Compliance Whitepaper Discussion of Usage by Registered Representatives and Investment Advisor Representatives FOR BROKER-DEALER AND FINANCIAL ADVISOR USE ONLY Copyright 2015 Wealth2k, Inc. All rights reserved. The Income for Life Model is a registered trademark of Wealth2k, Inc. FINRA Review Reference: FR2014-0729-0433/E
Overview The Income for Life Model (IFLM) is a comprehensive suite of tools and services that collectively enable investment professionals to serve investors retirement income distribution needs. IFLM includes deliverables that help organizations introduce a successful retirement income initiative. Included in these deliverables are advisor training programs, an income distribution philosophy and process, consumer-facing communications tools, including multimedia and interactive educational presentations, and income-planning software that produces a customized income distribution strategy for each investor. IFLM is used successfully in all channels. It is equally effective for registered representatives and investment advisor representatives. FINRA Rule 2111 supports registered representatives use of strategies, and the wide breadth that incidental advice might encompass related to strategies. Wealth2k seeks to simplify the process of retirement income. We help create clarity and confidence for investors by providing concise and easy-to-understand software tools and educational materials. Consistent with the process of simplification, we seek to maintain efficacy via an investing strategy that helps protect retirees from risks that can severely damage their retirement security, including sequence-of-return risk, inflation risk and longevity risk. For the purpose of retirement income planning, Wealth2k believes that both investment professionals and their clients benefit from trusted, impartial tools. We also believe that investors should understand the far-reaching consequences of their financial decisions. Our conviction is that retirees are likely to be more financially secure in retirement when they have a formal, written strategy for generating durable retirement income. The IFLM software calculator aids investment professionals in their attempt to illustrate and disclose the complexities of their unique investment recommendations, as well as the effect of time on those recommendations. This can be helpful to all investment professionals as they deal with their overlapping tasks of giving ongoing and incidental advice, and designing long-term strategies for their clients. Americans are simply not well equipped to fight through the complexity to make to make sound and sensible decisions. In fact, we now hear every day from people who lament the choices they made, often expressing anguished regret that they did not know about the risks involved at the time they made key financial decisions. So we are keenly aware that consumers of all ages need sound information and advice to bolster their financial knowledge. But where can they find these tools? Richard Codray Director, Consumer Financial Protection Bureau May 29, 2013 2 IFLM Compliance Overview
FINRA Regulatory Notice 11-02 Know Your Customer and Suitability IFLM may help investment professionals address key responsibilities in the context of retirement income planning. Consistent with FINRA guidelines, all investment professionals should educate consumers on the following: Basic investment concepts such as risk and return, diversification, dollar cost averaging, compounded return, and taxdeferred investment. Historic differences in the return of asset classes (e.g. equities, bonds and cash) based upon standard market indices. Effects of inflation. Estimates of future retirement income needs, and, Assessment of customer s investment profile. Both registered representatives and investment advisor representatives work in the finance market, but they perform two different roles. Each profession, in fact, gives advice, and each has a duty of care toward the consumer- be it a fiduciary or a suitability standard. Persons in both professions must have a combination of complex communications and analytical skills. Investment advisor representatives typically do not sell securities, but rather manage portfolios or act as wealth managers. Registered representatives often handle individual transactions or may employ reasonably designed strategies to meet their clients financial needs. Regardless, both professions must educate consumers, gain detailed insight into their customers financial situations, and develop investment strategies. The IFLM software calculator assists registered representatives and investment advisor representatives to document certain details of their customers financial situation and may assist in the documentation of product comparisons made while attempting to meet their customers goals. Sources FINRA Regulatory Notice 11-02 FINRA Rule 2111, Know Your Customer and Suitability SEC Office of Investor Education, May 8, 2015 IFLM Compliance Overview 3
The IFLM Software Calculator The Income for Life Model calculator is a dynamic tool for crafting an income distribution strategy. IFLM is not deemed to be a financial planning or investment advice program. It does however, provide a formal, written income distribution analysis, a strategy, for every investor. The IFLM software calculator may help both registered representatives and investment advisor representatives better educate consumers on complex matters related to achieving their stated long-term financial goals and objectives. The calculator may also help professionals illustrate how their recommended strategy addresses the customer s tolerance for risk and additional sources of funds. No tool should be used in a way that exceeds the financial professional s expertise, misleads the consumer or fails to consider all relevant facts and circumstances. The data used to validate the investment decision or used as the basis of any recommendation e.g. input into any tool must be factual and must also consider the customer s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose Calculators are designed to be informational and educational tools only, and when used alone do not constitute investment advice Source FINRA.org/calculators May 11, 2015 Rule 2111 and RM 11-02 Rule 2111 and RM11-02 s inclusion of other investments and apparent concern regarding additional sources of funds and emergency funds make it clear that any financial professional must consider outside assets such as a consumer s savings, life insurance, other securities accounts or other items of value held away from the registered representative s or investment advisor representative s firm, when he or she is entering data into a tool or making any form of investment decision or recommendation. Sources FINRA Regulatory Notice 11-02 FINRA Rule 2111, Know Your Customer and Suitability 4 IFLM Compliance Overview
