Breach of Fiduciary Duty

Core ValuesThe SEC recently commenced an enforcement action against an investment advisory firm and its principal in connection with the failure to disclose material conflicts of interest in connection with new mutual funds that the firm recently created and managed. The SEC is seeking disgorgement and an injunction against the firm and its principal.

Clients of the firm paid a fee for investment advice. Initially, the clients were invested in an ETF program. The firm subsequently created its own mutual funds that it managed for a fee.
Without disclosing that it would be paid both an investment advisory fee and fees for managing the mutual funds, the firm moved its clients into the mutual funds, which mirrored the investments in the ETF program. So why did the SEC take issue with this?

For one, the firm did not disclose the conflict of interest associated with this new strategy. The conflict of interest is that the firm is going to be paid two fees for an investment program that was the same as the prior program for which clients were only charged one fee.

Interestingly, the SEC in its complaint does not contend that the charging of two fees is per se improper. Instead, the issue is the fact that the firm did not disclose the conflict to its client before shifting the investment program. So what does this mean?

It all comes down to disclosure. If you disclose all conflicts of interest in sufficient detail, you may be able to avoid these types of enforcement issues.

It was great speaking at the May 17 New York NSCP regional conference on risk issues facing firms where Ernie Badway and I discussed cyber-security, risk issues, regulatory matters, issues involving elder clients and ways compliance personnel can protect themselves.  For those of you who could not make the conference, these topics are frequently discussed in our various publications.  Feel free to access them here and use them as you see fit.  Core Values

On Tuesday, May 17, Ernie Badway and I are the keynote speakers at the NSCP Spring Conference in New York, entitled “Juggling Compliance Risks — Maintaining the Balance“. BoardAmong other things, Ernie and I will be speaking about cybersecurity, risk avoidance techniques, government regulations, elder client issues and compliance.  We hope to see you at the conference.

The SEC recently charged four investment advisors who allegedly used free dinners to entice older clients to their firm. At these dinners, these individuals allegedly provided fraudulent marketing materials to the attendees and ultimately did not invest all of the money that they were given.whistleblower

Granted these four advisors may just be bad apples and not an indictment of the use of free lunches or dinners to attract new clients and money. However, if you do engage in these types of “seminars”, this enforcement action should be a wake-up call.

The SEC and FINRA have made it very clearly how they intend to approach marketing efforts directly at seniors. Both regulators will be taking a hard look at these types of seminars used to attract elder investors.

So, if you are going to offer a free meal, make sure that you are giving something of value to your prospects. Do everything on the up and up when offering these types of opportunities because your regulator is watching.

It is no secret that FINRA and the SEC are sharply focused on issues regarding elder clients, including severe disciplinary action. There is another elder “issue” that must be kept in the forefront as well; senior designations.

Senior designations are “certifications” that financial advisors tag onto their other designations like CFA, etc. Such designations are meant to give an advisor an air of credibility or specialization when it comes to servicing elder clients.whistleblower

However, not all such designations are legitimate. Indeed, some are no different than the secret decoder rings we used to get out of a box of cereal. So what should you do?

You should not let any of your advisors tout any such designations unless and until you have had a chance to vet the legitimacy of the designation and the entity that is promoting it. Is there any sort of testing and continuing education requirement to maintain this designation? Have FINRA or the SEC ever commented on this designation and/or the entity that may be promoting it?

The key to any sort of senior designation is for you to conduct proper due diligence to ensure its legitimacy. Otherwise, you run the risk of running afoul with your regulator for allowing your advisors to tout a specialization that does not exist.

With the exception of those of you who have literally been asleep for the last few years, you are well-versed in the attention FINRA and the SEC are giving to issues surrounding elder investors. Among other things, there is a real focus on elder abuse.

