When investment advisers who are dually registered as brokers determine which side of the business to place a client's account, they need to be prepared to defend that decision, compliance experts at the securities law firm Sutherland, Asbill & Brennan are cautioning.
That's because the feds are taking a hard look at account selection. It’s part of their aim to crack down on what's known as reverse churning, the practice of parking a client's assets in a fee-based advisory account when little or no trading is likely to occur, according to Brian Rubin, a Sutherland partner.
"The SEC has recently been looking at a number of firms to sort of justify why clients are in advisory accounts versus brokerage accounts," Rubin said, noting that many firms have not implemented policies and procedures on the issue of account selection. "But the SEC is now coming and saying justify that account, and how is the firm supervising that account?"
CLUES
SEC watchers often look for clues of a broader enforcement agenda in the actions the commission takes against firms or individuals, and Rubin sees ample reason for concern in a
The feds are taking a hard look at account selection.
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The SEC dinged those firms both for failing to monitor their accounts to determine whether they belong in a fee-based or commission structure, and also for collecting unwarranted fees from steering clients into higher-cost share classes of mutual funds, another red flag.
"The SEC's position seems to be that you should be having the lowest-cost share class and you shouldn't be charging 12b-1 fees," Rubin said.
Rubin argues that the agency approaches advisory accounts with a degree of skepticism, expecting firms to "prove why it makes sense for the clients to be in those accounts."
"[T]hey're focusing on advisory accounts that don't trade a lot, so the question is, why are the clients there? Why aren't they trading?" he said.
UNDER FINRA SCRUTINY
For brokers registered with FINRA, Sutherland's attorneys caution that they are dealing with an increasingly assertive regulator. The firm keeps a database of disciplinary actions that FINRA has brought, reporting a 36% spike since 2008, resulting in 1,462 cases in 2015, and industry bans for 25 firms.
We're seeing AML becoming a very popular topic for FINRA.
Like the SEC, FINRA has produced a long
"We're seeing AML becoming a very popular topic for FINRA, resulting in very significant fines over the past few years, so firms should consider where their programs are, and make sure that everything is working effectively as it should be," McCormick said.
In that case, which saw a record fine for AML violations, FINRA cited a similar previous action that it had brought against Raymond James. FINRA described RJ as a fast-growing enterprise whose business had outpaced its compliance procedures, concluding that the firm had not lived up to earlier commitments to tighten up its AML program.
FINRA has signaled its concern with the fees associated with variable annuities.
"The key takeaways from this case is that the compliance systems should keep up with the business. FINRA really cited that as an issue here," McCormick said. "When problems are discovered, you should address them and fix them, especially if you told a regulator you would previously do so."
SIGNALING A CONCERN WITH FEES
Just as the SEC is examining issues of account placement and share classes, FINRA has signaled its concern with the fees associated with variable annuities. Last month, FINRA
That penalty may have set a new high-water mark for FINRA in cases involving variable annuities (and carried the second-largest fine that the regulator has levied in any disciplinary action), but it should not be viewed as an isolated incident, according to Rubin, who warns of more cases in the pipeline.
"FINRA is looking at a number of firms dealing with replacements, checking the math, looking at the numbers," Rubin said. "I know of a number of cases that FINRA is working on right now, so it makes sense for firms to focus on this issue to the extent they haven't."
