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Diminished Capacity: How to Deal with the Emerging
Regulatory Structure
Jonathan Cyprys – Associate, Greenberg Traurig, LLP
Ben Marzouk – Associate, Sutherland Asbill & Brennan LLP
Louis Dempsey – President, Renaissance Regulatory Services, Inc.
Overview Background
Comparison of:
◦ NASAA Model Act to Protect Seniors and Vulnerable Adults
◦ Proposed FINRA Rules 4512 & 2165
◦ Senior Safe Act
◦ Chapter 415 of FL Statutes – Adult Protective Services
Training Registered Representatives
◦ SEC and FINRA National Senior Initiative
◦ IRA Rollovers
Implementing Firm Policies
Background How did we get here?
◦ 2013 - 44.7MM people
reported to be over 65+
82.3MM by 2040
◦ 2012 - 86% of seniors reported
social security as primary
source of income
◦ Risk investing in retirement
accounts
◦ Fewer employer pensions
Background
Joint Reports by SEC, FINRA, and NASAA: “Protecting Senior
Investors: Compliance, Supervisory and Other Practices Used by
Financial Services Firms in Serving Senior Investors”
◦ September 2007
◦ September 2008
◦ August 2010
FINRA Regulatory Notice 07-43, “FINRA Reminds Firms of Their
Obligations Relating to Senior Investors and Highlights Industry
Practices to Serve these Customers”
FINRA Regulatory Notice 11-52, “FINRA Reminds Firms of Their
Obligations Regarding the Supervision of Registered Persons Using
Senior Designations”
FINRA 2011 Annual Regulatory and Examination Priorities Letter
Background 2016 FINRA Exam Priorities
◦ Areas of Focus 2016 - Sales Practice
Senior and Vulnerable Investors
Firms should monitor:
unusual asset movements
aggressive investments
FINRA Securities Helpline for Seniors
• Launched April 2015
• December 2015 report revealed:
Victims of financial exploitation
Various types of investment schemes
Unsuitable products
Inappropriate commission/fee
structures
Background 2016 SEC Exam Priorities
◦ Protecting Retail Investors Saving for
Retirement
Investors more dependent on
retirement savings
Multi-year exam initiative regarding:
investors with retirement accounts
fee selection and reverse churning
variable annuities – suitability and
disclosure
public pension advisors
NASAA Model Act to Protect
Vulnerable Adults from Financial
Exploitation
Mandates:
◦ Notification of all authorized parties to the account
◦ Reporting to state regulators when broker has a reasonable belief that
exploitation has occurred
◦ Providing relevant records to authorities regarding exploitation
Authorizes:
◦ Notification to designated third parties
◦ Delay disbursement of funds up to 15 business days if exploitation
suspected
Provides:
◦ Immunity from civil or administrative liability for broker-dealers or
investment advisors
FINRA Proposed New Rule 2165
(Financial Exploitation of Specified Adults)
Mandates:
◦ None – the proposed rule creates no obligation or requirement to withhold
disbursement of funds or securities where financial exploitation may be occurring
◦ “Safe Harbor” – when FA exercises discretion in placing temporary holds
Proposal applies to:
◦ “Specified Adults”
A natural person age 65 and older; or
A natural person age 18 and older whom the firm reasonably believes has an
impairment that renders the person unable to protect own interests
Authorizes:
◦ Firm to place temporary hold on disbursement of funds or securities from accounts
of a specified adult when there is a reasonable belief of financial exploitation
FINRA Proposed New Rule 2165
Challenges and Criticisms
FINRA RN 15-37
◦ Comment period expired November 30, 2015
◦ 40 total comment letters received (FSI, SIFMA, ICI, NASSA)
Filed with SEC on October 19, 2016
Challenges?
◦ Section 22(e) of the Investment Company Act of 1940
◦ Investor due process concerns
Recourse? Unlimited freezes?
◦ Privacy concerns and compliance with Regulation S-P
◦ Definition of “Specified Adult” (compare to NASAA)
◦ Reporting to securities regulators
◦ Expansion of safe harbor
◦ Only applies to “disbursements”
Proposed Amendments to FINRA Rule 4512
(Customer Account Information)
Trusted Contact Person (TCP) – firms need to
disclose in writing that associated person may contact
TCP
◦ Disclosure may be provided at account opening for new
accounts, or when applicable laws require updating
customer account information for existing accounts
Does not prohibit open or maintaining accounts if no
TCP is identified
Asking a customer to provide a name and contact
information constitutes reasonable efforts
TCP must be:
◦ 18 years or older
◦ Not authorized to transact business
Senior Safe Act of 2016 (H.R. 4538)
Unanimously approved by House of Representatives on July 5, 2016
Limited immunity from disclosures of financial exploitation of senior investors to government agencies ◦ Reconciling with:
FINRA reporting/disclosures?
