Protecting Vulnerable Adults from Financial Exploitation

The organization that represents the state securities agencies, North American Securities Administrators Association (NASAA), recently announced that its membership had voted to adopt a model act designed to protect vulnerable adults from financial exploitation.¹ The model act, titled “An Act to Protect Vulnerable Adults from Financial Exploitation”, is now available for states to enact as legislation or implement through regulation. In addition, two new rules have been proposed by FINRA, which are also designed to also help combat financial exploitation of vulnerable adults.² Finally, to bring more attention to this issue, the Consumer Financial Protection Bureau (CFPB) issued a report directed at financial institutions aimed at combating elder financial exploitation.

Protecting Vulnerable Adults in a Nutshell

Vulnerable adults are defined as persons over 65 years of age and those that qualify for protection under a state adult protective services statute. The protections for these individuals impact broker-dealers, investment advisor representatives, and those who serve in a supervisory, compliance, or legal capacity for broker-dealers and investment advisors. Generally, it will mean that as you are dealing with seniors and adults with disabilities, you may have additional responsibilities and a small amount of flexibility from regulators in dealing with certain situations.

Financial Exploitation

The type of financial exploitation that potentially could be stopped is the unauthorized use of the vulnerable adult’s assets, including when a power of attorney, guardianship, or conservatorship is used to make decisions harmful to the client. Both NASAA and the federal agencies have compiled evidence showing that trusted caregivers may obtain control over the vulnerable adult’s assets, then deprive them of the assets or convert the assets by exploiting the services of financial institutions including broker-dealers and investment advisors.³

Possible Changes

State securities regulators, FINRA and the CFPB may begin to incorporate regulatory changes to address this public concern. Advisors that have a reasonable belief that financial exploitation has been attempted or has occurred among their clients may be required to report it to the appropriate regulator and adult protective services agencies. Updates to state and federal rules may also allow advisors to notify any third parties designated by clients of their suspicions of financial exploitation, excepting any third party that are suspected to be the part of the financial exploitation. Finally, state rules may allow advisors to initially delay disbursements from an account of a vulnerable adult for up to 15 business days if, after review, there is suspicion that the disbursement may result in financial exploitation. The advisors may also extend the delay of disbursement for an additional 10 business days at the request of either the state securities regulator or adult protective services.

Crucially, NASAA’s model act grants immunity from administrative or civil liability for advisors when reporting to state regulators and agencies, notifying appropriate third parties, and delaying disbursements based on reasonable suspicions of financial exploitation while acting in good faith. However, the advisor will be required to provide records, including historical records, relevant to the suspected financial exploitation to the state’s adult protective services or law enforcement. As with all things compliance your books and records are very important.

CCO Best Practices

To prepare for dealing with vulnerable adults at your firm AdvisorAssist recommends the best practices of:

• Train staff to prevent, detect, and respond to elder financial abuse by escalating any suspicious activity to the CCO.
• Harness technology such as suspicious activity monitoring technology to identify potential financial abuse.
• Collaborate with stakeholders like custodians, banks, and plan sponsors to identify potentially at-risk clients and trusted third parties acting for the client’s protection
• Document, validate and report suspicious activity to your state regulators or federal agencies.
• Offer clients the ability to have your firm notify a trusted third party when financial exploitation is suspected.
• Maintain awareness of any existing rules or changes at your state securities regulator regarding their adoption of rules regarding vulnerable adults.

^{1. See NASAA Members Adopt Model Act at: Link. ↩}

^{2. See FINRA Regulatory Notice 15-37, October 2015 at: Link. ↩}

^{3. See Testimony of Judith Shaw, NASAA President before the US Senate Special Committee on Aging at: Link. ↩}

AdvisorAssist News for RIAs is a series of articles that will help your firm understand and prepare for changes that may be occurring on the state or federal level. Our goal is to help you increase your confidence that your firm remains in compliance as well as provide some practical steps to help Chief Compliance Officers address this topic.

Contributors:

Brendan Furey
Michael Conlon

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CCO Series: Top Regulatory Deficiencies for RIAs -- Advisory Agreements

What you need to know

Examiners will review agreements that the advisor uses for its client engagements during an examination as a standard request item. This will include a review of the agreement templates that you use for your prospective clients and a sample of agreements that your firm has executed with existing clients. In reviewing agreements examiners report finding two common deficiencies: 1) the fees are not fully disclosed in the agreement and 2) that firms do not have an executed copy of its client agreements in the advisor’s books and records.

Common Deficiency: Fees fully disclosed

The written advisory agreement must detail the relationship that the client is entering into with the advisor, including how fees are calculated and the payment methodology. The fees section of the agreement must be comprehensive to cover all fees being charged for the services, when the fees are being charged, and how they are to be paid. The information in the client agreement should also align with the general disclosure of fees made in Form ADV Part 2A Disclosure Brochure in Item 5. Any additional compensation that the firm receives in its advisory practice should also be described in Form ADV Part 2A in Item 14.

