Report on the Anticipated Operational Impacts to Broker- Dealers of the Department of Labor's ...

55 Pages·2015·3.37 MB·English

by  Kumar, Vishal

Report on the Anticipated
Operational Impacts to Broker-
Dealers of the Department of Labor’s
Proposed Conflicts of Interest Rule
Package
July 17, 2015
This document contains general information only and Deloitte & Touche LLP is not, by
means of this document, rendering accounting, business, financial, investment, legal, tax,
or other professional advice or services. This document is not a substitute for such
professional advice or services, nor should it be used as a basis for any decision or action
that may affect your business. Before making any decision or taking any action that may
affect your business, you should consult a qualified professional advisor. Deloitte & Touche
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document.
Member of Deloitte Touche Tohmatsu Limited
Copyright © 2015 Deloitte Development LLC. All rights reserved.
Contents
Executive Summary 4
1.Operationally Impractical 7
2.Operationally Onerous 14
3.Impediment to Business 26
4.Potential Regulatory Implications 29
5.Rule Package Ambiguity 31
Conclusion 34
Appendix: Rule Package Requirement Process Flows and Decision Trees 35
Contacts 54
3
Executive Summary

Introduction
On April 20, 2015, the Department of Labor (“DOL”) proposed1 a new definition of investment advice
fiduciary under 29 CFR 2510.3-21 and a series of prohibited transaction exemptions (referred to as
the “Rule Package” throughout the document). From the DOL’s perspective the amended rules are
designed to provide further protection to the public from “questionable retirement investment advice”
by requiring retirement advisors to follow strict “fiduciary” standards2. However, the Securities
Industry and Financial Markets Association (“SIFMA”) working group members who participated in the
study (“SIFMA Working Group”) indicated that they believe the potential effects of the proposed
changes extend beyond the realm of retirement advice and will have broad and extensive operational
impacts into many areas of financial services institutions, including profound changes to existing
business models, compensations practices of broker-dealers, available investments, client
relationships and firm operations and infrastructure.
Existing rules in this area were defined by the Employee Retirement Income Security Act of 1974
(“ERISA”), which was enacted at a time when professionally managed defined benefit pension funds
were the retirement norm. Over the past 40 years, however, self-managed investments such as
Individual Retirement Accounts (“IRAs”) and other defined contribution arrangements such as 401(k)
plans have taken over as the primary ways to save for retirement, which has increased the availability
and variety of retirement savings options for individuals. In the view of the SIFMA Working Group,
the DOL’s Rule Package may have unintended consequences for the broker-dealer industry as well
as individual investors which the industry serves. Consider Figure I.1 that shows almost $20 trillion in
US retirement assets will be affected by the proposed Rule Package3:
Figure I.1 – Dollar Amount of Retirement Assets by Account Type in 2014

1 Federal Register Vol. 80, No. 75 - Proposed Rules – Employee Benefits Security Administration (4/20/2015)
2 Source: Department of Labor “Fiduciary Investment Advice – Regulatory Impact Analysis”
http://www.dol.gov/ebsa/pdf/conflictsofinterestria.pdf
3 Source: ICI “The U.S. Retirement Market”, (4Q 2014); Devenir “HSA Research Report”, (Dec 2014); Strategic
Insight “529 Industry Analysis”, (2015)
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Approach
To understand the views of the broker-dealer industry on the extent of the operational impacts of the
proposed rule to the financial services community, SIFMA engaged Deloitte & Touche LLP (“Deloitte”)
to facilitate a study with a SIFMA Working Group comprised of over 140 senior operations,
technology, and legal professionals from approximately 40 SIFMA member firms whose business
include providing individual investors with financial advice and services (referred to as the “SIFMA
Working Group” throughout this report). The SIFMA Working Group analyzed the requirements of the
proposed Rule Package across the customer life cycle to primarily understand the technology or
operational reformation needed to align existing processes with new obligations of the proposed rule.
Additionally, process flow diagrams were developed to illustrate the requirements and necessary
process augmentations4 identified by the SIFMA Working Group to operationalize the Rule Package’s
requirements from the point of view of financial services firms, investment professionals (e.g., client
facing financial advisors or registered representatives) and customers.
Through the analysis, the SIFMA Working Group sought to identify operational “hot spots” reflecting
required operational changes to systems, personnel, processes and business models. Finally,
SIFMA conducted a cost survey with a subset of the SIFMA Working Group to understand how the
Rule Package requirements may impact operational expenses for implementing and maintaining the
operational changes, processes and systems that will be required to comply with the Rule Package.
The findings represent the views expressed by the SIFMA Working Group as communicated to
Deloitte through facilitated discussions and surveys. Deloitte has aggregated and summarized these
views, but was not asked to and did not independently verify, validate or audit the information
presented by the SIFMA Working Group5.
Summary of the findings
The collective views of the SIFMA Working Group yielded five themes6 that indicated broker-dealers
will likely face immense challenges in operationalizing the requirements of the proposed Rule
Package. Given the business and legal frameworks within which the financial services industry
operates, the SIFMA Working Group identified areas where the proposed Rule Package will be
impractical or impossible to implement as currently drafted (e.g., contracts signed before service
provider is hired or before the first sales pitch; two indicative quotes before any approval of a principal
transaction; a written chart provided to clients projecting future performance and future cost before
any trade). It was noted by the SIFMA Working Group that they believe that the proposed Rule
Package is so broad in scope, subjective and ambiguous in certain areas that it will be impossible to
build operational systems and processes to ensure compliance, to create objective surveillance
systems, or to run risk and compliance routines in connection with the requirements. Finally, the
SIFMA Working Group noted that the proposed Rule Package will impose requirements that may
conflict with other existing regulatory obligations.
The SIFMA Working Group expressed concern that the punitive and automatic nature of excise taxes
for non-compliance, even in instances of immaterial or inadvertent non-compliance, coupled with the

