Regulators’ push for greater transparency is rippling through a broker-dealer industry that’s queasy or downright cagey about disclosing conflicts of interest.
As a result, firms vary in how they share information with the public — with the most well-resourced and willing firms aiming to stay ahead of the curve.
For Commonwealth Financial Network, it's manifested in a "kitchen sink" of SEC Form ADV disclosures, its chief compliance officer says.
“Upon reading it, it’s terrible. It makes us sound terrible,” Commonwealth Financial Network CCO ’s chief compliance officer, Paul Tolley, said about the language the firm is now using in its Form ADV. The firm would not have considered using some of the language two to five years ago, said Tolley, who was speaking at FINRA’s annual conference.
Few, if any, other BDs have gotten so specific about their revenue sharing, and they’re leery of greater detail in FINRA settlement documents as well. Another firm, Northwestern Mutual, doesn’t even file a Form ADV for the company's main retail advice entity because it’s not an RIA.
But after the SEC’s recent 12b-1 fee cases, Commonwealth’s RIA is pulling out all the stops to explain how the firm makes money — even if that means adding a painful level of detail to its filings and website. “The reality is that we need to disclose that information,” Tolley said. The firm is “going to err in the most extreme way” on the side of spelling out conflicts, he added.
While firms differ in the methods they use to meet regulators' disclosure requirements, the landscape may change shortly. Yet critics question whether the SEC’s proposed Regulation Best Interest would actually reduce any of the conflicts. As firms await the final rule, their disclosures remain a dense patchwork that’s affecting their bottom lines.
Commonwealth's RIA affiliate
In light of the enhanced scrutiny from regulators, the “only mistake firms can make right now is to bury their heads in the sand,” according to Jacob Frenkel, a former SEC enforcement official who is now a member of the Dickinson Wright law firm.
“What works for one firm is not necessary applicable for others,” Frenkel says. “Each firm really has to do its own assessment as to what they must disclose on the Form ADV to ensure transparency.”
Tolley later cited Commonwealth's sections on revenue sharing with custodians and product sponsors as not presenting the firm in the best light. Its revenue surged by 15% to $1.4 billion in 2018, placing it fourth among IBDs behind Raymond James, Ameriprise and LPL Financial.
Commonwealth’s compliance practices have helped keep its regulatory cases at fewer than a third of the number amassed by its three rivals. Commonwealth has 40 regulatory disclosures listed on FINRA BrokerCheck, compared to an average of 184 each at the larger firms.
OUTLIERS AND LOOPHOLES?
Regulators' transparency efforts are putting pressure on firms to take an approach closer to that of Commonwealth's. But some outliers are able to make fewer disclosures than other companies of their size.
In contrast to the top 4 firms and most IBDs, Northwestern Mutual uses a limited purpose federal savings bank as its primary entity for providing fiduciary services for retail clients.
That entity — Northwestern Mutual Wealth Management — has $87 billion in assets under management but doesn’t file a Form ADV since it’s not an RIA. Two other affiliated RIAs called Mason Street Advisors and Northwestern Mutual Investment Services have Form ADVs, though.
Mason Street only provides advisory services to Northwestern entities, while the Investment Services RIA shares the same name as the firm’s BD but has no AUM. Investment Services offers brokerage products to support Wealth Management’s advisory offerings, its ADV states.
“We’ve determined that offering various financial services through a limited purpose bank like [Wealth Management] provides the greatest efficiency and convenience to our clients and financial representatives,” Northwestern spokeswoman Betsy Hoylman said in an email.
Regardless, firms’ various required technical documents haven’t helped clients’ muddied understanding of the difference between brokerage and RIA services or their grasp of industry practices like revenue sharing, according to PIABA President Christine Lazaro.
“There is a way to avoid disclosing that conflict. That would be to eliminate it,” Lazaro says, noting the recent SEC share-class cases.
“It seems like they were saying that it was OK to use a higher priced share class of a fund so long as you told everyone that's what you were doing,” she adds. “A clear disclosure which says, ‘I can sell you a cheaper fund but I'm going to sell you the more expensive class’ would raise some red flags with investors.”
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Royal Alliance must pay more than $2.5 million to one ex-client while dealing with charges against the firm and a former rep by William Galvin’s office.
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RIAs must start disclosing more about bad actors, auditors and asset breakdowns.
TOO MUCH DISCLOSURE?
Firms see disclosure as uncomfortably on the rise in multiple ways, however. In another panel at the conference, executives and attorneys for other firms also noted enhanced clarity about FINRA’s enforcement cases in firms’ Letters of Acceptance, Waiver and Consent settlements.
The regulator is including more information about the underlying allegations and facts of each case than in years past, according to securities attorney Ashley Bashur, counsel at WilmerHale. She would favor more material about which sanctions resulted from which violations, she said.
“It’s almost like reading tea leaves sometimes, and so the more you put in there about what the facts were, the more helpful that is to advise our clients both proactively and reactively when we’re dealing with FINRA,” Bashur said, adding that there’s a “delicate balance” to strike to give enough context without engaging in so-called rulemaking by enforcement.
LPL and other firms read the AWC documents carefully, according to Dean Jeske, an associate general counsel. LPL uses them to test its own policies and controls to identify any gaps that warrant attention, Jeske said.
“The transparency is really important to us,” Jeske said. “There’s sort of a push and pull involved in that, because we want transparency when it’s everyone else’s case. And we’re maybe less interested in transparency when it’s our case.”
Commonwealth agreed to pay $1.6 million to settle its 12b-1 fee case with the SEC. Its latest ADV shows bulked-up information about how it makes money through its custodial and product sponsor relationships, as well as
The firm’s primary custodian, Fidelity Clearing & Custody Solutions’ National Financial Services, enables “substantial economic benefits” to Commonwealth like a markup to brokerage account costs, and revenue-sharing based on transactions and assets held at NFS, the ADV shows.
At least 30 mutual fund companies the firm calls its “core partners” also provide Commonwealth with annual payments. Advisors don’t receive them, but product sponsors do pay for their travel, meals and lodging at educational conferences, as well as other perks and reimbursements.
While
Commonwealth is “often able to obtain price improvement through its trade executions with NFS that it believes is beneficial to its clients,” according to the ADV. The firm’s website outlines revenue sharing with NFS, fund and insurance companies, nontraded product sponsors and retirement plan recordkeepers.
Representatives for Fidelity didn’t respond to requests for comment on Tolley’s remarks at the conference.
Commonwealth maintains a “risk conflicts document” Tolley describes as having 500 different items listing the nature of the conflicts, applicable rules and how the firm mitigates them or discloses them. It’s a “a living and breathing document” that’s constantly evaluated, he says.
The firm’s supervisory controls unit works alongside its business managers in annual and periodic tests of protocol, while senior executives like CEO Wayne Bloom attend weekly product committee meetings aimed at assessing risks, conflicts and how to address them, Tolley says.
Commonwealth also uses six different versions of forms for advisors designed “to get into the heart” of outside business activities, he says. The firm doesn’t approve any advisors to have custody or control of client funds, other than those of their family members.
Tolley had tenures with LPL, National Planning and other BDs prior to joining Commonwealth in 2006. Firms that haven’t given the same attention to compliance or invested as much in it may be in for a painful lesson in future cases and examinations, he said after the panel.
“They had better start devoting the resources to it or look at the possibility of being extinct,” Tolley said. “Firms that are not paying attention to this or not taking it seriously really need to reconsider.”
