Several of our registered investment adviser and broker-dealer clients have recently asked whether it is permissible for an adviser or broker-dealer to make a recommendation to a 401(k) plan participant that he roll over his account into an IRA. This activity is often referred to as “cross selling” or “rollover recapture.” Because there is not a single answer to this question, we thought it would be helpful to review the current Department of Labor (DOL) guidance on this issue.

In a 2005 Advisory Opinion (AO), the DOL responded to a request for guidance concerning advice, including advice about rollovers and other services provided directly to plan participants by financial planners and advisers. The AO contained three questions and answers that are summarized below.

Q1: Is an individual who advises a participant for a fee on how to invest the assets in the participant’s 401(k) plan account, or who manages the investment of the participant’s 401(k) plan account, a fiduciary with respect to the 401(k) plan within the meaning of ERISA Section 3(21)(A)?

A1: Yes. Directing the investment of a plan constitutes the exercise of authority and control over the management or disposition of plan assets and the person directing the investments would be an ERISA fiduciary, even if the person is chosen by the participant and has no other connection to the plan.

Q2: Does the recommendation that a participant roll over his account balance to an IRA constitute investment advice with respect to plan assets?

A2: Merely advising a participant to take an otherwise permissible plan distribution, even when that advice is combined with a recommendation as to how the distribution should be invested, is not investment advice under ERISA. Where, however, the adviser or broker-dealer is already a fiduciary to the plan (because he is already providing investment advice or management at either the plan or participant level), then responding to participant questions concerning the advisability of taking a distribution or the investment of amounts distributed from the plan is a fiduciary act subject to ERISA’s fiduciary obligations (which require the fiduciary to act prudently and solely in the interest of the participant). Additionally, if, for example, an adviser or broker-dealer who is a fiduciary causes a 401(k) plan participant to take a distribution and then invest the proceeds in an IRA account managed by the fiduciary (or an affiliated company), the fiduciary may be using plan assets in his own interest in violation of ERISA’s self dealing prohibited transaction rules.

Q3: Would an adviser or broker-dealer who is not otherwise a fiduciary and who recommends that a participant take a plan distribution and invest the funds in an IRA engage in a prohibited transaction if the adviser or broker-dealer will earn management or other investment fees related to the IRA?

A3: No. A recommendation that a participant take an otherwise permissible distribution by someone who is not connected to the plan, even when combined with a recommendation as to how to invest the distributed funds, is not investment advice under ERISA.

The AO does not prohibit an adviser or broker-dealer who is a fiduciary from making a rollover recommendation, provided the adviser or broker-dealer considers only what is in the best interests of the participant. Depending on the participant’s situation, it may be in the participant’s best interest to remain in the plan. If a participant determines that a rollover into an IRA is more appropriate, an adviser or broker-dealer who is a fiduciary cannot receive any commission or other incentive payment in connection with a rollover from the 401(k) plan into an IRA. In addition, if the funds are rolled over into an IRA managed by an adviser or broker dealer who is a fiduciary, the fee charged by the IRA should be the same or lower than the fee currently being paid to the adviser or broker-dealer by the 401(k) plan or the participant. Such transactions likely would not run afoul of ERISA’s self-dealing prohibited transaction rules.

Yesterday, the Securities and Exchange Commission announced that it has issued its first whistleblower award under the new bounty program established after the 2010 Dodd-Frank Act. Under the Act, whistleblowers may be rewarded between 10 and 30 percent of any money collected in an SEC enforcement action where more than $1 million in sanctions is awarded.

According to yesterday’s SEC press release, the whistleblower in this case has received $50,000, representing 30 percent of the amount collected from the defendant in this “multi-million dollar fraud”. The SEC noted that the whistleblower was eligible to receive further payouts when and if any additional money is collected from this defendant, or if sanctions are awarded against other defendants in this matter. As required by law, the whistleblower’s identity is being kept confidential. Similarly, the particular enforcement action was not identified.