4 Illustrative process flow diagrams may not be all inclusive of actual implementation requirements
5 This engagement was performed in accordance with Standards for Consulting Services established by the
American Institute of Certified Public Accountants. Deloitte & Touche LLP did not provide any assurances
regarding the sufficiency of the services provided for SIFMA’s purpose. Deloitte & Touche LLP services
provided in conjunction with this assignment do not constitute an engagement to provide audit, review,
compilation or attestation services as described in the pronouncements on professional standards issued by
the American Institute of Certified Public Accountants and, accordingly, Deloitte & Touche LLP did not provide
any assurance concerning the reliability of any assertion that is the responsibility of another party. These
services did not result in the issuance of any written or oral communication by Deloitte & Touche LLP
expressing an opinion or any other form of assurance with respect to financial data or internal controls to
SIFMA or any third party.
6 The themes and views identified by the SIFMA Working Group and represented in this report are not all
inclusive of all impacts or costs associated with the proposed Rule Package.
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view that many of the Rule Package requirements are impractical and ambiguous, may cause some
financial services firms to exit the market, terminate smaller accounts or migrate to wrap programs
where suitable.
The five themes identified by the SIFMA Working Group, which will be discussed in detail in the
following pages, are as follows:
• It will be unfeasible or impossible to operationalize certain Rule Package
requirements
Operationally Impractical
o
 Disclosure challenges and challenging operations
 Financial market implications and credit rating limitations
 Best Interest and Principal Transaction Exemption Contract implications

• Significant personnel, process and technology changes and investments to
operations, business and compliance will be required to comply with the Rule
Package
o Operationally Onerous
 Substantial changes and investments to systems and processes
 Large-scale new data collection and management requirements
 High-dollar cost to implementing and maintaining

• Rule Package requirements will create disruptions to business operations and
customer experience
Impediment to Business
o
 Negative impacts to customer experience
• Customer confusion as a result of the Rule Package
• Impact of investment education limitations
• Investment option limitations and disadvantages

• Rule Package requirements may conflict with existing regulatory obligations
Potential Regulatory Implications
o
 Migration to multiple and various types of accounts
 Inconsistencies with other existing rules and guidance

• The Rule Package is ambiguous and broad in certain areas, which challenges the
operationalization of the Rule Package’s requirements
Rule Package Ambiguity
o
 The definitions of terms are not clear
 The scope of requirements is not clear
 Other areas of the Rule Package require clarification

