Yesterday, the Enforcement Section of the Massachusetts Securities Division charged Scottrade with violating the impartial conduct standards of the Labor Department’s fiduciary rule, which became effective on June 9, 2017.
Please find below a reaction on from Ropes & Gray tax & benefits partner Josh Lichtenstein.
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Statement from Josh Lichtenstein:
The complaint filed by the Enforcement Section of the Massachusetts Securities Division may mark the start of a new chapter in the saga of the DOL’s fiduciary rule. This complaint alleges that Scottrade failed to comply with provisions of its compliance manuals that it added to facilitate compliance with the DOL’s fiduciary rule, and that by failing to comply with those provisions, it was not “working diligently and in good faith” to comply with the fiduciary rule. There are a number of questions that will need to be resolved following the filing of this action, but the Securities Division’s action reinforces the importance of ensuring that compliance policies adopted in connection with the fiduciary rule are actually followed by institutions and their financial advisors. The filing also serves as a reminder that institutions should review their procedures to ensure that they are appropriate for complying with the rule as it stands during the current transition period.
COMMONWEALTH OF MASSACHUSETTS
OFFICE OF THE SECRETARY OF THE COMMONWEALTH
ONE ASHBURTON PLACE, ROOM 1701
BOSTON, MASSACHUSETTS 02108
IN THE MATTER OF:
Docket No. E-2017-0045
1. PRELIMINARY STATEMENT 4
The Enforcement Section of the Massachusetts Securities Division of the Office of the Secretary of the Conunonwealth (the “Enforcement Section” and the “Division,” respectively) files this Administrative Complaint (the “Complaint”) to commence an adjudicatory proceeding against Scottradc, Inc. (“Scottrade” or “Respondent”) for violations of MASS. GEN. LAWS ch. 11oA, the Massachusetts Uniform Securities Act (the “Act”), and the regulations promulgated thereunder at 950 MASS. CODE REGS. 10.00 – 14.413 (the “Regulations”). The Enforcement Section alleges that Respondent engaged in acts and practices in violation of Section 204 of the Act and Regulations.
The Enforcement Section seeks an order: I) finding as fact the allegations set forth below; 2) finding that all the sanctions and remedies detailed herein are in the public interest and necessary for the protection of Massachusetts investors; 3) requiring Respondent to permanently cease and desist from further conduct in violation of the Act; 4) censuring Respondent; 5) requiring Respondent to review its supervisory procedures to ensure compliance with applicable state and federal laws; 6) requiring Respondent to provide a verified accounting of all proceeds which were received as a result of the alleged wrongdoing; 7) requiring Respondent to disgorge all profits and other direct or indirect remuneration received from the alleged wrongdoing; 8) imposing an administrative fine on Respondent in such amount and upon such terms and conditions as the Director or Presiding Officer may determine; and 9) taking any such further action which may be necessary or appropriate in the public interest for the protection of Massachusetts investors.
Scottrade, Inc. (“Scottrade”), a Massachusetts-registered broker-dealer, has knowingly violated its own internal policies designed to ensure compliance ‘with the United States Department of Labor (“DOL”) Fiduciary Rule by running a series of sales contests involving retirement account clients. On April 6, 2016, the DOL issued the Fiduciary Rule, which expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974. The Fiduciary Rule significantly expands the circumstances in which broker-dealers, investment advisers, insurance agents, plan consultants, and other intermediaries are treated as fiduciaries. In part, the Fiduciary Rule, which requires that material conflicts of interest be disclosed to clients, intends to stem the tide of unethical sales practices in the brokerage business. On June 9, 2017, the impartial conduct standards of the Fiduciary Rule went into effect. The impartial conduct standards require all financial advisors who manage retirement accounts or provide retirement advice to act as fiduciaries, placing the interests of their customers ahead of their own.