For practitioners, and especially in-house counsel, it will be important to see how this whistleblower bounty program continues to develop. After the Dodd-Frank Act was passed in 2010, there was concern that whistleblowers would bypass internal reporting systems and, instead, take their grievances and observations directly to the SEC in hopes of collecting a large payout for their information. If the SEC continues to award 30 percent bounties, it may entice individuals to skip internal reporting in favor of the bounty program. However, while this individual received the maximum possible payout under the program, it is interesting to note that the SEC denied the second whistleblower’s claim for a portion of the monetary sanctions in this case. In support of that decision, the SEC notes that the information supplied by this second claimant “did not lead to or significantly contribute to the SEC’s enforcement action, as required for an award.”

For further information on the bounty program or this particular award, please see the SEC press release.

Another instructive AML disciplinary action reveals more of FINRA’s expectations for the independent testing process for AML compliance programs (“AMLCP”).

Recently, FINRA censured and fined a firm and its Chief Compliance Officer, jointly and severally, $15,000 for certain failures in its AML Program and Independent Testing. As this was an identical disciplinary action toward the same firm in 2 years, the firm must provide FINRA copies of the annual independent testing reports for this year and the previous 2 years. The fine this time around was increased by a factor of 3. All totaled, this firm has shelled out $20,000 in fines for essentially identical violations.

In the first disciplinary action, the firm was censured and fined because it failed to conduct and evidence an independent test of its AMLCP for calendar year 2008. In the second instance, FINRA found that the firm did not conduct and evidence an adequate independent test of its AMLCP.

In this second go-around, the firm delegated the “independent testing” to the Public Finance Co-Manager. Given the findings, however, it appeared that the person chosen for the independent testing did not have a working knowledge of the applicable requirements and implementing regulations under the Bank Secrecy Act, which is a pre-requisite of anyone who undertakes to conduct such testing. FINRA chose not to sanction that person in this case and limited the individual action to the firm’s CCO, who was also the AML Compliance Officer responsible for administering the program and ensuring the adequacy of the independent testing.

FINRA’s findings in this disciplinary action are instructive and, frankly, astonishing. The inadequacies in the testing were as follows:

The review was limited to only one branch office instead of sampling transactions at all branch locations.

1. Transaction sampling at the branch was limited to deposit slips.
2. The testing did not review or test the firm’s AML procedures or make an assessment of the AMLCP’s adequacy for the firm.
3. The Customer Identification Program (“CIP”) was likewise not reviewed or assessed, nor did the testing review whether the firm’s registered representatives were complying with its CIP.
4. The testing did not include any review of the AML training program, its adequacy, and whether the firm’s registered representatives complied with the annual training program.
5. The firm did not review samples from all of its business lines.
6. The test failed to review for the movement of funds that were previously deposited in accounts.

Take this case and use it to assess your independent testing process and be sure you’re doing adequate sampling and comprehensive assessment of your AMLCP. FINRA expects firms to have a robust and well-tailored program to fit the firm’s businesses. Gone are the days of reviewing the AML policy against the FINRA template to ensure completeness and writing up a report. FINRA expects robust testing of transactions and procedures by a well-qualified independent party. Please feel free to contact me at ddawe@wnj.com, or any other member of our group, if you have any additional questions or if you think you might need to review your independent testing process at your firm.

Recent Security and Exchange Commission (“SEC”) examinations of investment advisers have again focused on the knowledge and authority of the Chief Compliance Officer (“CCO”).  Rule 206(4)-7 requires investment adviser firms to designate a supervised person as CCO.  In addition, the SEC states in Release No. 2204, that in order for the supervised person to compel others to adhere to the compliance policies and procedures they must be in “a position of sufficient seniority and authority within the organization.”  For many firms, the CCO has other managerial responsibilities and, therefore, is challenged to stay informed on the ever changing regulatory environment.  The CCO continues to require support to implement effective policies and procedures that adequately monitor the firm’s policies and procedures.

Some resources to help the CCO, compliance staff and firm employees identify and manage risks and determine appropriate compliance controls may be found below.

