Recently, the staff at the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) issued a report to help broker-dealers be better prepared to assist the large number of investors entering retirement over the next 15 years. Although there is no universally accepted definition of “senior investors,” it appears that those entering retirement over the next 15 years are among those investors contemplated as part of the “Senior Investor Initiative.” Further, the currently prevailing environment of historically low investment yields is at least one impetus behind the SEC and FINRA’s interest in issues related to these senior investors. Specifically, the articulated concern is that the low yields could cause some broker-dealers to recommend higher risk (and thus potentially unsuitable) investments to senior investors in an attempt to generate greater returns.
The recent report is part of OCIE and FINRA’s National Senior Investor Initiative. During 2013, OCIE, in connection with FINRA, examined 44 broker-dealers, focusing on the types of securities being sold to senior investors, as well as the methods the firms are using when recommending those securities. The examination candidates were identified using a risk-based approach that considered such factors as the types of securities sold and the number of registered individuals, as well as previous sales practices and supervisory deficiencies and customer complaints.
In 2015, consistent with the published exam parameters, the SEC and FINRA will continue to examine broker-dealers in relation to senior investors. The examinations are expected to focus on several areas, including training on senior investor issues, use of senior designations, marketing and communications with senior investors, account documentation, suitability, disclosures, customer complaints, and supervision.
FINRA Rule 1250(b) requires firms to have a training plan that is appropriate for all business activities. Although FINRA does not require training specific to issues such as the exploitation of elders or elder financial abuse, matters subject to examination suggest that such training would better prepare representatives to understand the needs of senior investors. Specific topics could include ensuring senior investors were fully informed of the risks involved with each product, how investment needs change as investors age, and appropriate steps to take in the event of signs of diminished capacity or elder financial abuse.
FINRA Regulatory Notice 11-52 reminds broker-dealers of their supervisory responsibilities concerning the use of senior designations. While some designations have more stringent requirements, others do not have any requirements. Thus, the designations can be misleading to all investors, not just senior investors. The examination suggested that best practices would require firms to limit the use of such designations. Specifically, firms could only allow the use of designations where the corresponding curriculum and continuing education requirements meet specified standards and were recognized by independent accrediting organizations. Additionally, firms should continue to supervise and track which representatives employ senior designations. In some cases, firms may even want to prohibit the use of senior designations.
The examination staff found that the use of senior designations also might give rise to compliance issues under Rule 2210 (communications with the public), specifically in the context of retail communications sent to senior investors. Best practices include creating written policies and procedures regarding communications, and ensuring that communications are not misleading and that content is properly reviewed and supervised.
For senior investors, investment objectives, needs, and risk tolerance may be more fluid as their goals shift from accumulation to income production. Consequently, strict adherence to Exchange Act Rules 17a-3(a)(17)(i)(A) and 17a-3(a)(17)(i)(B) will be carefully scrutinized. One best practice specific to this area includes obtaining additional or more detailed account information than what might otherwise be required under the current regulatory scheme, such as expense information, retirement status, and sources of incomes. Additionally, the report highlights the use of automated supervisory alerts to help ensure that investment profiles accurately reflect changes in customers’ personal and financial circumstances.
Through its examinations, the staff identified potentially unsuitable recommendations made with regard to variable annuities, alternative investments, mutual funds, structured products, market-linked CDs, and REITs. The examination staff suggests that firms adopt specific senior investor-oriented policies and procedures for addressing suitability risks, require representatives to memorialize conversations with senior investors regarding recommendations, draft product applications that require firm representatives to consider and document crucial investment profile information, and establish strict product concentration guidelines for senior investors.
As a result of these examinations, the staff concluded that most broker-dealers appear to be providing the appropriate disclosures to senior investors. The staff, however, also noted that most deficiencies in such disclosures tended to occur with non-traditional securities, such as variable annuities and REITs. There are several best practices mentioned in the report that can help ensure compliance with the applicable rules. These practices include requiring a customer signature on a disclosure form indicating receipt of the prospectus for new open-end mutual funds, requiring an explanation of the tax ramifications and alternative investment possibilities for all customers that purchase a variable annuity in an IRA, providing a detailed description of registered representative compensation for each product sold, and providing one comprehensive disclosure form that includes simple definitions for industry nomenclature and the schedule of fees and expenses for specific securities.
Although the examination staff found that all examined firms were properly maintaining records of customers complaints, it still suggested that coding complaints from seniors as “senior related” could help reduce complaints. This specific coding could enable a firm to better respond to and address the primary concerns of senior investors.
Lastly, the examination staff reviewed firms’ supervision of the business being conducted by their representatives with senior investors. The reviews indicated that many firms are paying increased attention to the accounts of senior investors, especially when there are transactions involving non- traditional securities in those accounts. The examination staff recommended several notable practices in relation to supervision, including establishing written policies that address FINRA Regulatory Notice 07-43, maintaining suitability guidelines for senior investors purchasing complex or alternative products, use of a centralized supervisory review group to approve transactions and new accounts for senior investors, as well as use of an automated system that is integrated with the firms’ branch supervisory review system and compliance departments.