The Financial Industry Regulatory Authority (“FINRA”) and the Securities Exchange Commission’s (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) have highlighted concerns around the sale of 529 College Savings Plans (“529 Plans”).1 The concerns they have expressed revolve primarily around 529 Plans share class recommendations and the conflicts of interest that may exist with such recommendations. These concerns remain relevant, and may receive additional scrutiny given the current focus of multiple regulators on fees, conflicts of interest and fiduciary behavior.
What this means
In response to the concerns expressed by the SEC and FINRA, firms should revisit their practices around 529 Plans. A few actions to consider taking are below:
- Confirm effectiveness of conflicts of interest management: Firms should ensure they have a conflicts of interest program in place to identify, address, and disclose conflicts in connection to the sale of 529 Plans. Examples of conflicts for which firms may want to confirm the completeness and effectiveness of their program include compensation models that may incentivize financial advisors (“FAs”) to recommend share classes based on drivers other than what is suitable for investors, as well as recommendations made for proprietary plans or products that may be more expensive and/or less suitable than available third-party alternatives.
- Evaluate share class calculation engine: Firms should ensure they have a well-defined and consistent calculation engine to determine the share class that meets the needs of the customer. The employed calculation methodology should consider2 a customer’s:
- State of residence
- Holding period/age of the beneficiary
- Investment amount
- Annual rate of return
- Sales charges (front-end/back-end loads)
- Other fees (e.g., maintenance fees, operating fees)
- Breakpoint opportunities
- FA documentation/rationale for initial recommendation
- Confirm and enhance analytics capabilities: Firms should evaluate their current analytics capabilities for testing compliance with sales policies, detecting potential prohibited activities and identifying patterns and trends. Examples of analytics capabilities that firms should confirm or develop would include identification in sales patterns by share class; identification of changes or spikes in sales of a particular product or share class, including sales of proprietary vs. non-proprietary offerings; and identification of FAs whose sales practices make them potential outliers that warrant further investigation.
- Conduct Periodic Account Reviews: Firms should periodically review their customers’ 529 Plans and perform back-tests to determine whether policies and procedures and the calculation methodology are working in practice as in design. Firms should have exception reports to identify accounts where issues may exist, and clear policies on how to evaluate and take action on potential issues that may require remediation. FAs should be kept actively engaged during periodic account reviews in the event that they need to discuss account changes with customers.
- Review policies and procedures: Firms should revisit current policies and procedures to confirm they are up to date and address potential issues that FINRA and the SEC have highlighted. In general, policies and procedures should address:
- Suitability requirements, including factors used to determine share class appropriateness
- Documentation requirements
- Conflicts of interest
- 529 Plan periodic account reviews
- Principal/supervisory review processes
- Issue identification and escalation processes
- Send 529 communications to FAs: Firms should regularly remind and provide refresher trainings to FAs of their responsibilities and the firm’s policies for the sale of 529 Plans. Such communications, among other things, should highlight firm policies and regulatory requirements regarding 529 Plan sales, as well as related conflicts of interest.
The above are actions for firms to consider to address FINRA and SEC concerns and manage regulatory risk. Should you have questions regarding these actions or the regulatory and operational risk associated with 529 Plans, please do not hesitate to contact us.
Principal | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
Managing Director | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
Senior Manager | Deloitte Risk and Financial Advisory
Deloitte & Touche LLP
1FINRA 2016 Regulatory and Examination Priorities Letter, January 5, 2016, available at http://www.finra.org/industry/2016-regulatory-and-examination-priorities-letter; and OCIE’s 2016 Share Class Initiative, July 13, 2016, available at https://www.sec.gov/ocie/announcement/ocie-risk-alert-2016-share-class-initiative.pdf
2Considerations for the methodology are based on the attributes of FINRA’s 529 Expense Analyzer and Deloitte’s industry experience
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