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Compliance
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Massachusetts Settles Allegations With Five Independent Broker Dealers For Improper Sales Of Non-Traded REITs, Returning Over $11 Million To Investors |
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Thursday, May 23, 2013 16:08
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Ameriprise, Commonwealth Financial, Lincoln Financial, Securities America and Royal Alliance yesterday settled charges and agreed to a censure by the Commonwealth of Massachusetts for selling non-traded real estate investment trusts that amounted to more than 10% of the liquid net worth of Massachusetts residents. This Website Is For Financial Professionals Only
The five BDs agreed to make restitution totaling $11 million to Massachusetts investors and agreed to take action to prevent further violations of rules regarding sales of alternative investments.
It will be interesting to see if laws like the one in Massachusetts to avoid highly sales of concentrated positions in alternative investments have been adopted in other states because that presumably could trigger additional actions by other states. According to the complaints filed by the state:
- Ameriprise sold the REITs in 54 transactions with Massachusetts residents worth about $2.5 million in violation of the state’s net worth requirement.
- Commonwealth sold the REITs in 42 transactions with Massachusetts residents worth about $2.1 million in violation of the state’s net worth requirement.
- Lincoln Financial sold the REITs in eight transactions with Massachusetts residents worth about $500,000 in violation of the state’s net worth requirement.
- Royal Alliance sold the REITs in four transactions with Massachusetts residents worth about $59,000 in violation of the state’s net worth requirement.
- Securities America sold the REITs in 13 transactions with Massachusetts residents worthabout $778,000 in violation of the state’s net worth requirement.
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Are Brokers Fiduciaries, Even Though They Accept Commissions? Yes, Says Financial Advice Ethics Expert Ron Rhoades |
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Wednesday, May 22, 2013 20:41
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Tags: compensation | Dodd-Frank | fiduciaries | fiduciary standard
A lot of fee-only advisors think that advisors who accept commission compensation cannot be fiduciaries. That’s not necessarily true. Legal experts say the Securities Exchange Act of 1934 imposes a fiduciary obligation on brokers accepting commissions similar to the fiduciary standard under the Investment Advisers Act of 1940, and financial advice ethics experts Ron Rhoades published a pamphlet earlier this week saying that brokers are required to act as fiduciaries under state common law. Yet the issue continues to be highly contentious and has been the main sticking point separating Financial Planning Coalition and groups representing fee-only advisors from groups like Financial Services Institute, representing registered reps. This Website Is For Financial Professionals Only
With financial regulators and Congress wrestling with how to implement the Dodd-Frank Act, figuring out who should regulate RIAs, and being urged to consider creation of a single fiduciary standard that would apply to all financial advisors—fee-only and commission, I emailed Rhoades several questions about the obligation of commission-compensated brokers to act as fiduciaries. Below are Rhoades’ answers to my questions about how brokers can accept commissions and still be a fiduciary.
Please elaborate on the issue of advisors accepting commissions and still owing a fiduciary responsibility to clients.
If commissions are agreed-to in advance with the client, are reasonable in amount for the services and advice provided, and no additional compensation to the broker results from the sale of the product (such as other forms of revenue-sharing arrangements), then the commission fee structure is essentially the same as paying an agreed-upon fixed fee for the advice to be provided, given the amount to be invested. However, difficulties exist with commissions, in several respects:
First, is the amount of the compensation reasonable? If all you are doing is recommending an asset allocation to the client, and picking mutual funds, and if you charge 4% of $1,000,000 invested across multiple fund complexes, these acts might very well result in unreasonable compensation for the services provided. In each case, expert testimony is required to examine the services provided, and to determine whether the fee is “reasonable” under the fiduciary standard for the advice which is provided. There are many, many different circumstances in which brokers are currently operating on a commission basis, where the compensation might be viewed by an expert as unreasonable.
Second, have you as a fiduciary limited yourself too much, in terms of the products being able to be accessed? Dodd-Frank permits a broker, if the fiduciary standard is applied, to have a limited range of product offerings. Even then, the SEC may place limits on this practice.
Third, have you avoided all differential compensation? As stated above, differential or variable compensation is difficult to defend under the “best interests” fiduciary standard, and likely prohibited under ERISA’s tougher “sole interests” fiduciary standard.
