Compliance May 17, 2023

Common Pitfalls in Reg BE, BI, According to FINRA, SEC

Riskier and complicated assets require more due diligence, and regulatory officials laid out some practices for advisers to avoid.

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At the Financial Industry Regulatory Authority’s annual conference, enforcement leaders from the Securities and Exchange Commission and FINRA elaborated on some of the common problems they encounter during exams on compliance with both Reg BI and Reg BE.

Reg BI

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On Reg BI, Gurbir Grewal, the director of the SEC’s division of enforcement, noted an SEC complaint from June 2022 in which the SEC charged Western International Securities with marketing a high-risk and illiquid debt security to retail and retirement investors when the issuer recommended it be marketed to wealthier investors due to its riskier nature. Because there was no reasonable basis to market the security in this way, it violated the care obligation as required under Reg BI.

Nicole McCafferty, vice president of examinations for FINRA, elaborated on the same point later in the conference. She said advisers must consider a range of alternatives when giving advice to clients, but it is especially important when recommending securities that are relatively risky or complicated. James Wrona, vice president and associate general counsel for FINRA, added that assets in this category could include investments such as: investments traded on margin, cryptocurrency, penny stocks, private placements and asset-backed securities. Wrona said advisers should have specific training and procedures related to these assets.

McCafferty said that merely having a client sign a statement acknowledging the risk involved with an investment, a practice McCafferty says she has noticed, is not adequate to meet the standard of Reg BI. The adviser must clearly explain the risks to the client and how those risks fit into their stated goals and existing portfolio. McCafferty said advisers should document such transactions to ensure an adviser can prove compliance with Reg BI, including when a client goes against an adviser’s advice and invests in something that the adviser believes is not in their best interest. The adviser could be asked to justify such an investment during a FINRA exam and having that documentation would be valuable.

She recommended that advisers begin with basic due diligence and knowledge of specific investments before even turning to the specific needs of a client. She finds advisers often know their customers well but are not as familiar with the products they are advising as they ought to be.

Another common refrain from SEC and FINRA officials during the conference was that merely disclosing conflicts of interest is not adequate; attempts to mitigate those conflicts must also be made. McCafferty said an advisory firm cannot disclose to clients that they hold regular sales contests and rely on that disclosure to satisfy their obligation under the regulation. A sales contest creates a conflict that must be eliminated because of the incentive structure it creates, putting the firms’ interests or its employees’ interests ahead of clients’ interests.

When FINRA conducts examinations, its officials also look for corrective action related to past failure notices, McCafferty explained. Such follow-up exams that look for changes are not limited to past FINRA exams. FINRA will also examine failures noted by the SEC and state-level authorities, and FINRA examiners expect to see corrective actions based on those observations.

Reg BE

On Reg BE, which addresses trade execution, Chris Kelly, senior vice president and acting head of enforcement at FINRA, noted two recent cases in which broker/dealers routed orders to affiliated trading systems without looking for better pricing in other trading systems. This behavior is a violation of Reg BE, because if an unaffiliated trading venue can offer a better price, the broker should execute the trade on that venue instead. Kelly explained that this is not a failure based on “technicality or nuance,” but instead is “a complete failure.”

Kelly warned of some of the risks associated with finance professionals who are registered simultaneously as both a financial adviser and as a broker/dealer. He highlighted a pattern of dual registrants moving securities back and forth between brokerage and advisory accounts to drive up fees. For example, Kelly said he has seen some dual registrants who charge clients to buy securities in their capacity as a broker, only to transfer those securities to an advisory account so they can also charge advisory fees on the same assets.

Data & Research May 17, 2023

24% of Participants May Cut 401(k) Contributions

Nationwide Retirement Institute recommends that advisers and recordkeepers work to help participants maintain their financial futures.

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High cost of living and fears of a recession may be driving consumers to make bad decisions with their workplace retirement savings plans and finances in general, according to a new study from Nationwide Mutual Insurance Co.’s retirement institute.

