529 Plan Share Class Initiative has been added to your bookmarks.
529 Plan Share Class Initiative
FINRA regulatory notice 19-04
FINRA launched the 529 Plan Share Class Initiative to promote compliance with the rules governing 529 plan recommendations and promptly address potential supervisory and suitability violations.
March 18, 2019 | Financial services
Industry regulators have increased their focus on compliance with rules governing multi-share class products. On January 29, 2019, the Financial Industry Regulatory Authority (FINRA) launched the 529 Plan Share Class Initiative1 (the '529 Initiative') to promote compliance with the rules governing 529 savings plans (529 Plans) and associated recommendations; to promptly address potential supervisory and suitability violations related to recommendations of share classes that are inconsistent with investment objectives; to efficiently assess the impact to customers; and to remediate customers in the future, as necessary. FINRA followed the 529 Initiative with Frequently Asked Questions2 (FAQs) in response to several inquiries it received from firms and trade associations. By participating in the 529 Initiative, a firm may avoid any fine that FINRA might impose in an Enforcement action concerning the firm’s failure to supervise the suitability of 529 Plans and associated recommendations.
The 529 Initiative comes on the heels of the Securities and Exchange Commission’s (SEC) Share Class Selection Disclosure Initiative3 (SCSD Initiative), which allowed investment advisers to self-report violations of the federal securities law relating to the selection of mutual fund share classes. As an outcome of the SCSD Initiative, the SEC settled charges4 against 79 investment advisers who self-reported Advisers Act violations and will return more than $125 million to clients, with a substantial majority of the funds going to retail investors.
To be eligible for the 529 Initiative, firms should self-report by providing written notification to FINRA Enforcement by April 30, 2019, and submit all the required information for the period of January 2013 through June 2018 (the 'disclosure period'), by May 31, 2019. Firms may request an extension by emailing 529Initiative@finra.org.
Background and FINRA’s concerns
As municipal securities, the sale of 529 Plans is governed under rules from the Municipal Securities Rulemaking Board (MSRB). Shares of 529 Plans are commonly sold in different classes with differing fee structures. These classes have a differing cost impact depending on the length of time the customer holds the securities. Time and again, FINRA has raised specific concerns over recommendations and supervision of these recommendations of different share-classes to 529 Plan customers. FINRA is concerned that because of the unique features of 529 Plans, some member firms may not provide adequate supervision. FINRA indicates that information
With the January 2018 amendments to the Internal Revenue Code regarding the use of 529 Plans for tuition for grades K-12, it is even more important now to recommend a share class that is tailored to the unique circumstances and needs of the customer. According to FINRA, the 529 Initiative is intended to encourage firms to qualitatively assess their supervisory systems and procedures governing 529 Plans’ share-class recommendations; to identify any supervisory and training weaknesses; and to later remediate, as well as compensate, any investors harmed by the supervisory failures.
Data Submission Requirements
As part of this 529 Initiative, FINRA has laid out six specific data submission requirements for firms choosing to participate:
- A list of the 529 Plans sold by the firm, including the 529 Plan name and the dates the firm offered each 529 Plan.
- The total aggregate principal amount invested in each 529 Plan sold by the firm during the disclosure period.
- A description of the firm’s supervisory systems and procedures relating to 529 Plan sales during the disclosure period.
- A description of the changes to the firm’s supervisory systems and procedures that the firm has implemented or will implement in order to strengthen compliance with its supervisory obligations. To the extent the firm identifies changes that have not yet been implemented, the firm should identify the individual supervisor at the firm who is responsible for the implementation.
- The firm’s assessment of potential impact on customers of supervision weaknesses, including a description of the firm’s methodology for assessing the impact on customers and a description of the firm’s proposal to make restitution payments to harmed customers.
- Any other information the firm believes would assist FINRA Enforcement in understanding the firm’s assessment of an account’s expected investment horizon, the suitability of the firm’s recommendations, or the reasonableness of the firm’s supervisory system regarding share class recommendations.
Through the 529 Initiative, FINRA has stressed the importance of having supervisory systems, policies, and procedures in place to manage 529 Plans share-class recommendations. FINRA has clarified in the FAQs that FINRA is encouraging firms to undertake a qualitative review, not a quantitative analysis. To assess the impact and ability to timely self-report for the 529 Initiative, firms should consider undertaking the following steps:
- 529 plans program mobilization and impact analysis
Once firms decide to provide written notice to FINRA about self-reporting, they should mobilize a dedicated team for 529 Plans remediation exercises. Firms need to understand the universe of potentially impacted customers and 529 Plans during the disclosure period, considering the particular circumstances of the beneficiary; compile and review 529 Plans transactions offered during the disclosure period; identify supervision mechanisms used for those transactions; obtain details of suitability related trainings provided to its registered representatives; and prepare the six data submission requirements. As a first step, firms choosing to participate in the 529 Initiative need only determine whether there was a potential supervisory violation using qualitative factors; they need not calculate customer harm. If potential violations are identified, firms may need to undertake additional actions, including needing to identify the front-end sales charges, distribution & service fee; the number of years for conversion to lower share class; and other applicable conditions that will be applied while performing impact calculations.