Advice, and The Overlap Registered Representative Wide variety of services Research Commission/concession Advice incidental to recommendations or strategy Buy or sell a particular security or product occasionally or as part of a strategy Investment Advisor Representative Asset management Wealth manager Fee or commission Ongoing advice and services Develop a detailed strategy or implement a financial plan For over ten years, the breadth and definition of the word advice has often been debated amongst compliance staff, but in fact, all financial professionals be they registered representatives or investment advisor representatives give consumers advice in a variety of ways. Expanded wording in FINRA Rule 2111 shows that FINRA understands that registered representatives do and will continue to recommend purchases and sales of securities as part of strategies designed to meet stated financial goals. FINRA explicitly covers recommended strategies. Through its various NTMs regarding supervision of complex products, FINRA also clearly recognizes that discussions with clients should include a conversation about the characteristics of complex products and how those characteristics do or don t meet the customer s stated goals. Rule 2111 does not debate the word advice- incidental or otherwise. Instead, 2111 explicitly permits the suitability analysis to be performed within the context of the customer s other investments. 2111 requires that a financial professional have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer s investment profile. The SEC similarly doesn t quibble over the word advice, but comments variously on a financial planner s assumed ability to assess every aspect of your financial life - including saving, investments, insurance, taxes, retirement, and estate planning - and help you develop a detailed strategy or financial plan for meeting all your financial goals. The IFLM software calculator is an aid to both registered representatives and investment advisor representatives alike as they develop, Illustrate, discuss and recommend or implement a long-term retirement income strategy to meet their clients stated goals. Sources FINRA Rule 2111 SEC.gov/investor/pubs/invadvisers.htm FINRA NTM 12-03 IFLM Compliance Overview 5
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The IFLM software calculator is an aid to both registered representatives and investment advisor representatives alike as they develop, Illustrate, discuss and recommend or implement a long-term retirement income strategy to meet their clients stated goals. IFLM Compliance Overview 7
Context for Product Selection In designing a strategy for retirement income distribution, no single investment or insurance product is typically an adequate answer to meet the investor s long-term needs. Different types of products provide varying features and benefits and have different types of utility in an income strategy. IFLM may help compliance reviewers more clearly see where certain recommendations - recommendations that might have seemed out of place standing alone - appropriately fit into the long-term strategy and how recommendations help meet the client s stated goals. Big Picture View IFLM may contribute to a valuable, bigger picture view behind a recommendation. It can help create a context for the overarching strategy the registered representative or investment advisor professional discussed with the client - a strategy perhaps based on his or her recommendations alone, or perhaps encompassing some outside assets that warranted consideration and couldn t be left out of a prudent review of the client s financial situation. The IFLM software calculator is an aid to both registered representatives and investment advisor representatives alike as they develop, Illustrate, discuss and recommend or implement a long-term retirement income strategy to meet their clients stated goals What is a Strategy? A strategy generally involves: Setting goals Determining action to achieve goals Mobilizing resources to execute the actions A strategy describes how the ends (goals) will be achieved by the means (resources). 8 IFLM Compliance Overview
Both registered representatives and investment advisor representatives address a given strategy when determining how best to meet their customers financial goals. They both give advice some is incidental such as: - how maturities affect a bond ladder over time. - how the accumulation value of an annuity contract grows, and the potential effects of future withdrawals versus annuitization. - how fees or Rights of Accumulation can negatively or positively affect a mutual fund purchase. Sometimes, the advice can be broader and cover a myriad of areas including but not limited to: - the correlation of asset classes. - theories on the Efficient Frontier, or - the reasoning behind benchmarking. Both often deal with meeting the long-term financial goals of clients. The IFLM strategy can be populated with any range of products to support a strategy that fits a registered representative s or investment advisor representative s licensing restrictions, the accepted breadth of their advice, and their customer s stated goals. Rule 2111: A Reasonable Design Rule 2111 sets forth definitions of a reasonable design. The strategy or plan will not harm the customer. The strategy or plan meets stated income-generation needs where applicable. The strategy or plan is based upon a complete and in-depth review of the customer. Where needed to meet stated goals: the strategy or plan creates a diverse portfolio made up of securities with different levels of liquidity, risk and time horizons. Use of the IFLM software calculator is immaterial to: Whether the customer receives planning services or advice. How the customer pays their financial professional. The product restrictions, if any, that licensing may bring into play for the registered representative or investment advisor representative. IFLM Compliance Overview 9
