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16 Compliance Trends To watch In the New Year
By Tobias Salinger

Financial advisors face a slew of new regulatory issues in 2018, and when it comes to compliance, they’re “better off changing the oil regularly than waiting for the engine to blow up.”

The vivid warning comes from Todd Cipperman, founder of a consulting firm specializing in regulatory compliance. His company, Cipperman Compliance Services, together with the Kreisher Miller law firm hosted a forum outside Philadelphia in early December on industry trends.

The top takeaway? Advisors should pay attention as regulators increasingly focus on personal liability, rather than just pursuing cases against firms.

President Trump’s administration delayed the enforcement provisions of the fiduciary rule until mid-2018, and the President and top officials have made deregulation of several industries a top priority. Their actions do not, however, clear advisors of individual responsibility for a series of current and shifting obligations, Cipperman says.

Wealth management firms should spend no less than 5% of their revenue on compliance, Cipperman and his team often tell clients. Regulatory oversight has steadily increased since the financial crisis and the Great Recession, and advisors should only expect the supervision to grow next year.

Follow the link for Cipperman’s take on the top FINRA and SEC examination priorities this year¹ or a budgetary analysis of the SEC² . To find out what to expect next year according to Cipperman, as well as Bao Nguyen of Kaufman Rossin’s risk advisory services practice, please click through our slideshow.

SEC to probe more advisors

Planners will see increased exams in the coming year.

SEC Chairman Jay Clayton predicted exams of advisors by the SEC’s Office of Compliance Inspections and Examinations to grow by 20% this year and by an additional 5% by 2018, even with a slight reduction in spending. The agency devoted roughly half of its budgetary request to OCIE, Cipperman notes.

Clayton and OCIE officials have spoken publicly about the technological capabilities allowing them to probe more firms with fewer resources.

“When you have a reduction in budget, you’re going to have a reduction in staff,” Nguyen says, noting the contrasting increase in exams. “The only way to do that is to be the most efficient as possible and the only way to be the most efficient as possible is to use technology and data.”

Broker Protocol exits could lead to more litigation

Decisions in recent weeks by Morgan Stanley and UBS to leave the Broker Protocol have prompted concerns that wirehouse firms will pursue more litigation against breakaway brokers.

At least 90 advisors managing $12.3 billion have left the two firms since their announcements, which contrasts with Merrill Lynch’s pledge to remain in the accord. Cipperman doesn’t expect any further exits from the Protocol to cut off the long-term movement of assets to the independent channel.

“Important, big team will continue to be able to write their own ticket and little teams will continue to bop around to look for the right one,” he says. “It’s less important than it once was.”

Get ready for changes to Form ADV
New guidelines taking effect next year will require firms to disclose more information about their assets under management, compliance staff and social media presences, to name a few areas of change.

“I think the biggest one is that, if the RIA outsources its [Chief Compliance Officer] functions or outsources its CCO at all, that is something that the SEC requires on the new Form ADV,” Nguyen says. The SEC has identified such outsourcing as a potential risk area, given that one CCO could be overseeing 10 firms or more, he says.

Outsourced CCO services do, however, provide smaller firms with fully equipped compliance teams that bring an industry-wide perspective, Cipperman points out. Third-party firms also offer the independence required by institutional investors, he says.

“We have told the SEC that we heavily monitor the number of CCO relationships per person and staff with a team so as not to overburden any one person,” Cipperman wrote in an email.

“We agree with the SEC that outsourcing must be done right. This means a high level of client engagement including no less than six onsite visits per year, weekly live calls, file sharing, and a designated internal compliance liaison to share information.”

Regulators to move cybersecurity from alerts to enforcement

The SEC’s new cybersecurity unit, sweeps of firms’ protection systems and public alerts will yield several significant enforcement cases next year, Cipperman says.

FINRA and state regulators have also warned advisors to be more vigilant in protecting their firms from the ever-increasing wave of hack attacks. Advisors should hire a different firm to probe their firms’ systems from any third-party information technology firm they retain for other services, Nguyen says.

