At the request of member firms (according to FINRA), FINRA has now released its 2019 Reports on Examination Findings summarizing key findings from member exams. Different from earlier reports (2017 and 2018), this time around, FINRA says it wanted to make clearer the distinction between exam findings (violations of SEC, FINRA rules) and observations (suggestions for improving control environment).
FINRA’s stated goals are to identify issues and advise members of effective practices that can address deficient compliance programs in areas covering sales practice and supervision, firm operations, market integrity, and financial management. While the list contains many of the usual deficiencies, it also includes specific and noteworthy observations about how to strengthen compliance in these areas, including
supervision and document requirements
Suitability Rule violations
Digital Communication Use
Anti-Money Laundering (AML)
Uniform Transfers and Grants to Minors Accounts
Business Continuity Plans
Fixed Income Mark-up Disclosure
Direct Market Access Controls
Liquidity and Credit Risk Management
Segregation of Client Assets
Net Capital Calculations
A link to the report can be found here.
“For these examinations, OCIE will select firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses, or other charges. With respect to mutual fund share classes, OCIE will continue to evaluate financial incentives for financial professionals that may influence their selection of particular share classes….” *
*From SEC’s 2019 Examination Priorities (Office of Compliance and Examinations)
By the time many firms read the SEC’s missive, they were likely already at the stage of settling enforcement actions, self-reported or been apprised by examiners of their failure to adequately disclose conflicts of interest related to the sale of higher-cost mutual fund share classes when a lower-cost share class was available.
BMO Harris Financial Advisors and BMO Asset Management are two of the latest casualties in the SEC’s crack down on mutual fund share-class disclosure failures. The affiliated advisers agreed to settlement of charges that they failed to disclose a practice of maintaining approximately 50% of their client funds in proprietary mutual funds and selecting higher-cost share classes of these funds and certain other funds when lower-cost share classes were available for the same funds. The practice benefited the BMO advisers allowing them to receive additional management fees and avoid paying transaction costs to its clearing broker. The SEC found these actions (i) to be a conflict of interest (ii) involved revenue sharing not disclosed to clients (iii) violated the firms’ duty of best execution and (iv) failed to implement written policies and procedures to prevent violations of the Investment Advisers Act of 1940 and the rules thereunder.
Both firms agreed to a censure, disgorgement, prejudgment interest and a civil penalty totaling about $38 million.
Also, yesterday, the SEC announced settled orders against 10 other investment advisers finding that they failed to adequately disclose conflicts of interest related to the sale of higher-cost mutual fund share classes when a lower-cost share class was available. These SEC’s orders have found that the settling investment advisers placed their clients in mutual fund share classes that charged 12b-1 fees – which are recurring fees deducted from the fund’s assets – when lower-cost share classes of the same fund were available without adequately disclosing that they were selecting the higher cost share class.
Presumably, and sooner than later, the SEC will announce more settlements, and the SEC’s examination program will continue to make share class selection-related violations a priority.