Given the regulatory expectation that strategies will be reasonably designed, that customers will be educated and that all aspects of complex products and long-term investing will be discussed, the allowable range of incidental advice a registered representative might provide is actually extremely broad. And, of course, an investment advisor representative s capacity to provide advice is naturally even more expansive. FINRA s NTM 12-03, Supervision of Complex Products and comments to SIFMA in 2014 make it clear that regulators expect registered representatives to know and discuss, for example, the basic tax aspects of the securities, including insurance products, that they recommend or that the death proceeds of a life insurance policy are generally income tax-free. Discussion of the hold recommendation in clarified Rule 2111 also can infer that while a registered representative s role may be transactional, FINRA realizes that registered representatives provide ongoing communication to their clients, such as when and how to replace securities, as they attempt to achieve their stated financial goals. Rather than debating again the definition of incidental advice, numerous FINRA disciplinary actions instead center on the lack of trustworthy financial advice. FINRA Complaint F2007010902501 cites a registered representative s unsuitable recommendation because he lacked information on the client s assets at another firm. FINRA Complaint F2013037757701 discusses failure to adequately discuss the complexities of an annuity. FINRA revised the Sanction Guidelines to increase the high-end of the suspension from one year to two years for suitability violations and advises adjudicators to strongly consider barring an individual respondent where aggravating factors predominate the respondent s misconduct. There is no mention of too much advice, only too little or unsuitable advice. The IFLM Calculator may help investment advisor representatives and registered representatives discuss the complexities of certain products and the effect of time on those products as they develop and discuss reasonably designed strategies or financial plans to meet their customers goals. Sources FINRA Information Notice 4/10/15 FINRA Newsroom: SIFMA Complex Products Forum 10/28/2014 FINRA Regulatory Notice 13-31 FINRA Monthly Disciplinary Actions 9/2014, FINRA Cases 2013037757701, 20110269351 SR FINRA 2014-043 IFLM Saves Time and Money Organizations are committing more and more time to compliance-related matters. The sheer volume of new rules, rule changes, examinations, sweeps, and inquiries is putting enormous strain on staff at many firms. Firms reported that senior management is now spending substantially more time on compliance-related activities, reaching as much as 30-40% of their time in many instances. In addition, the retail sales force and many other non-compliance staff are spending as much as 25% of their time on compliance-related activities. Source SIFMA s Cost of Compliance Survey 10 IFLM Compliance Overview
The majority of compliance-related spending is staff related, 93.9% according to the latest SIFMA survey. This is especially true for mid and large-sized firms. Small firms tend to compensate by outsourcing staff activities, which significantly increases out-of-pocket expense. IFLM helps to control the adverse impact on overall compliance spending brought on by regulations and legislative mandate. Firms may find that it is easier to maintain high standards of oversight and client protection, with fewer additions to staff. IFLM offers other benefits to compliance departments: Improve documentation of the recommendation, planning and review processes. It makes for a cost-effective response to the challenges posed by FINRA s Rule 2111 requirement to review the suitability of strategies. Makes it easier to methodically document disclosures made to clients during the recommendation and planning process. Provides additional evidence of comparisons occurring during the asset allocation and product selection process. Illustrates for the reviewer how recommendations of products with different liquidity, risk or time horizon meet specific clients needs. What CCOs are saying about IFLM It was like adding staff to my review desk. - CCO, Mid-size BD/RIA Helped us see the bigger picture. My staff could more quickly determine how a recommendation that, reviewed alone might be questioned, really fit into the overall strategy or plan. - CCO, Large BD/RIA Cut down significantly on the number of back-and forth communications with RRs and IARs during our suitability and activity reviews. - CCO, Insurance-Affiliated BD/RIA Conclusion According to the Rand Corporation, retirement income is older Americans top financial concern. But it s not just older people who are anxious about retirement. A remarkable 70% of Americans between the ages of 30 and 49 indicate that not having enough retirement income is also their biggest financial concern. For investment professionals, no work they do may be more important than helping investors convert their retirement savings into durable, inflation-adjusted income. The Income for Life Model provides the tools, education, and insights required to ignite organizational success in this key business opportunity. It s important to understand than when a strategy or plan is in the client s best interest, the IFLM software calculator can be used by both registered representatives and investment advisor representatives to illustrate a reasonably designed strategy or financial plan that consists of a variety of securities or products, considers a customer s broad holdings, and responds to long-term needs. IFLM Compliance Overview 11
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