• Subscribe and read the Warner Norcross & Judd LLP Compliance Corner Blog http://compliancecorner.wnj.com/
• Bookmark and periodically visit the SEC’s website http://www.sec.gov/divisions/investment.shtml
  • Review Staff Guidance and Studies
  • Review recent No-Action and Interpretive Letters
• Join the National Society of Compliance Professionals (“NSCP”) a non-profit organization that provides support to compliance professionals in the securities industry.  Membership benefits include:
  • Access to webinars, regional and national conventions
  • Subscription to NSCP Currents, a bi-monthly compliance journal
  • Additional information may be found at http://www.nscp.org/.
• Attend the NSCP’s National Conference October 22 – 24, 2012 in WashingtonD.C.  https://www.eiseverywhere.com/ehome/42305
  • Conference will cover over 80 topics for compliance professionals at IA, BD, Hedge Fund/Private Fund and Investment Companies.
  • Workshops applicable to small and large firms
  • CCOs and other compliance professionals will benefit from relevant information.

Contact any member of the Broker Dealer/Investment Adviser Practice Group at Warner Norcross & Judd to see how we might assist you with your compliance matters.

NASAA is reminding mid-sized  investment advisers eligible to switch from federal to state registration, that have yet to switch, to contact their state securities regulator to begin the process.

Read the full article here.

The SEC has extended the compliance date of the “Pay to Play” third-party solicitor provisions of the Investment Advisers Act from June 13, 2012, until nine months after the compliance date of the final rule when the Commission will adopt regarding municipal advisor registration.  The expected date for the municipal advisor registration rule is September 30, 2012.

The Pay to Play rule places a two year ban on investment advisers from providing “advisory services for compensation” after the adviser, or certain employees, make contributions to elected officials or candidates. The adviser and certain employees are also prohibited from paying a third party to solicit “advisory business from any government entity” unless such third-party is an SEC-registered investment adviser or a registered broker or dealer subject to pay to play restrictions.

Although, the compliance date has been extended, many states and local municipalities have adopted regulations regarding how advisers may solicit advisory business from government entities. Further, the SEC Pay to Play rule does not preempt those regulations and your local rules may already apply – and those laws may be more restrictive as to time banned and to the amount contributed. Further, under certain state laws, investment management activities provided to government entities could be considered lobbying and may require registration as a lobbyist, which could involve additional reporting and disclosure requirements, ethics training, and more fees. Among those states are: California, New York, Ohio, and Texas. Failure to register as a lobbyist could result in a fine, and possible loss of SEC safe harbor exemptions.

If you have questions about your compliance obligations, please contact any member of the Broker Dealer/Investment Adviser Practice Group at Warner Norcross & Judd.

The compliance date for the final service provider fee disclosure regulations under ERISA Section 408(b)(2) is July 1, 2012. That is when registered investment advisers (RIAs) and broker dealers (BDs) must disclose certain information to the responsible plan fiduciary, including services provided to the covered plan, fiduciary status and direct and indirect compensation.

We suggest RIAs and BDs take these seven steps right now:

1. Identify affected accounts
2. Determine identity of responsible plan fiduciary to ensure delivery to appropriate person
3. Determine the types of services being provided and the applicable disclosure requirements
4. Determine where and how to obtain disclosure data.
5. Develop an approach for meeting compliance deadline
6. Establish procedures for communicating any changes to disclosures – an amended Form ADV may be sufficient
7. Reconcile services provided with errors and omissions coverage

Click here to read an article with additional information about the requirements and the steps that must be taken to remain in compliance. Failure to comply can result in a 15% excise tax.

If you have questions about the disclosure regulations or need help with compliance, please contact Lisa Zimmer (lzimmer@wnj.com or 248.784.5191) or any other member of the Broker Dealer/Investment Adviser Law and Regulation Group at the law firm of Warner Norcross & Judd.

Spring is in the air and FINRA’s 2012 B-D inspections are in full swing. The other day, we received word from a client of a particular document request that merits a “heads up” to broker-dealers with regard to certain records and supervisory systems for subaccount transfers within variable annuities.

FINRA asked for an activity log or trade blotter of all subaccount transfers.  In the alternate, if the firm didn’t keep such a document, FINRA asked for a written statement from the firm as to how subaccount transfers are monitored and the associated documentation evidencing review by firm personnel.