Some commentators believe that all of this attention may inevitably lead to additional regulations regarding how you handle older investors. Like most things from a regulatory/legislative standpoint, the loudest wheel will get the most oil.confusion.jpg

With the graying of the baby boomers, this section of society will undoubtedly have a large voice in whatever regulations or laws may come to pass. It seems as though most of the claims I have defended over the last 20 years have involved investors over the age of 60 such that I can say there is a real issue with how firms handle older clients.

Is there anything that can be done to avoid this potential regulatory headache? I think that there are things that can be done on both a macro and micro level.

The macro solution requires firms to take a big picture view of its customer composition. Assuming that there is a graying component to your customer base, you should have specific firm-wide policies and procedures that address elder issues; i.e., heightened supervision, alternate decision-makers, a committee that addresses elder issues, etc.

The micro solution is tied to the macro and can be addressed by a simple question. What are you as a firm doing to ensure your policies and procedures pertaining to elder investors are being carried through as written by your advisors/representatives? If you cannot answer this question, you might as well be signing off on those regulations.

Avoiding elder client regulations may still be in your hands. Are you doing enough to address the issue at your firm? Only time will tell.

  • photo from freedigitalphotos.net

Those famous words of the immortal Yogi Berra hold true when it comes to the SEC exam priorities for 2016. Among those at the top of the list are two familiar friends; protecting retail investors and investors saving for retirement.

It is clear that the SEC is looking in particular toward how retail firms are dealing with their older clientele since it is fair to assume that older client are those most likely preparing for retirement. So what does the SEC want to know?whistle

The SEC is looking at retirement services being offered, focusing on whether there is a reasonable basis for recommendations, conflicts of interest, supervision and compliance controls, as well as marketing and disclosure practices. If you compare these priorities to FINRA’s exam priorities, you will see the overlap.

The overlap of these priorities should sound alarms bells off in your head. The SEC and FINRA have told you twice what your regulators will analyze during your next exam. You have a choice.
You can ignore these areas and not take prophylactic measures to make sure that your policies and procedures in these are consistent with current industry standards, or you can take a serious look at what your firm is doing for your clients who are focused on retirement investing. Something tells me that taking the path of least resistance will not win you any awards with your regulators.

So take affirmative steps and give your policies and procedures in these areas will deep thought. Do you have any policies and procedures in place? If so, do they go far enough and are they consistent with current industry trends and practices? FINRA and the SEC are doing some of your work for you, don’t miss out on the free advice they are giving you.

Most people say that New Year resolutions are only as good as the paper on which they are written. Notwithstanding that ringing endorsement, I will give it a shot.

Here are some things that you should be resolved to doing in the New Year:

  1. Read the SEC and FINRA exam priority letters that each issue shortly after the New Year.
  2. Reevaluate your data security policies and procedures by testing it with internal and external threats.confusion.jpg
  3. Reevaluate your policies and procedures regarding the client relationships you maintain with anyone over the age of 65.
  4. Communicate (in either writing or telephonically) with all of your clients at least once a quarter.
  5. Only communicate with your clients through a form of communication that is approved and monitored by your firm.
  6. Have a written follow-up communications after you speak with your clients.
  7. Put in writing to your clients those instances where your clients ignore your advice.
  8. Never put anything in an email that you are unwilling to see blown up 1000 times as an exhibit in a trial or disciplinary proceeding.
  9. Hold on tight for the roller-coaster ride that we may see in the markets next year; your clients will expect you to be the voice and reason and calm.
  10. If a client makes a complaint, immediately report it up the chain, and do not try to resolve it yourself.

I am sure each of you could think of more thinks to resolve yourself to doing. So have it and best wishes for a healthy, happy and prosperous New Year.

* photo from freedigitalphotos.net

Ernie Badway and I have prepared a series of podcasts dealing with the relationships between broker-dealer, investment advisors and their customers.  BoardHere is the third part of that series focused on risk avoidance techniques.  Here is the link: https://soundcloud.com/fox-rothschild-llp/securities-best-practices.

Ernie Badway and I have prepared a series of podcasts that highlights client-issues and risk avoidance techniques for broker-dealers and investment advisors.  We hope you’ll take a listen.