Prior to the Fiduciary Rule, Scottrade employed a firm-wide culture characterized by aggressive sales practices and incentive-based programs. For example, between December 2015 and April 2017, Scottrade ran a series of call nights and sales contests, in part to drum up additional business in light of an upcoming merger with TD Ameritrade. In response to the Fiduciary Rule, Scottrade added identical provisions to both its Brokerage and Investment Advisor Compliance Manuals. These provisions, titled “Impartial Conduct Standards Applicable to Covered Recommendations in Retirement Accounts,” provide that:
The firm does not use or rely upon quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation or other actions or incentives that are intended or reasonably expected to cause associates to make recommendations that are not in the best interest of Retirement Account clients or prospective Retirement Account clients.
Scottrade made these necessary changes in anticipation of its obligations under the upcoming Fiduciary Rule. However, Scottrade subsequently failed to enforce the above provisions, rendering these policies meaningless.
Despite its addition of policies related to the Fiduciary Rule, Scottrade expanded the scale and scope of the very sales practices its policies were designed to curtail. Notwithstanding the implementation of certain elements of the Fiduciary Rule on June 9, 2017, Scottrade launched two sales contests between June and September 2017 that ran in violation of its own internal policies designed to ensure compliance with the Fiduciary Rule. Scottrade launched the first of these two contests, the Q3 Win and Retain Sales Contest (the “Q3 Sales Contest”), on June 5, 2017. The Q3 Sales Contest came on the heels of predecessor sales contests, placed an explicit emphasis on generating net new assets, including retirement assets, and offered $285,000 in cash prizes. Almost immediately after the Q3 Sales Contest ended on July 31, 2017, Scottrade launched the Q4 Dials and Referral Contest (the “Q4 Sales Contest”), which was nearly identical in scope and structure. The Q4 Sales Contest offered weekly cash prizes in the amounts of $500 and $2,500. Both the Q3 and Q4 Sales Contests perversely incentivized Scottrade agents to bring in new assets from customers, including through the rollover of retirement assets.
During both the Q3 and Q4 Sales Contests, Scottrade knowingly included retirement account clients in the scope of the contests. As a result, the Q3 and Q4 Sales Contests, which focused on gathering additional assets, including those of Massachusetts retirement account clients, ran in direct contravention of Scottrade policy.
Scottrade encouraged its customers to bring new assets to the firm, while failing to inform them of the conflicts arising from the sales contests. To appraise the performance of its agents, Scottrade frequently circulated internal metrics and rankings during the Q3 and Q4 Sales Contests. Under the Q3 Sales Contest, Scottrade required its agents to achieve a call penetration of at least 80% in order to qualify for particular prizes. Under the Q4 Sales Contest, Scottrade required its agents to make recommendations and referrals to its investment advisory program in order to qualify for particular prizes. These contests could reasonably be expected to cause Scottrade agents to make recommendations in their own best interests rather than the best interests of their customers, including those with retirement accounts.
The DOL announced that until July 2019, it “will not pursue claims against fiduciaries working diligently and in good faith to comply with the Fiduciary Rule […} or treat those fiduciaries as being in violation of the Fiduciary Rule[.]” Although it had in place policies designed to ensure compliance with the Fiduciary Rule, Scottrade failed to take any meaningful steps to implement and enforce such policies. In fact, Scottrade developed and ran the Q3 and Q4 Sales Contests in violation of these very policies. Scottrade’s own internal-use materials instructed agents to target a client’s “pain point” and emotional vulnerability, while training sessions lauded the use of emotion over logic in getting a client to bring additional assets to the firm. These tactics do not represent the behavior of a fiduciary.
Massachusetts retirement account holders, regardless of portfolio size, should be advised by professionals who put the interests of their customers ahead of their own. In response to a firm-wide culture characterized by aggressive sales practices, Scottrade and its agents neglected their duty to Massachusetts retirees while focusing on gathering new assets in anticipation of the TD Ameritrade merger. By instituting this proceeding, the Enforcement Section charges Scottrade with knowingly violating its own internal policies related to the Fiduciary Rule, a clear demonstration that Scottrade has failed to act in good faith to comply with the Fiduciary Rule.
See the full PDF below.