Asking around, we noticed more than a few firms who don’t routinely capture or supervise and monitor these variable annuity subaccount transfers.

This recent FINRA examination document request serves as a good reminder to firms that those variable annuity subaccounts are each separate securities, just as is the case with each mutual fund within a mutual fund family. Both FINRA and SEC books and records rules require that each such securities transaction, especially those initiated or recommended by registered representatives, be included in the firm’s trade blotters, including those done on a direct-way basis (i.e., that don’t go through the automated record-keeping processes of a clearing firm). Additionally, it also means that the firm has a duty to supervise the blottered trades and monitor for suitability, just as with any other security recommended by a representative.

Certain variable annuity products have automatic asset allocation and rebalancing programs for subaccounts. Since these are initiated by the insurance company’s own systems and bypass the representative, they don’t need to be recorded since they weren’t initiated or recommended by the representative. Of course, the initial suitability review of using such an automatic system for a given client is still required, but out of the purview of this current topic.

So you’re not blind-sided by any similar future regulatory request, we’d recommend a review of your written supervisory procedures to assess the adequacy of the supervisory systems and related recordkeeping for internal subaccount transfers. And if you’re not also capturing mutual fund exchanges, we’d urge a similar review for those.  Please feel free to contact me at ddawe@wnj.com or any other member of our group if you have any additional questions or comments.

New SEC Investment Adviser Guidance

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has made publicly available on OCIE’s webpage two new resources providing guidance about changes in its objectives, operations, as well as trends in examination deficiencies:

• National Exam Program Overview (issued March 13, 2012); and
• National IA Compliance Outreach Program (held January 31, 2012).

National Exam Program Overview.  This 45 page internally-generated SEC report describes OCIE’s “self-assessment” and related changes in its strategy, structure, people, process, training and technology improvements in its examination program to address, among other things, the Dodd-Frank Act’s redesign of investment adviser regulation.

The report includes a description of OCIE’s inspection process (Part II) and a summary of recent enforcement actions against investment advisers (Part I).  Current IA, BD, and investment company compliance issues and 2012 examination priorities are highlighted in Part III of the report.

OCIE has established an Office of Risk Assessment and Surveillance to evaluate risks, both in markets and in registrants.  New risk-assessment tools have been developed and more training is being provided to IA examiners.  Other exam program improvements are described, including a new alignment of OCIE’s national exam program leadership.  OCIE expects to issue more Investor Risk Alerts and sweep examination reports in 2012.

National IA Compliance Outreach Program.  This day-long webcast can now be watched for free at your convenience on the SEC’s website.  The program aired on January 31, 2012, and its agenda included these topics:

Compliance and Enterprise Risk Management

• How risk management and compliance intersect
• How CCOs can engage operational units
• Documenting, reporting, and attesting to control activities

Trading Practices

• Risk management – insider trading issues
• Protecting confidential investment information from misuse
• Using expert networks, affiliations, relationships, and consultants
• Using Alpha capture systems
• Aligning risks to identify:

-   Potential insider trading (Section 204a) issues

-   Misuse of material non-public information

-   Insider trading

• Control Activities – detection tools

Dodd-Frank Wall Street Reform and Consumer Protection Act

• Rules implementing the Dodd-Frank IA amendments
• Transition of mid-sized advisers to state registration
• Private fund advisers – registration and/or reporting
• Collaboration with other regulators

Enforcement-related matters

• SEC Enforcement Division’s Asset Management Unit
• Enforcement trends and lessons
• Enforcement against CCOs
• National exam program changes

Safety and Soundness of Client Assets/Custody

• Lessons learned under the SEC’s Custody Rule
• Asset verification within the national exam program
• Terminated funds and funds-of-funds custody issues

In 2011, the OCIE hosted the CCOutreach Broker-Dealer Program addressing a wide range of broker-dealer compliance topics.  A recording of that webcast is available on the SEC’s website.  These materials could be useful in planning your firm’s next continuing education program.

Should you have any questions about these new SEC resources, please do not hesitate to contact any member of the WN&J Broker-Dealer and Investment Adviser Practice Group.