Every day for the next 15 years, an estimated 10,000 Americans will turn 65, according to Social Security Administration projections. Currently, more than 41 million people in the U.S. are 65 or older, based on 2011 U.S. Census Bureau data, the most recent available. By 2040, that number is expected to exceed 79 million – more than twice as many as in the year 2000.
This demographic wave – or Silver Tsunami, as the phenomenon is known – prompted the SEC’s Office of Compliance Inspection and Examinations to make the concerns of retirement investors a priority this year. Part of this focus includes determining if the information, advice, products and services being offered to retirement and other retail investors complies with applicable laws, according to an announcement by the SEC in January.
The agency cited two factors in its decision to step up scrutiny in this area. The decades-long shift from defined benefit pensions to defined contribution plans, such as the 401(k), has made investors more dependent than ever on their own investments for retirement. At the same time, the financial services industry is offering retail and retirement investors’ new products and services once classified as alternative or institutional products, such as private funds, illiquid investments, and structured products intended to generate higher yields in a low-interest environment.
The SEC says the goal of examiners will be to assess the risks to retail and retirement investors stemming from these trends. Specific areas of focus include:
1. Fee Selection and “Reverse Churning”
This is the second year the SEC has stepped up oversight of this practice in which brokerage firms trade very infrequently in accounts they manage for fixed fees – accounts that pay fixed fees but generate little or no activity to justify that fee. SEC officials have also expressed concern about firms moving from commission-based accounts to charging clients fees for a broader menu of services – including long-term financial planning and money management – though switching may not be in the client’s best interest.
2. Sales Practices
The SEC will assess whether firms are using improper or misleading practices when recommending the movement of retirement assets from employer-sponsored defined contribution plans to other investments and accounts, especially when they expose the investor to greater risk or charge higher fees.
SEC regulators will evaluate recommendations or determinations by registered asset managers to invest retirement assets in complex or structured products and higher yield securities, including whether due diligence conducted, disclosure made and the suitability of the recommendations are consistent with existing legal requirements.
4. Branch Offices
Regulators will look at the supervision by asset management firms of their investment representative and financial adviser representatives in branch offices. This will include analysis of analytic data by examiners to identify branches that may be deviating from the compliance practices of the firm’s home office.
All this scrutiny, of course, puts asset managers at greater risk. Action by the SEC can result in investigations, fines and penalties, and possibly legal action by affected investors.
In April, the SEC and the Financial Industry Regulatory Authority, the brokerage industry’s self-regulating body, issued a report aimed at helping broker-dealers assess, craft, or refine their policies and procedures for retirement investors. The National Senior Investor Initiative report includes observations and practices identified in examinations that focused on how firms conduct business with senior investors.
Insurance can also provide asset managers with further protection. While routine examinations are not typically covered by insurance, regulatory investigations are a coverage trigger. There are a few things to consider when examining insurance policies for asset managers:
(1) The definition of Claim should address the way that regulators can bring enforcement action. The primary regulator of investment advisers and investment companies is the Securities and Exchange Commission. The most traditional way the SEC can trigger the definition of Claim is through a formal order of investigation, under which it has subpoena power. However, nuances in SEC procedure can add complexity to whether or not coverage is triggered. For example, the SEC can issue a temporary restraining order or a preliminary injunction against an individual pursuant to Section 42(d) of the Investment Company Act of 1940. The easiest way to get peace of mind is to have it clearly spelled out on the policy.
(2) The definition of Professional Services should be broad enough to include adherence to regulatory requirements for designing internal policies and procedures as an asset manager.
(3) The Insured vs. Insured exclusion should be carved back in accordance with SEC procedure as well. For example, under Rule 42(d) of the Investment Company Act, a court can take exclusive jurisdiction or possession of an investment fund. In such instances, claims brought on behalf of such investment fund should be carved out of the exclusion.
(4) Pre-claim coverage is available in certain instances to cover the often significant costs incurred by an asset management firm prior to the issuance of a formal order of investigation. This coverage is typically available via endorsement to the policy and can vary widely. Be sure to examine the retention language to ensure that your policy is not subject to two retentions, one for the pre-claim costs and another for the actual claim that follows.
An insurance agent can help assess your individual risks and recommend the right of level of protection for your needs.
To learn more about The Hartford’s insurance offering for asset managers, visit www.thehartford.com/AMC.
Any discussion of coverage herein is summary only. Coverage depends on the actual facts of each claim and the terms, conditions, and exclusions of the issued policy. Please refer to the issued policy to determine all terms, conditions and exclusions of coverage. In the event of a conflict, the terms and conditions of the policy prevail. All coverages described in this document may be offered by one or more of the property and casualty insurance company subsidiaries of The Hartford Financial Services Group, Inc. Coverage may not be available in all states or to all businesses. Possession of these materials by a licensed insurance producer does not mean that such producer is an authorized agent of The Hartford. To ascertain such information, please contact your state Department of Insurance or The Hartford at 1-888-203-3823. All information and representations herein are as of August, 2015.
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