Cutting through the red tape of adviser regulation is tricky

Don't expect a simple rollback of rules under the Trump administration in 2018 — instead, regulators are on pace to bolster financial adviser oversight

Jan 20, 2018 @ 6:00 am

By Mark Schoeff Jr.

Although the Trump administration has made a rollback of regulations a top priority, the pace of rulemaking and oversight is set to pick up this year for financial advisers.

"Folks have a misconception about how things get done in Washington," said Karen Barr, president and chief executive of the Investment Adviser Association. "A new administration comes in and people think, 'Deregulatory, so now we don't have to worry. These rules are going to be rolled back.' That is just not the case."

So what can advisers expect?

The Securities and Exchange Commission has streamlined its near-term regulatory agenda, but two of the items have a direct impact on advisers. By October, the agency intends to propose a rule setting the standard for personalized investment advice and another that would ease the approval of new exchange-traded funds.

And SEC Chairman Jay Clayton has made retail investor fraud one of his enforcement priorities. The agency recently established a special unit whose agenda includes searching for hidden advisory fees.

"2018 is a year of action for the SEC," said Adrian Whelan, head of regulatory intelligence at Brown Brothers Harriman.

Finra is ready for action, too. The Financial Industry Regulatory Authority Inc. recently released a summary of its 2017 exam findings and its list of regulatory and exam priorities for 2018. In addition to new items, such as cyptocurrencies and business continuity planning, the organization is renewing its focus on high-risk brokers. It's also taking a closer look at high-fee share classes as well as the process of moving clients between brokerage and fee-based accounts.

Mr. Clayton has vowed to continue to increase the percentage of registered investment advisers who are examined annually, through data analytics and improved management of the SEC examination process. In recent years, that number has improved from 10% of the nearly 12,000 RIAs to 14%. Mr. Clayton wants to push it toward 20%.

20%Portion of RIAs SEC Chairman Jay Clayton seeks to examine per year

"I expect another uptick in examination and enforcement activity," said Todd Cipperman, principal at Cipperman Compliance Services. "Anyone who hasn't seen an exam in the last five years can almost count on seeing the SEC come this year. What I see them doing is examining more advisers less in-depth, but focusing more resources on the riskier advisers."

Financial advisers view regulation and enforcement as a potential danger. In the InvestmentNews 2018 Outlook Survey of 344 advisers in December, 26% said the DOL and SEC fiduciary rules could "negatively impact their book of business," while 21% said the same about cybersecurity exams, 12% about a crackdown on excessive fees and 11% about elder-abuse regulation.

Here are some regulatory areas to watch this year.


Crucial parts of the Labor Department's fiduciary rule — those that require brokers to act in the best interests of their clients in retirement accounts, as well as impartial conduct standards they must meet — were implemented last summer. The enforcement provisions have been delayed until 2019 while the DOL reviews the regulation under a directive from President Donald J. Trump.

But that doesn't mean all will be quiet on the fiduciary front in 2018.

The DOL and SEC have promised to work together on their fiduciary regulations. Each agency likely will release proposals this year.

The DOL's assessment now underway is likely to lead to changes to its rule, which would have to be proposed this year in order to be finalized by the summer of next year, when the delay is slated to end.

The big questions swirling around the industry are how much the DOL rule will be modified, what the SEC rule will look like and how the two regulations will interact.

Biggest issue facing financial advisers in 2018
Source: InvestmentNews' 2018 Outlook Survey of 344 advisers in December 2017.

Many anticipate the DOL will make changes to or eliminate the best-interest contract and many disclosure requirements in its current version of the rule and add other provisions to enable compliance, such as incorporating the sale of no-fee investment products.

"The scope and requirements of the exemptions may be simplified to align with the realities of the financial marketplace," said Stephen Wilkes, a partner at The Wagner Law Group.

The SEC has struggled to promulgate its own fiduciary rule since 2010, when it was authorized to do so by the Dodd-Frank financial reform law. The problem has been deep division on the issue among members,​ usually along party lines — Republicans against and Democrats for.