You say, "Commission‐based compensation is not, in and by itself, contrary to fiduciary principles, provided the commissions do not vary with the advice being given and provided that the compensation received by the advisor is reasonable for the services provided." What do you mean about commissions varying with the advice being given?
Technically, the “best interests” fiduciary standard of conduct does not prohibit commission-based compensation, nor does it prohibit additional compensation being paid to the fiduciary from a third party. In theory, there is nothing different from a flat fee being charged for one-time investment advice, versus a commission; the only difference is how the fee is computed (not necessarily the amount), and who pays it (either way, it results in a payment from the client, whether direct or indirect).
The problem arises when the amount of compensation varies depending upon the advice which is given. For example, if one product pays a fiduciary 6%, plus 0.25% trailing fee indefinitely, while another product pays a fiduciary only 4% with no trailing fee, then the fiduciary has a financial incentive to recommend the higher-cost product. In this respect, the fiduciary bears the burden of demonstrating, in a court of law (or arbitration), that the client is not harmed by paying a higher fee. Since substantial economic evidence demonstrates that higher-fee products possess, on average, lower returns, it becomes very problematic for the fiduciary to try to justify his or her actions.
Given the higher attention being paid by litigation attorneys to fiduciaries who recommend (or, in the case of plan sponsors, approve the selection of) higher-fee-and-cost products, it is only a matter of time before some client of a fiduciary would challenge the fiduciary in an arbitration or legal proceeding. In my mind, the better way is to avoid the conflict altogether. Specify and agree with the client on the amount of compensation to be paid, in advance of any recommendation being undertaken. Then adhere to that amount of compensation.
Of course, the business practices of Wall Street will be forced to change, under a levelized compensation approach. Gone will be the insidious practices of payment for shelf space (a type of “pay-to-play” arrangement), soft dollar compensation, and other compensation structures which result in the fiduciary (individual or firm) receiving greater total compensation as a result of recommending X product, instead of Y product.
Even fee-only advisors possess conflicts, however, which may cause differential compensation. The classic examples involve whether to purchase a fixed immediate annuity, or to pay off a mortgage or other debt. In both instances, a fee-only advisor whose fees are based upon the amount of investment assets managed would possess a conflict of interest. In these instances, fiduciary advisors must be very careful to justify the advice that they provide. There may be solid reasons to not purchase an immediate annuity for a client who is retired (there are many factors at play). There may be good reasons to not pay down a mortgage (due to deductibility of interest, possible low interest rate being paid relative to returns obtained in the capital markets, etc.). This is a case where the conflict of interest is unavoidable, and must be properly managed. Fee-only advisors are to be applauded for avoiding commission-based compensation, and other third-party payments, which can result in conflicts of interest. Yet, fee-only advisors may, in some instances, still possess a conflict of interest, which must in such instance be properly managed.
If an advisor can accept commissions and still be a fiduciary under ERISA, can a broker be a fiduciary on nonqualified assets?
And are you saying that the broker is a fiduciary under the ‘34 Act?
Not under the ’34 Act. But, rather, fiduciary status arises under state common law. Here’s the key. A person registered under the ’40 Act, and operating as an investment adviser, is automatically a fiduciary. At the time the 1940 Investment Advisers Act was adopted, everyone thought it imposed fiduciary duties. (The U.S. Supreme Court only confirmed that fact, in its seminal 1963 Capital Gains decision.)
A person registered under the ’34 Act may be, and often is, still a fiduciary. It was commonly known (and stated by NASD, now known as FINRA, and by the SEC, in the early 1940’s) that brokers were fiduciaries when they provided personalized investment advice—i.e., when they formed a relationship of trust and confidence with the client. Fiduciary status results not from the application of the ’40 Act (which relates only to whether registration is required), but due to the application of state common law.
The ’34 Act, unlike ERISA, does not preempt the application of state common law, as to the application of the fiduciary standard of conduct. Many, many brokers (and even some insurance agents) are found to be fiduciaries, applying state common law. In fact, the #1 complaint in arbitration proceedings against brokers in the past five years has been for “breach of fiduciary duty.”