“I don’t have to explain the conflict in that,” he says. “You’re going to do the risk and vulnerability assessment on your own work, hence some of the vulnerabilities we’re seeing.”

Uncertainty hangs over the fiduciary rule of 2018

Clayton has pledged to work with the Department of Labor and FINRA on possible changes to the fiduciary rule.

“The next step in anything like this would be a rule proposal,” Clayton said in testimony before the House Financial Services Committee in October. We’re working on such a proposal.”

Nevada led the way as the first state to move on its own version of the rule, and Cipperman predicts that at least two more states will follow with their own standards next year. Such state laws could effectively force compliance by national firms doing business in the states.

The issue of preparations for the rule has already emerged as a frequent question in exams, Cipperman says. The CFP Board’s move to make all certified members subject to a fiduciary standard will also add to the momentum, he notes, forecasting the eventual creation of a uniform rule under the SEC.

“They should have done that five years ago,” Cipperman says. “Everyone wanted them to do it.”

State-registered RIAs face stricter oversight

State regulators examined more categories related to RIAs’ compliance in 2017 than in years past and found many more deficiencies, according to the North American Securities Administrators Association. Fines and restitutions meted out at the state level also hit a five-year high in 2016, NASAA says.

“They brought a record number of cases and penalties,” Cipperman says. “NASAA’s really upping their enforcement game.”

Continued IBD consolidation poses compliance questions

The number of independent broker-dealers in shrinking as firms bifurcate between giants and boutiques.

LPL Financial’s purchase of the assets of National Planning Holdings in August formed the most significant M&A deal of the year. Just last week, Wentworth Management Services acquired the hybrid-serving IBD Purshe Kaplan Sterling Investments.

Acquisitions bring compliance questions to the buyer, regardless of the terms of structure of the deal, Cipperman says.

“Corporate lawyers get this idea in their heads that if you do an acquisition that’s a purchase of substantially all of the assets as opposed to a stock purchase, you leave liability behind. That is not the case in the regulatory world,” he says. “Yes, as a contractual matter, you cannot get sued under their contract. But the SEC can still go after you.”

Growth of RIAs comes with greater supervision

New RIA registrations have jumped 75% during the past five years to 199 firms with a combined $55 billion in assets under management, according to Charles Schwab Advisor Services.

M&A deals with consolidators and platform-provider agreements are helping the new entrants to the space launch their RIAs. As a result of the growth in RIAs and the consolidation in the IBD space, OCIE has moved much of its IBD staffers to positions overseeing RIAs, Nguyen says.

“The SEC has really reallocated its resources to that space,” he says. “That’s why you’ve seen the uptick this year in examinations.”

What will become of the mutual fund alphabet in 2018?

Regulators are taking a harder look at advisors’ recommendations around mutual-fund shares, and the fiduciary rule debate has only sharpened that focus.

The SEC placed share classes and 12b-1 fees at the center of several of its recent enforcement cases. Mutual fund companies openly admit that they don’t know whether certain share classes will survive the onslaught of regulation and oversight.

FINRA alone has sanctioned 35 firms and assessed restitution payments of nearly $80 million in the past three years over waivers the regulators say the firms could have used to allow for discounts to their retirement and charitable-organization clients.

“I would say that if there’s been one area that’s been a hot area of 2017, it’s been this idea that not all mutual fund share classes are created equally,” Cipperman says. “There have been a bunch of cases out there alleging violations of fiduciary rules because advisors selected the wrong share class, a share class that was too expensive.”

Revenue-sharing is a ‘dinosaur’

In another issue related to mutual funds and other investment products, the SEC has been zeroing in on revenue-sharing agreements involving payments of commissions and 12b-1 fees to representatives from the issuers of the products, Cipperman says.

Such “back-door payments” are “really problematic,” for RIAs he says.

“Our firm position is that revenue sharing is a dinosaur,” Cipperman says. “If you’re getting revenue-sharing and you’re in a fiduciary capacity, you’re going to have a very hard time justifying it during an exam. You’ve got to start thinking almost like an ERISA plan, where a fiduciary is just not allowed to take payola.”

