the no-action letter, the SEC has defined the term “promptly” as requiring that “transmission or delivery is made no later than noon of the next business day after the receipt of such funds or securities.” This is, thus, the core of BWIS’s concerns about suitability and timeliness of retirement-plan-to-IRA check processing. As the rules are written, in order to rely on an exemption from Exchange Act Rule 15c3-3 pursuant to paragraph (k) of the rule, a broker/dealer must forward checks made payable to a carrying broker/dealer by noon of the next business day following a registered representative’s receipt of such a check from a customer.
At this point, the SEC’s letter acknowledges the difficult position this narrow exemption may place a firm in when it is processing retirement plan distributions destined for an IRA held at the home office or carrying broker/dealer.
“Based on your representations, [SEC staff] will not recommend enforcement action to the Commission if BWIS fails to transmit a customer’s rollover check to the carrying broker/dealer by noon of the next business day after receipt, if the purpose for holding the check is to complete the fair dealing or suitability process in compliance with applicable FINRA rules,” the no-action letter states.
The letter immediately lays out further stipulations for BWIS, declaring that the firm must do the following:
- Establish policies and procedures reasonably designed to ensure that customer checks are safeguarded;
- Ensure that a registered representative of BWIS who takes possession of the rollover check promptly transmits such check to an office of supervisory jurisdiction (OSJ) of BWIS for processing;
- Ensure a registered representative of BWIS complete the fair dealing or suitability process within seven business days after an OSJ of BWIS receives the rollover check;
- Transmit the rollover check to the carrying broker/dealer no later than noon of the business day following the date a registered representative of BWIS completes the fair dealing or suitability process;
- Maintain a copy of each such check and create a record of the date the check was received from the customer and the date the check was transmitted to the carrying broker/dealer if the customer’s rollover request is approved, or returned to the customer if it is rejected; and
- Disclose to customers its process for handling customer checks received in connection with rollovers.
The SEC letter concludes by warning BWIS (and anyone in a similar position) “should be aware that this is a staff position with respect to enforcement only and does not purport to express any legal conclusions regarding the application of the federal securities laws.”
“This position is based solely on the foregoing description,” the no-action letter concludes. “Factual variations could warrant a different response, and any material change in the facts must be brought to the staff’s attention. This position may be withdrawn or modified if the staff determines that such action is necessary for the protection of investors, in the public interest, or otherwise in furtherance of the securities laws.”
The full texts of the BWIS request and the SEC no-action letter are available here.