Now that the agency has a full complement of five members for the first time in two years, it can put its full force into the issue. But it still will be difficult to wrestle fiduciary to the ground.

"We'll see a proposed rule, maybe in the first half of the year," said David Tittsworth, counsel at Ropes & Gray. "Beyond that, I'm not convinced there are three votes for anything right now. I wouldn't bet on a final rule."


The recent rage among investors for bitcoin makes cryptocurrency an increasing worry for regulators. The SEC, Finra, the Commodity Futures Trading Commission and state regulators all have issued multiple warnings to investors about digital money. None has proposed a rule, but that may change.

"They have to regulate it in some capacity," said Amy Lynch, president of Frontline Compliance. "Something has to happen, because it's going to affect the markets. If the bubble bursts, it's going to be big and it's going to be bad. It will be retail investors who are going to get hurt."


Like cryptocurrency, cybersecurity is an area of growing concern for regulators, none of whom has promulgated a rule. They will continue to put pressure on advisers and brokers to shore up their defense against breaches.

"They're not going to hesitate to bring enforcement cases where they feel an investment adviser has not taken appropriate steps to protect their clients," Ms. Barr said.

Mr. Cipperman also foresees an enforcement focus on advisory firms' preparation for an attack.

"Firms will be charged with infrastructure problems," he said.

Finra is working with member brokerages to get them up to speed on cybersecurity, said Brian Rubin, a partner at Eversheds Sutherland.

"They are trying to make firms understand the issue and react in the proper way, rather than just bringing a rulemaking right out of the box or doing rulemaking through enforcement," he said.


Another area that has drawn the attention of all regulators is elder financial abuse. The problem falls in a sweet spot — the nexus of an aging population and worries about retirement investing.

A new Finra rule will go into effect Feb. 5 that requires brokers to make a good faith attempt to establish a trusted contact for the account of an elderly person. It also allows brokers to stop disbursements from accounts if the broker suspects that her aging client is being preyed upon.

"It's a good start," Mr. Rubin said. "They've been working with the industry to come up with rules that make sense."

Mr. Cipperman is skeptical.

"It's going to be difficult for firms to administer it and it's going to make customers very upset," he said.

The Finra rule differs from a North American Securities Administrators Association model rule that allows advisers to stop disbursements from accounts but also requires them to report suspected abuse cases to the proper authorities.

Several states have adopted the model rule and others are likely to follow this year.

"The regulatory focus is going to continue to get stronger in this area," said Nicholas Losurdo, counsel at Goodwin Procter.


One of the fastest-growing investment products is exchange-traded funds, whose low cost, tax efficiency and liquidity have made them investor favorites. They also are subject to a cumbersome regulatory process.

The types of ETFs have proliferated, and each requires sign-off by the SEC because there is no general ETF rule. This year, the SEC will consider a regulation that would apply to so-called plain-vanilla ETFs that are linked to indexes.

The person leading the SEC's new approach to ETFs will be the new director of the Division of Investment Management, Dalia Blass, who is an expert on the funds.

"What they will have is more explicit rather than implicit rules of thumb for ETFs as products," Mr. Whelan said. "You will see less confusion and opaqueness around what ETFs can and can't do. They will make it less gray and more black and white."


Mr. Clayton has been at the SEC's helm since last May. This year, his enforcement philosophy will result in action: Harm to retail investors caused by hidden adviser fees will get the SEC's attention.

"By all indications, they're looking to bring cases against money managers, investment advisers and brokerage firms," said Ian Roffman, a partner at Nutter McClennen & Fish. "They're signaling they're going to target funds that affect individuals and potentially also types of institutions that are collective vehicles for individuals, such as retirement or pension funds."

As summed up by Ms. Barr, expectations of deregulation, under Mr. Trump's or any administration, can often be overstated, as there is, in fact, always ongoing activity at the staff level. And the process of amending or taking rules off the books — as both the SEC and Finra are considering — is an arduous haul.

"It takes almost as much, if not more, effort to deregulate than to regulate. Less will change than people think," she said.


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