Wrap-fee programs under scrutiny

SEC enforcement has made wrap accounts, which bundle a variety of services under one fee, “highly endangered,” Cipperman says.

Cases about wrap fees in recent years have dinged firms over mutual fund share-class selection, due diligence, trading away and reverse churning, he notes. Barclays agreed to pay $97 million in May following an SEC investigation into its practices.

“The SEC is finding all these different ways to attach wrap programs,” Cipperman says. “I can tell you, in exams, if our clients have wrap programs, we spend a lot of time tap-dancing, even if it’s a legitimate wrap program.

Treasury Department could decide on anti-money laundering rules

RIAs have been waiting years to find out if the Treasury Department will follow through on a proposed rule placing them under the same anti-money laundering regime as IBDs and banks.

FINRA referenced AML provisions as a common area of concern for IBDS in a report last week on the findings of its examinations this year. The proposed rule would subject RIAs to a rigorous five-pronged requirement through the supervision of Treasury’s Financial Crimes Enforcement Network, Nguyen says.

“It’s a pretty big deal. If that gets approved, you’re going to see some pretty big changes in the RIA space where they would now have a burden under the Bank Secrecy Act,” Nguyen says, adding that he doesn’t think the Trump administration is likely to embrace the rule.

Watch for enforcement cases involving marketing practices

Despite longtime rules governing the language and visual representations of investments, in September the SEC issued a risk alert about firms’ advertising efforts stemming from OCIE exam findings.

Cipperman predicts there will be two or three SEC cases “making a point in the marketing and advertising space,” he says. Misleading performance metrics and other issues could form the basis of the cases.

“What happens is, OCIE will release a risk alert, and then they bring enforcement cases,” Cipperman says. “So I’m guessing that’s going to happen.”

New custody rule requirements

Advisors with standing letters of authorization, which allow them to move clients’ assets in and out of their accounts, received word from the SEC in February that they are considered to have custody of the assets in question.

The judgement, released in a no-action letter to the Investment Adviser Association, adds additional compliance requirements for advisors using the SLOAs. It’s possible that the agency will take a renewed look at custody in 2018, Cipperman says.

“I think the SEC is going to rewrite the custody rule,” he says. “Nobody likes the custody rule. It’s a disaster, and not because the intent isn’t good, but I’ve read it. Every time I get a custody question, I re-read it because I think I understand it, and I don’t. So I think they’re going to rewrite that.”

Bad brokers ‘a really hot area’

Regulators at all levels have indicated their desire to weed out repeat offenders from the industry.
Clayton pledged “zero tolerance” for bad actors during his confirmation hearing, and he announced last month that the agency will make its own public database of barred or suspended advisors. State regulators attributed their bulked-up enforcement, in part, to the presence of bad actors.

Bad brokers are “a really hot area,” and FINRA will bring cases next year against firms that hire them, Cipperman says.

FINRA CEO Robert COOK, in a June speech, called for firms to step up their efforts to kick them out of the field. FINRA has barred nearly 120 advisors since the regulator began its high-risk oversight program in 2014.

“Firms must do their part by, among other steps, reviewing their hiring practices, monitoring their brokers, improving supervisory systems and investigating red flags suggestive of misconduct,” Cook said.

A firm isn’t a liability shield

An SEC enforcement attorney told Cipperman at an industry conference last year that, unless she receives permission from senior personnel, she can only bring a case if it names an individual as a respondent, Cipperman says.

The agency views individual accountability as a “core enforcement principle,” and 80% of cases since Clayton took office have named an individual, according to Cipperman.

“They’re trying to scare the heck out of people,” he says. “If you can threaten people’s careers, throw them out of the industry, threaten to put them in jail, they’re hoping that has a widening deterrent effect.”


¹ https://www.financial-planning.com/slideshow/sec-and-finra-examinations-what-advisers-should-know

² https://www.financial-planning.com/slideshow/sec-ocie-exams-to-rise-despite-lower-budget