When the ’40 Act was enacted, nowhere in the ’40 Act did it state that brokers were not fiduciaries. Indeed, it was commonly known at the time that brokers were fiduciaries when providing personalized investment advice—i.e., when in a relationship of trust and confidence with the client. And simply by the use of a title such as “financial consultant,” or a designation such as “financial planner,” the broker has taken the necessary step to invite the client into, and accept, a relationship of trust and confidence. Every instance is still a facts-and-circumstances analysis, yet most brokers – who pride themselves in knowing their clients, meeting with them regularly, etc. – have likely formed the relationship of trust and confidence which results in fiduciary status being imposed, as to those clients.
Can a broker get paid different commissions depending on the class of shares of a mutual fund and still be a fiduciary?
Technically, yes under state common law and under the Advisers Act, but not under ERISA (unless the DOL grants exemptive relief in this area). Differential compensation under ERISA would violate its strict “sole interests” fiduciary standard and ERISA’s prohibited transaction rules.
For example, in the retirement space arena a mutual fund may have share classes which vary from R-1 to R-6. R-1 may have a 1.00% 12b-1 fee (which is passed on to the brokerage firm in a revenue-sharing arrangement), while class R-6 might have a 0.05% annual 12b-1 fee. Other classes would have fees in between. This permits the fiduciary advisor to negotiate, in advance with the client, what the fees to be received will be. (Even then, I think 12b-1 fees are fraught with problems, including anti-competitiveness.) If the agent is being paid a straight commission, then the commission should be negotiated in advance between the fiduciary and the client. Any product which fits within that commission level can then be considered by the fiduciary. (A disclosure must be made that other products will not be considered by the fiduciary, and the ramification of that limitation should likewise be explained to the client). If, however, no agreement is made in advance with the client as to the maximum amount of commission to be charged, then the selection of a fund with a higher commission becomes problematic, for the reasons noted above.
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RIA Brochure Delivery Rule: Do I Really Have To Deliver This "Thing" To Clients If I Made No Material Changes Since Last Year? |
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Thursday, May 02, 2013 17:43
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A Registered Investment Adviser’s ADV Part 2A--also called a "brochure"--is one of ithe most critical documents an an advisory firm creates. It's your public disclosure form, the document everyone you work or hope to work with with must see.
As securities attorneys, we spend many hours interpreting the SEC’s instructions and tailoring brochures to each RIA's business--your people, products, style, and operations.
Here are some insights into the process of creating this important disclosure document, including one that forever quashes the notion that you are not required to deliver your brochure to clients annaully if you have made no material changes to your broichure since you last sent it to a client.
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After about an hour into a meeting an attorney, advisors have a tendency to start calling their brochure, “this thing.” It's understandable. Almost all of the 18 or 19 Items covered in the brochure leave something up to interpretation. It becomes a "thing" with a life of its own.
Meanwhile, minute details take time and attention to draft, like what constitutes soft dollars, a description of the material risks involved with investing, and disclosures about separate account managers, subadvisory relationships, or unaffiliated wrap programs.
At some point during the process, many advisors seem to step back ask two questions:
- Is anyone actually going to read this thing?
- What am I supposed to do with this thing?
The first question is relatively simple. While you would hope that every investment advisory client read your brochure cover to cover, that is not a reality.
However, it is safe to assume that any regulator charged with auditing an investment advisory will read “this thing” in its entirety. Accordingly, it is imperative for this (if no other reason) that the brochure is thorough, clear, and accurate.
The second question is also relatively simple, but with a slight twist. Under SEC Rule 204-3, codified at 17 CFR 275.204-3(b)(2), a registered investment advisor is required to deliver a brochure to a client or prospective client before or at the time of entering into an investment advisory agreement. Moving forward, a registered investment advisor is required to:
(2) Deliver to each client, annually within 120 days after the end of your fiscal year and without charge, if there are material changes in your brochure since your last annual updating amendment:
(i) A current brochure; or
(ii) the summary of material changes to the brochure as required by Item 2 of Form ADV, Part 2A that offers to provide your current brochure without charge. (Emphasis added.)
This leads to the logical conclusion: an investment advisory firm is not required to deliver a brochure to each of its existing clients unless there has been a material change. However, the instructions for Form ADV Part 2A indicate otherwise:
Each year you must (i) deliver, within 120 days of the end of your fiscal year, to each client a free updated brochure that either includes a summary of material changes or is accompanied by a summary of material changes, or (ii) deliver to each client a summary of material changes that includes an offer to provide a copy of the updated brochure and information on how a client may obtain the brochure. See SEC rule 204-3(b) and similar state rules.