Common Deficiency: Books and records

Advisors are required to keep and maintain all written agreements (or copies thereof) entered into by the advisor with any client.¹Examiners are reporting to the North American Securities Administrators Association that advisors are not creating written agreements for all of their client relationships. They also noted that when written agreements are created, the agreements are not clearly noting, and adequately explaining, the advisory fees as described above.²

How do we avoid these deficiencies?

To avoid these deficiencies at your firm AdvisorAssist recommends the best practices of:

• Reviewing the language in your Form ADV Part 2A Disclosure Brochure to ensure that it adequately discloses for each type of fee the following:
1. How fees accrue for each service offered.
2. How fees are billed to the clients.
3. Whether the advisory fees include other fees, such as brokerage trading fees.
4. How fees are impacted by contract termination, such as a pro-rata refund if collected in advance.
5. Whether the fees represent any compensation for the sales of securities or other conflicts of interest.
• For each new client onboarded, ensure that a written agreement is executed for the services that the client will receive and the fee is consistent with Form ADV Part 2A.
• Review client agreement[s] templates and Form ADV Part 2A at least annually to ensure that the fees described are consistent and fully disclosed.

<sup>1. See 17 CFR §275.204-2(a)(10). Link. ↩
2. See North American Securities Administrators Association, “2015 Investment Adviser Coordinated Exams,”. Link. ↩</sup>

AdvisorAssist’s CCO Series: Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready” as well as some practical steps to help Chief Compliance Officers address this topic.

Contributors:
Brendan Furey
Michael Conlon

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Analyzing the Department of Labor Fiduciary Rule

The revised Department of Labor (DOL) fiduciary rule (Rule) was published in its final form in the Federal Register and can be accessed by clicking this link. Although effective starting June 7th, 2016 the DOL has granted time for affected service providers of retirement plans to adjust to fiduciary status and partial compliance is not required until April 10, 2017 with full compliance required by January 1, 2018.

The focus here is determining if fiduciary status applies to your firm based on the advice provided to retirement plans or participants, what exemptions may apply, and what steps must be taken to maintain compliance.

Definition of Fiduciary

Under the Rule a fiduciary will now include a person providing investment advice regarding money or property within the plan for a fee or other compensation, directly or indirectly, to a plan, plan participant or beneficiary, IRA or IRA owner. Investment advice relevant to this definition include the following:

1. A recommendation as to the advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property, or a recommendation as to how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA;
2. A recommendation as to the management of securities or other investment property, including, among other things, recommendations on investment policies or strategies, portfolio composition, selection of other persons to provide investment advice or investment management services, selection of investment account arrangements (e.g., brokerage versus advisory); or recommendations with respect to rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made; and
3. The investment advice is made, directly or indirectly (through an affiliate), by a person who:
1. Represents or acknowledges that it is acting as a fiduciary within the meaning of the ERISA or the IRS Code;
2. Renders the advice pursuant to a written or verbal agreement, arrangement, or understanding that the advice is based on the particular needs of the advice recipient; or
3. Directs the advice to a specific advice recipient or recipients regarding the advisability of a particular investment or management decision with respect to securities or other investment property of the plan or IRA.

The definition goes on to explain what constitutes a “recommendation” and what may be excluded from that definition, such as providing certain services or information regarding the plan or IRA, such as marketing or making available to a plan fiduciary a platform or similar mechanism where the plan fiduciary may select or monitor investment alternatives; identifying investment alternatives that meet objective criteria specified by the plan fiduciary; providing objective financial data and comparisons with independent benchmarks to the plan fiduciary.

The definition also clarifies that an advisor is not a fiduciary when providing advice to an independent person who is a fiduciary of a plan or IRA, if that fiduciary is a bank, insurance carrier, registered investment adviser, broker-dealer, or other person that holds or has assets under management of at least $50 million. This means the old definition has been expanded to focus on advice given to IRA owners and people rolling over their employer sponsored plan (e.g., 401(k) account) into an IRA. Finally, education and general marketing materials that a reasonable person would not view as investment recommendations are not included in the definition of retirement investment advice, so advisors may continue to provide general materials on retirement saving without triggering fiduciary duties.

As a fiduciary, an advisor must adhere to a “best interest” standard for a client, rather than a “suitability” standard for an investment product. Therefore, an advisor cannot receive fees that could be seen as creating conflicts of interest (i.e. commission or revenue-sharing), unless a qualified exemption applies.

