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FINRA CEO Pushes Back on DOL Fiduciary Proposal

The Labor Department’s fiduciary proposal — or more specifically, its “appropriate standard of care” for brokers and dealers — was the focus of comments by Financial Industry Regulatory Authority (FINRA) Chairman and Chief Executive Officer Richard Ketchum at the 2015 FINRA Annual Conference May 27.

Ketchum reiterated his support for a best-interests-of-the-customer standard, but said he was “disappointed” regarding the rhetoric about the broker-dealer industry and its current level of regulations that accompanied the DOL’s proposal.

He outlined the current FINRA rules and enforcement mechanisms, noting that, “Through rule adoption and enforcement actions, the SEC and FINRA have adjusted regulatory requirements to address many conflict issues.”

While acknowledging that the present system is not perfect, Ketchum noted that “depictions of the present environment as providing ‘caveat emptor’ freedom to broker-dealers to place investors in any investment that benefits the firm financially with no disclosure of their financial incentives or the risks of the product, are simply not true.”

He proceeded to outline rationale for why the time is right to move forward to a best-interest standard: that FINRA’s enforcement actions continue to find “unacceptable instances of unsuitable sales of more complex products without the appropriate disclosure to clients;” that some firms continue to approach conflict management on a “haphazard” basis; and despite their recent notice on recommendations regarding 401(k) rollovers to IRAs, “we continue to be concerned that there is often not enough effort made to provide a balanced discussion of the potentially higher fees involved in IRAs to permit a customer to make a fully informed decision.”

Concerns with DOL Proposal

Ketchum enumerated several specific concerns with the DOL’s current proposal:

  • The IRA enforcement jurisdiction moves “enforcement of these provisions to civil class action lawsuits or arbitrations where the legal focus must be on a contractual interpretation.”

  • Insufficient workable guidance provided either to the firm or the judicial arbiter on how to manage conflicts in most firms’ present business models other than moving to pure asset-based fees, or a completely fee-neutral environment.

  • It applies a different legal standard to IRAs and 401(k)s than to the rest of an investor’s assets.

Crafting a Best Interest Standard

Ketchum also outlined what he called “markers” in crafting a best interest standard, including:

  • It should make clear that customer interests come first and that any remaining conflicts must be knowingly consented to by the customer.

  • It should include a requirement that financial firms establish carefully designed and articulated structures to manage conflicts of interest that arise in their businesses.

  • It should begin by applying know-your-customer and suitability standards as “belt and suspenders” backstops, similar to what is contained in FINRA’s rules.

  • It should be more effective disclosure provided to investors, specifically that broker-dealers should be required to provide customers an ADV-like document annually that provides clear, plain English descriptions of the conflicts they may have and an explanation of all product and administrative fees, as well as point-of-sale disclosures regarding relevant conflict, risk and fee issues relating to a recommendation, or, in the alternative, follow up any discussion involving a recommendation with a written or email communication that memorializes the conversation by describing the key contractual terms and fees entailed in the product.

Ketchum also noted that firms should take concrete steps to address the incentives for their registered persons from differential product compensation, including creating fee neutrality across products that minimize incentives for salespersons to favor one type of product over another.

The text of Ketchum’s remarks is available here.