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1. It will be unfeasible or impossible for
firms to operationalize certain Rule
Package requirements
Operationally Impractical
The SIFMA Working Group identified several requirements of the proposed Rule Package that will be
unfeasible or impossible for firms to operationalize within existing business, operational and
compliance frameworks. Specifically, the SIFMA Working Group noted concerns with the industry’s
ability to operationalize components of the contract and disclosure requirements of the Best Interest
Contract Exemption and Principal Transaction Exemption. Examples were identified by the SIFMA
Working Group where the nature of financial markets, products, business models, third-party
relationships or operational processes will be challenging for firms to meet the obligations of the
proposed Rule Package.
1.1 Disclosure challenges and illogical operational structures
Under the proposed Best Interest Contract Exemption obligations, firms and investment professionals
will be required to provide new disclosures to customers at the point of sale, annually and through a
webpage. The SIFMA Working Group identified several components of the Best Interest Contract
Exemption disclosure requirements as impractical to implement due to legal restrictions and illogical
operational processes including:
• The potential inability to obtain information from third parties as a result of how information is
collected and shared amongst various stakeholders will make it difficult for firms to provide
annual disclosures within 45 days of year end – Information around fees for inclusion in the
annual disclosure to customers may not be available to firms within the 45 day timeframe.
The expectation that firms will be able to obtain this information and perform necessary
calculations of direct and indirect fees for products in the allotted timeframe will be difficult.
The SIFMA Working Group noted that some vendors pay certain fees and compensations to
institutions after close of the business year which may take more than 45 days to receive,
reconcile and post.
• Attributing direct and indirect compensation and fees earned by firms and investment
professionals to the individual investor and transactions will likely be a lengthy, complicated
process – Currently, many compensation fees earned by firms and investment professionals
are not directly attributable to specific transactions and customers due to the nature of
revenue sharing arrangements and other compensation models utilized by product
companies. Specifically, the SIFMA Working Group indicated there will be complications on
precisely attributing the revenue sharing in specific transactions to the corresponding
specific account. Additionally, because the Rule Package does not enumerate the
methodology that should be used to attribute these fees, these calculations may vary and be
performed inconsistently across the industry.
• The SIFMA Working Group noted the calculation of indirect compensation and fees
attributable to specific transactions and investors will be an impractical process that
ultimately does not result in the disclosure of fees that materially affect the customers’
bottom line – The SIFMA Working Group emphasized that there are indirect compensation
and fees paid by firms that are passed through to investors, the indirect compensation and
fees often cannot be attributed to specific transactions or investors and may not be material
fees to individual investors or specific transactions. Attributing the indirect compensation and
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fees will likely require updates to calculations, technology and systems and will be
impossible for certain products. Furthermore, the calculations of the indirect compensation
and fees specific to customers would likely not yield material fee amounts for individual
investors attributed to their specific transactions. For example, the SIFMA Working Group
noted that fees that intermediaries pay to the manufacturer of an investment product often
depend upon the amount of a product that an intermediary places with customers over a
period. As such, the intermediary will not know the exact fee associated with a product until
the end of a calculating period. Additionally, because the Rule Package lacks guidance on
how to calculate and attribute fees, these calculations may vary and be performed
inconsistently across the industry.
Figure 1.1 is an excerpt from the Best Interest Contract Exemption process flow (See Appendix)
illustrating the points where the SIFMA Working Group indicated that Rule Package requirements are
expected to impact the processes within the transaction/maintenance portion of the customer transaction
life cycle:
Figure 1.1 – Best Interest Contract Exemption Process Impacts of the Rule Package to the
Transaction/Maintenance portion of the customer life cycle

Onboarding/Pre-Transaction Transaction Maintenance
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Figure 1.2 is an excerpt from the Principal Transaction Exemption process flow (See Appendix) illustrating
the points where the SIFMA Working Group indicated that Rule Package requirements are expected to
impact the processes within the transaction/maintenance portion of the customer transaction life cycle:
Figure 1.2 – Principal Transaction Exemption Process Impacts of the Rule Package to the
Transaction/Maintenance portion of the customer life cycle
Onboarding/Pre-Transaction Transaction Maintenance
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1.2 Financial market implications and credit rating limitations
The SIFMA Working Group identified several instances where financial market implications and credit
rating limitations may prevent components of the Principal Transaction Exemption disclosure
requirements from being operationalized. Under the proposed Principal Transaction Exemption
requirements, transactions must not involve debt securities with greater than “moderate credit risk” or
that are not “sufficiently liquid” such that a sale at approximately “fair market value” would not be
possible in a reasonably short period. Obtaining precise and timely credit risk ratings at the point of
sale will not be possible for all debt securities because of the dynamic nature of the market.
Additionally, the continuously changing financial market conditions would likely impact the accuracy
and effectiveness of the Principal Transaction Exemption’s liquidity and disclosure requirements.
Under the proposed Principal Transaction Exemption obligations, investment professional and firms
will be required to disclose mark up and mark down information as well as price quotes when making
a recommendation to a customer. The price quotes need to reflect that the current transaction will be
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at least as favorable to customers as would be available in a (a) non-principal transaction and (b)
contemporaneously offered by two counterparties. The natural changing conditions of the financial
market environment will make these disclosures requirements difficult and may create unintended
harm to consumers. Specifically, the SIFMA Working Group cited the following concerns pertaining to
financial market implications and credit rating limitations that will prevent the proposed Rule Package
from being implemented as written include:
• Obtaining accurate and timely credit risk ratings at the point of sale will not be possible for all
debt securities due to the nature of the securities rating system currently in place –
Depending on the specific debt security, there will be limited consistency in determining
ratings as a result of securities not being rated at all or the rating being outdated.
• As a result of liquidity being a point in time determination, concluding if a debt security is
“sufficiently liquid” will be difficult and subjective – Given that liquidity is dependent on
market conditions, ongoing monitoring of liquidity will be difficult, time consuming and
potentially inaccurate with changes or fluctuations in the financial markets. Additionally,
liquidity may be hard to measure and monitor as it changes under different scenarios that
are largely dependent on the order size and market conditions at the time of a transaction.
• A change in price, credit rating and/or liquidity prior to transaction execution will lead to a
repetitive disclosure process with unintended harmful consequences to customers as a
result of best execution limitations and pricing disparities – Financial market fluctuations will
create situations where there are changes to prices, credit ratings or liquidity conditions in
the time between the initial transaction disclosure recommendation and the customer’s
decision to execute the transaction. For the firm to stay in compliance with the exemption,
the investment professional would be required to perform additional disclosures if prices,
credit ratings or liquidity changes during this time period. Delays caused from performing
repetitive disclosure process may have unintended harmful consequences to customers
such as best execution requirements and pricing disparities.

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