Best Practices for Retail Non-

Deposit Investment Programs

Louis Dempsey, RenaissanceBen Marzouk, Eversheds SutherlandDavid Porteous, Faegre Baker Daniels

Agenda

■ Regulatory Developments

• Focus on Fixed Income, Interest Rate Sensitive & Structured Products

■ Compensation Practices

■ Training

■ Compliance Oversight

Regulatory Developments

■ SEC Share Class Disclosure Initiative

• Background:

> SEC Division of Enforcement announced the Initiative on February 12, 2018.

> Encourages self-reporting of share class disclosure violations in exchange for favorable settlement terms.

> Applies to RIAs only.

• Initiative is squarely focused on comparatively more expensive share classes with 12b-1 fees selected for clients without adequate disclosure.

> Query: Does disclosure alone cure Section 206 violations for recommending a more expensive share class when less expensive option is available?

• SEC action against Ameriprise (Feb. 28, 2018)

Regulatory Developments

■ Offerings of ICOs and Cryptocurrencies

• SEC DAO Report (July 25, 2017)

> Status of ICOs as “securities” requiring SEC registration.

> Howey test.

> Impact for future ICOs?

• SEC Division of Investment Management Letter to ICI (Jan. 18, 2018)

> Mutual funds are ETFs pegged to cryptocurrency markets.

> Concerns regarding valuation, liquidity, and market manipulation.

> Request to halt cryptocurrency fund registration requests.

• Query: Allow reps to purchase? Allow customers to purchase?

Focus On Fixed Income Products

FINRA Comments and other enforcement actions indicate that FINRA believes firms should:

Have robust product review, approval, and monitoring process to assess product specific risks

and provide centralized guidance

Develop customized training/guidance for RRs, managers, and Principal Review that flow out

of the due diligence process

Inadequate to rely on sponsors + access to RRs must be supervised so:

• Know what sponsors are selling and advising RRs

• Control sponsor conflict of interest

• Ensure consistency with firm’s analysis of risks

Have product-specific suitability metrics including for Principal Review review

Have product expertise in Principal Review review process

Particular concern for bank-channel and older, less sophisticated or more

conservative customers who may be chasing rates or not understand risks

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FINRA Annual Examination Priority Guidance – Examiner Focus Areas Regarding

Interest Rate Sensitive Products

■ Concentration Risk –concentrated positions in interest rate sensitive products

■ Long Duration Risk re: FI Products & Bond Funds – if rates rise (including from changes in monetary policy),

such products could lose a substantial portion of their value regardless of credit quality of underlying portfolio assets

■ Long Holding Periods to Maturity –should match customer risk tolerance, time horizon, liquidity needs

■ High-Yield, Municipal, Other FI –may be particularly sensitive to rate changes

■ RR Training & Guidance –will look for firm training to ensure RRs

• Understand such products and risks

• Make suitable recommendations, and

• Have proactive conversations with customers about such risks

■ Customer Guidance & Disclosure –will look for quality of disclosures re: same

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Common SEC Exam Questions Regarding Product

Sales, Disclosures and Account TypesProvide any written disclosures and any scripts used during the Examination Period regarding:

■ a. distribution options (i.e., maintaining assets in a former employer’s plan, transferring assets to a new employer’s plan, rolling assets over to an IRA, or taking a lump sum distribution), the tax implications of those options, and other considerations (e.g., required minimum distribution requirements, availability of penalty-free withdrawals, protection of assets from lawsuits, and estate planning);

■ b. conflicts of interest or financial interests that Registrant or its representatives have in recommending any specific product or account type;

■ c. the various types of account options available to clients (i.e., IRA Rollover), including the account- level fees and expenses and services provided.; and

■ d. the various investment options available to clients (i.e., structured products, REITs, variable annuities, mutual funds, and ETFs), including information regarding product-specific fees and expenses, revenue sharing, loads, commissions, and other charges.

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SEC Data Analysis Of Structured Securities Product

Transactions By Investment Objective

■ Predominant types of customers that had purchased SSPs at each firm and branch office

■ Focused on branch offices and representatives that had highest numbers of sales that merited further review

■ Trends among customer investment objectives:

• More SSPs sold to customers in its most conservative investment objective (“Income”) than in the most aggressive (“speculation”) ($96mm “income” to $11 mm “speculative”)

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Regulatory Developments

■ SEC and State Fiduciary Developments

• SEC:

> June 1, 2017 – SEC Chairman Jay Clayton invites public comment on proposed rulemaking for uniform standard of conduct for BDs and IAs.

> Coordination with DOL?

• States:

> Certain states already impose fiduciary standards through either unethical business practices rules/regulations, or court decisions.

> Nevada “financial planner” amendment.

> Several other states taking steps to impose fiduciary duty on financial services providers (e.g., New York, New Jersey, Connecticut, Maryland).

> “Disclosure-based” fiduciary vs. “explicit fiduciary” standards.

Compensation Practices

■ Sales Contests [Loop in DOLFR treatment; Scottrade enforcement action by Massachusetts proves DOLFR still has teeth]

■ Referral Payments

■ Regulation R

■ Revenue Shares

■ Management Overrides

Training

■ Acceptable referral and sales practices

■ Who receives training?

• Reps

• Principal Review Desk

• Managers

■ Who performs training? (third party vendors / product sponsors)

• If training is provided by vendors / product sponsors, is it supervised?

• Know what sponsors are selling and advising reps

■ Supervision of training

• Product committee review and approval of marketing and advertising materials used

• Training should flow from customer profile identified for sale of product and making sure there is clear messaging regarding customer profile and interaction with management and PRD regarding questions

• Focus on messaging to bank-channel customers – how would this be understood by someone less familiar with market risk?

Compliance Oversight and Auditing

■ Titles [Note: Received attention from Clayton and others @ SEC Speaks; BDs calling themselves FAs etc…]

■ FINRA Regulatory Notice 18-08 re: OBA/PST streamlined new rule proposal

■ What how and when to examine investment program?

IDENTIFYING PRODUCTS FOR FURTHER ANALYSIS■ Materiality as measured as overall percentage of sales (e.g., rollover /

breakpoint cases) ■ Regulatory attention level■ Macroeconomic environment triggering heightened risk

• E.g., interest rate future guidance and potential impact on product performance and customer impact

■ Degree of unrealized losses in product class■ Underperformance or uneven performance■ Products that people may be using differently than intended (e.g., unsolicited

liquidations in specific products prior to term or recommended holding period)■ Complaint trending ■ Substantial Switch Activity (to/from) – documentation of comparison ■ Analysis of sales against higher-risk suitability factors including

• Age, risk profile, investment objective, other factors

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Questions?