- Supervision systems, policies, procedures, and controls
Firms should consider reviewing their policies and procedures to ensure they reflect clearly defined roles and responsibilities between registered representatives, the first line of defense (e.g., Supervision) and second line of defense (e.g., Compliance). Policies and procedures should accurately describe the steps registered representatives will need to take when making 529 Plans recommendations to customers and the steps supervisors will need to take when reviewing and approving the suitability of share classes, including the potential for breakpoint discounts or sales charge waivers. Firms should further consider reviewing the existing systems for what information is captured relevant to the suitability determination of 529 Plans transactions, if and how 529 Plans transaction records are maintained, procedures in place to review the suitability of 529 Plans transactions and those controls in place for 529 Plans recommendation and supervision. Systems may need to be enhanced/updated to achieve compliance with this 529 Initiative. Testing should be performed across the lines of defense, with a clear demarcation of roles and responsibilities.
If potential issues or gaps are noted during the review, firms should consider developing a clear and actionable plan for addressing the identified gaps along with a specific timeline for implementation which can be provided to FINRA as part of the data submission.
- Data availability, recordkeeping, and analytics capabilities
Firms should evaluate their current analytics capabilities for testing compliance with 529 Plans’ sales policies, detecting potentially prohibited activities, and identifying patterns and trends. Examples of analytics capabilities that firms can consider or develop would include identification in sales patterns by share class; identification of changes or spikes in sales of a product or share class, including sales of proprietary vs. non-proprietary offerings (including out of state plans); and identification of employees whose sales practices make them potential outliers that warrant further investigation.
Firms need to understand the data available to them with regard to 529 Plans sales and properly document and record them. Firms should ensure that they store records of suitability transactions involving 529 Plans, including all the information relevant to the suitability determination. Integration of data into a firm’s supervisory and surveillance systems is often difficult. One challenge may include the change in plan managers, that may require the need to gather information from more than one firm to obtain data that covers the entire period of analysis. Additionally, broker-dealers may have merged over time which may require the need to gather customer data from multiple firms. These are representative operational gaps that align with FINRA’s concern noted in the 529 Initiative announcement and may be a significant obstacle requiring immediate attention to enable compliance with current timelines. Further, it is also important to capture data related to beneficiary circumstances (as explained in #5 below).
- Training and communication programs
Firms should consider reviewing their training programs to ensure that employees and registered representatives involved in the sale and supervision of 529 Plans understand the costs and benefits of different 529 Plans share classes and the different factors to consider, including beneficiary age, time frame, etc. Firms should regularly remind and provide refresher training to registered representatives 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 Plans sales, as well as related conflicts of interest.
To prepare for potential participation in this 529 Initiative, firms should consider ensuring dates, attendance, and content of such training during the disclosure period are clearly and accurately documented. If potential issues or weaknesses are noted, firms should consider developing a clear and actionable plan for addressing the identified gaps in training along with a specific timeline for implementation.
- Conflicts of interest management
Firms should ensure they have a conflict 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 registered representatives 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. Firms may also need to evaluate whether these alternatives are out of state plans and any conflicts arising because of that.
- 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 include customer and plan considerations,6 including:
- State of residence
- Expected holding period/Time to expected redemption
- Age of the beneficiary
- Investment amount
- The estimated annual rate of return
- Sales charges (front-end/back-end loads)
- Other fees (e.g., maintenance fees, operating fees)
- Breakpoint opportunities
- Conversion characteristics
- 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 design. Firms should have exception reports to identify accounts where issues may exist and policies on how to evaluate and act on potential issues that may require remediation. Registered representatives should be kept actively engaged during periodic account reviews in case they need to discuss account changes with customers.
As communicated in the 529 Initiative announcement, FINRA’s Member Supervision and Enforcement departments will continue to examine and investigate firms’ supervision of share-class recommendations to customers of 529 Plans. To the extent that firms meet the requirements of the 529 Initiative, firms should consider identifying and self-reporting issues with 529 Plans share-class supervision, as well as assessing and self-reporting the potential impact of such supervisory failures. Deloitte has helped multiple firms in 529 Plans-related compliance and can assist you in this voluntarily reporting and assessment. Should you have any questions or need any assistance, please feel free to contact us.
5 See MSRB Interpretation on Customer Obligations Related to Marketing of 529 College Savings Plans (Aug 7, 2006)
6 Considerations based on the attributes of FINRA’s 529 Expense Analyzer and Deloitte’s industry experience
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication 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 shall not be responsible for any loss sustained by any person who relies on this publication.
AML compliance, 2018 CDD rule included in four top priorities
Reviewing framework for adhering to BCBS regulation