FINRA “safe harbor”?
Cures potential Regulation S-P privacy violations
Immunity only applies for associated person who has received adequate training to identify and report financial exploitation
Chapter 415 of FL Statutes: Adult Protective Services Act
Mandates:
◦ Reporting any neglect, abuse and exploitation of vulnerable adults
Exploitation means a person who:
◦ Stands in a position of trust with a vulnerable adult; and
◦ Knowingly by deception obtains a vulnerable adult’s assets or property with
◦ Intent to deprive a vulnerable adult of the use or benefit of assets or property
Exploitation may include:
◦ Breaches of fiduciary duty, unauthorized taking of personal assets, misappropriation, and misuse of money belonging to a vulnerable adult
Vulnerable Adult – 18 or older whose ability to perform normal activities is impaired
Rule Comparison
NASAA
◦ All authorized parties to the account must be notified
◦ Required reporting to state regulators
■ Chapter 415 of FL Statutes
• All authorized persons must report potential abuse, neglect and/or exploitation
■ FINRA
• Does not create a duty to report suspected abuse
Senior Safe Act
◦ Immunity from
disclosures of
financial
exploitation to
government
agencies
Training Registered
Representatives SEC and FINRA National Senior Investor Initiative
◦ More than 77% of B/Ds train registered representatives regarding senior investors
◦ Training topics:
Risk disclosures of recommended products
Re-evaluating Senior Investor’s Suitability Factors (investment needs may change with age)
Escalation protocol where customer shows signs of diminished capacity
Potential warning signs:
Unexplained withdrawals
Drastic shifts in investment style
Changes in beneficiaries
Memory Loss – both short and long term
Incoherence
Delusions
Training Registered Representatives
IRA Rollovers ◦ FINRA Regulatory Notice 13-45, “Rollovers to Individual
Retirement Accounts”
28% of all U.S. retirement assets in IRAs
13x more IRA rollovers than direct contributions
◦ FINRA 2014 Annual Regulatory and Examination Priorities Letter
“Free IRAs” or “No-fee IRAs”
FINRA RN 13-23
◦ U.S. GAO March 2013 Report: “401(k) Plans: Labor and IRS could improve the Rollover Process for Participants”
◦ ICI September 2012 Report: “The U.S. Retirement Market”
More than 90% of funds flowing into traditional IRAs came from retirement plan rollovers
Training Registered Representatives
Training
◦ Investment Options – low cost funds may not offer array of
investments
◦ Fees and Expenses – (i) investment-related expenses and (ii) plan
or account fees
◦ Services – investment advice, planning tools, telephone help lines
and educational materials
◦ Penalty-Free Withdrawals (ages 55 – 59 ½) may be able to take
withdrawals
◦ Protection from creditors and legal judgments
◦ Required minimum distributions
◦ Rolling over employer related stock
Potential Elder Abuse Red Flag
◦ Changes in IRA beneficiaries and/or investment behavior
Firm Policy re: Diminished Capacity
and Elder Abuse Communicate to all employees the firm’s diminished capacity policy
Employees bring to the attention of the CCO any trigger event that
indicates a client is of diminished capacity
Employees document their communications with clients affected by
diminished capacity
Employees provide written follow up of discussions to client and any
designated person
CCO determines if monitoring of transactions is warranted
The firm documents and reviews its Investment Policy Statement annually
with client
Firm Policy re: Diminished Capacity
and Elder Abuse Employees document and report to CCO any suspicious activity that may
indicate elder abuse (multiple withdrawals, new beneficiaries)
CCO reviews the suspicious incident and seeks outside counsel if he/she
feels the client may be a victim of elder financial abuse
Potential Litigation
◦ If you are aggressive or non-responsive, for
example, the plaintiff bar is preparing to sue
you either way.
◦ How do you protect yourself?
Internal controls
Escalation when “red flags” occur
Get help from others and document the process
Protection of Seniors
There are numerous statutes protecting Seniors.
What do you do when a Senior has capacity issues but does not want any
help?
What Happens when the Senior refuses to diversify or make “appropriate”
investment?
Medical laws and privacy issues
Extreme protection of the elderly can have unforeseen (other) adverse
consequences.
Seek help early when there are potential issues or red flags.