To offset inflation, 37% of respondents are considering increasing their credit card debt to stay afloat; 24% are thinking about reducing their retirement plan contributions; 21% are considering taking or have already taken out a loan, according to a multiple response question in an April survey of 2,000 adult consumers conducted by the Nationwide Retirement Institute.

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Meanwhile, 57% of consumers have tapped into savings in the past 12 months to pay for everyday expenses, with Gen Z (born from 1997 through 2012) and Millennial (1981 through 1996) consumers doing so at the highest rates, 64% and 66%, respectively, according to the report.

These short-term tactics may erode the financial future for many consumers, who may not realize the resources and help available to them through workplace retirement plans, says Kristi Martin Rodriguez, senior vice president of the Nationwide Retirement Institute.

“Part of the problem is that participants tend to think of their 401(k) plan as a merely a savings vehicle,” Rodriguez says. “The truth is, it’s likely their plan offers more than just a means of accumulating savings. In many cases, plans offer free advice and planning tools and, in some cases, a means for turning their savings into a predictable stream of income in retirement.”

Rodriguez, who led the study for Columbus, Ohio-based Nationwide, says a good recordkeeper will be communicating with participants about financial education and tools available to them. Meanwhile, retirement plan advisers can work with the plan sponsor and participants on how to leverage these tools.

“Advisers can complement their own tools and resources with those offered by the plan’s recordkeeper to support participants with their day-to-day planning needs,” she says. “They can also partner with the recordkeeper and plan sponsor to develop a comprehensive strategy for creating visibility of these resources among employees and participants.”

Recession Concerns

Consumers may be acting cautiously with their money due to fears of a financial pinch in the near future, according to the survey findings. Of those surveyed, 68% expect a recession within the next six months, and nearly 80% of those expect it to be severe.

Due in part to this fear, positive consumer sentiment about the economy has fallen to only 16% of consumers, according to Nationwide, down from 24% last year. That decline in sentiment is matched by a drop in consumers citing positive feelings toward their own personal finances, which clocked in at 39% of those surveyed, down from 47% last year.

In the event of a recession, most consumers showed concern about their retirement saving and outcomes. According to a multiple response question from Nationwide, 52% of consumers were worried about their ability to save for retirement, 52% were worried about their retirement account losing value and 42% have concern about their ability to retire on time if a recession hits.

“It’s not surprising that people are feeling anxious,” Rodriguez says. “It’s important for advisers and financial professionals to understand the emotions their clients are feeling right now as a first step to helping them stay focused on their long-term financial plans.”

Communication is Key

Rodriguez notes that provisions in the SECURE 2.0 Act of 2022 can help bolster retirement savings. She points in particular to the creation of emergency savings vehicles that allow up to $1,000 per year for plan participants who need help covering “unexpected expenses like a car repair or medical bills.” She also calls out the potential for employers to offer a match for participants making payments on student loan debt.

The success of these and other programs, however, relies in part on communicating to participants, according to the retirement institute head.

“A good recordkeeper will bring a strong communications strategy for helping participants understand these resources, but there’s also a huge opportunity for leaders of the company to be more deliberate about encouraging employees to engage with these communications to understand their options,” she says.

Getting people’s attention, however, may continue to be a challenge, according to the survey results. Most consumers, especially of younger generations, are turning to advice from friends and family, online resources, prayer and social media, according to Nationwide.

Only 30% say they are working with a financial adviser, with the other 70% citing cost (46%), not having enough assets to make financial advisement worth it (37%), not knowing who to go to (22%) and not believing they need advice (21%) as reasons why. Meanwhile, about one-third of all respondents (31%) said ChatGPT will provide better financial advice than a human adviser in the next five years, with that percentage at 37% for Gen Z and 43% among Millennials.

Rodriguez says today’s moment of fear can be one for financial professionals to engage with consumers.

“There can be a real temptation for consumers to retreat or even surrender when the financial news cycle seems so challenging,” Rodriguez says. “The first step for advisers is understanding where their clients are coming from by listening with empathy. That can set the stage for a more collaborative conversation about steps to keep them on track.”

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