The term “unless there has been a material change” is demonstrably absent from the instructions.
In light of the above conflict and the SEC’s stated justification for imposing what is commonly called the “Brochure Delivery Rule,” it is clear that RIAs must deliver (or offer to deliver) an updated brochure to its existing clients within 120 days of fiscal year end-–even if there have been no material changes.
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Securities Lawyers Investigate Losses In UBS Willow Fund |
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Friday, April 26, 2013 14:46
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Tags: compliance | fraud Securities attorneys at Klayman & Toskes say they are investigating claims of UBS Financial Services customers who purchased the UBS Willow Fund, a private hedge fund formed in 2000. In October of 2012, investors were notified that the Fund would be liquidated. With the massive losses losses reportedly sustained by investiors in this UBS hedge fund, it's wise for RIAs to be aware of the case.
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According to a press release, "many investors were advised that the Fund was a safe, low risk product." The Fund has declined about 80%.
"K&T is investigating whether UBS adequately disclosed the risks associated with the Willow Fund," says the release, "as well as whether investors’ portfolios were over-concentrated in the Fund."
The individual brokers and advisors who sold the Willow Fund are not the target of this investigation.
K&T is looking into UBS’s conduct in connection with its marketing of the Fund to its customers, and whether the Willow Fund deviated from its disclosed strategy of investing in distressed debt and instead started speculating in foreign sovereign debt credit default swaps. It is believed that credit default swaps eventually led to the collapse of the fund, and caused investors to lose a substantial portion of their investment.
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Consumer Financial Protection Board Weighs In On Senior Advisor Designations; Says SEC, States, And Other Lawmakers Must Act |
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Thursday, April 25, 2013 20:02
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Tags: Advisor businesses | CFPB | client education | fraud | regulation Consumer Financial Protection Board (CFPB), an agency created by Dodd-Frank Act as an uber-regulator of financial services in the U.S., issued a report and recommendations today addressing the problem to senior citizens by of designation proliferation. The report offers some very sound conclusions that any sensible, informed, and well-meaning individual would have to agree with, but whether or not CFPB’s recommendations will prompt any reform is anybody’s guess.
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The CFPB could turn out to be an agency with little power. It doesn't have the staff to police the securities industry and it's difficult to to know if the Securities and Exchange Commission, state regulators, or other regulators of the financial services industry will act on its recommendations. This report shows that the agency can study an issue and come up with some pretty obvious conclusions, but we'll have to see if it has the political capital to get anything done and whether it wants to spend that capital addressing issues that financial advice professionals care about.
Some of the reports recommendations, which start on page 48, and some highlights are clipped below:
- The SEC may wish to consider establishing a centralized tool through which senior investors can verify a financial adviser’s designations.
- The SEC may wish to consider establishing a mechanism to capture complaints and enforcement actions against senior designation holders and consider reporting the data to designation providers consistent with and to the extent allowed by the Commission’s legal obligations.
- The SEC may wish to consider establishing a mechanism to capture complaints and enforcement actions against senior designation holders and consider reporting the data to designation providers consistent with and to the extent allowed by the Commission’s legal obligations.
- The Bureau found that the use of senior designations is extremely confusing for consumers. There are more than 50 different senior designations currently used in today’s marketplace with senior designees recommending or selling a variety of products, such as securities, investment opportunities, financial products.
- The titles and acronyms for the different designations are often similar or nearly identical to other designations, making it difficult for consumers to distinguish between different The use of senior designations is extremely confusing for consumers.
- Every senior designation is different, and there is a very wide range in their characteristics. For example, there are differences regarding training requirements, qualifying examinations, continuing education requirements, oversight by the conferring organization, complaint procedures for aggrieved clients, and accreditation. Moreover, the presence, depth and rigor of these components vary widely among designations.
- Rigorous training standards for the approved use of senior designations would reduce risks to consumers. If state and federal regulators imposed rigorous criteria for acquiring senior designations, including specific standards for qualifying prerequisites, education, training, and accreditation, consumers would likely encounter fewer designations, and those offered would require a consistent and a high-level of training and oversight. Rigorous standards of conduct for those using senior designations would reduce risks to consumers. If state and federal regulators set minimum standards for the conduct of senior designation holders, consumers would experience a more predictable, consumer-oriented market when shopping for senior financial expertise.
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