Best Interest Contract Exemption (BICE) and Impartial Conduct Standards

This exemption, published at this link, provides relief for compensation, such as commissions and revenue sharing, that an advisor and the advisor’s employing firm might receive in connection with investment advice to retail retirement investors. The BICE requires financial institutions and advisors to acknowledge fiduciary status for itself and its advisors, adhere to basic standards of impartial conduct by giving prudent advice in the client’s best interest, avoid misleading statements, and receive only reasonable compensation. Additionally, financial institutions must adopt policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, disclose basic information about their conflicts of interest and the cost of their advice. Level Fee fiduciaries are subject to more streamlined conditions.

Principal Transactions Exemption

The other main exemption from the Rule is the Principal Transactions Exemption, published at this link, which permits advisors to sell or purchase certain debt securities and other investments out of their own inventories to or from plans and IRA owners. The exemption applies even though this transaction results in payment to the advisor. However, similar to the BIC exemption, the advisor must adhere to Impartial Conduct Standards and disclose to the client any conflicts of interest in order to make use of the exemption.

How should a Chief Compliance Officer respond to the Rule?

In all cases, the advisor will want to retain documentation of compliance with this new rule, including contracts, policies, procedures, and disclosures, to support your Books & Record requirements. However, there are no additional record retention requirements for detailed data on inflows, outflows, holdings, and returns for retirement plan or IRA clients.

Chief Compliance Officers should review the information in their Form ADV Part 2A and client agreements to determine whether or not they are acting as a fiduciary based on the recommendations provided to clients regarding retirement plans, participants, beneficiaries or IRAs, and ensuring that their client agreements and ADV contains all disclosures required by the Rule regarding conflicts of interest and compensation arrangements, including a statement as to whether or not they are a fiduciary.

Although an RIA may not be compensated by a commission or revenue sharing, Form ADV requires disclosure to clients regarding potential conflicts and compensation arrangements. Hybrid advisors receiving commission compensation will want to ensure they are satisfying the BICE. Therefore as a best practice we recommend that even firms without commission or revenue sharing fees should provide notice to retirement clients that they are providing their services in the client's best interest to uphold their fiduciary duty and review and update disclosures of any potential conflict of interest. This will ensure that you are availing your firm of the BICE and creating a presumption of compliance with the Rule.

Contributors:
Brendan Furey
Michael Conlon

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CCO Series: Top 12 Regulatory Deficiencies for RIAs -- # 3: Advisory Agreements

What You Need to Know

According to the North American Securities Administrators Association (NASAA), 44% of regulatory exams conducted in 2013 resulted in deficiencies related to the firm’s contracts or advisory agreements.

The most common contract deficiency was not in the content of the contracts, but instead the faulty execution of them. In cases where the actual content of the contracts were deficient, the most common issues were:

• Fees and fee calculation methods not being correctly identified
• Inaccurate or out-dated terms within the agreement
• Use of “hedge clauses” that inappropriately limited the advisor’s role or responsibilities

Why You Should Care

Apart from regulatory issues, inaccurate advisory agreements have the potential to negatively impact your firm or your relationship with your clients by increasing business risk, creating the potential for personal liability and creating confusion among clients.

Improperly executed contracts create both regulatory and legal risk, and in some cases financial risk. Documenting and adhering to the fee terms and calculation methods in your advisory agreements will ensure that you are getting paid the correct amount by your clients. Performing a review of your existing agreements gives you a chance to find discrepancies before a regulator does.

Maintaining an updated version of all contract templates (both current and prior versions) serves as an effective control so that your firm is always using the most recent version with new clients.

Our Recommendations

To ensure that your firm is keeping up with regulatory requirements and industry best practices in this area:

• Don’t “borrow” language from another firm’s advisory agreement. Your agreements must be both internally consistent and in alignment with the language and declarations in your ADV (including the fee calculation methods used).
• Avoid hedge language that conflicts with or absolves you from your duties as a fiduciary
• Use a separate agreement for ongoing advisory services (both discretionary and nondiscretionary) as well as “project-based” services, like financial planning. Your duties differ with each and this should be clear in your agreements.
• Maintain one set of agreements as “production versions” to ensure that the most up-to-date contracts include the current terms.
• Store retired versions in your books and records files and take steps to ensure that IARs are pulling from the production version.
  
• Ensure that you track the delivery and receipt of advisory agreements and maintain a signed agreement for each client. Test the completeness of these files periodically.

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AdvisorAssist’s CCO Series: Top 12 Regulatory Deficiencies for RIAs is a series of articles that will help your firm understand and avoid the most common compliance deficiencies found by regulators. Our goal is to help you increase your confidence that your firm remains “exam ready.” Click here to read more posts from our CCO Series: Top 12 Regulatory Deficiencies for RIAs. We would welcome the chance to learn more about you and your firm. Click here to request an introductory call from one of our consultants.

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