The Problem

Investment companies have long allowed some retirement plans to buy Class A mutual fund shares with no up-front commission, so investors can benefit from investing with no commission as well as benefiting from lower management fees. But during routine audits in 2014, the Financial Industry Regulatory Authority (FINRA) discovered that a lot of broker-dealers hadn’t been reading (and/or complying with) all the fine print on fund prospectuses. Because of inadequate supervisory controls and training, investors entitled to sales charge waivers were either paying the sales charge, or being sold Class B or C shares with back-end sales charges and higher ongoing fees and expenses, even when A shares were available.

FINRA’s Response

To make investors whole, FINRA ruled that these broker-dealers would have to rebate these fees back to the plans, along with interest. And they would pay a penalty, unless they investigated trades going back to at least July 2009, including A-shares sold through their fund-direct business, and reported any problems to FINRA.

This sounds straight forward enough. But three years later, many broker-dealers still don’t know how to start fixing this problem. For one thing, they may not have access to the data they need, including a list of qualifying shares, historical NAVs and social codes. And they face the expensive, time-consuming and error-prone task of manually poring through thousands or even millions of trades – and even having to contact the funds, if fund family rules have changed since the original transaction.

The math is incredibly complex. To provide remediation for investors who were sold a Class B or C share, for example, firms are required to calculate a 75 basis point annual “differentiation” on the purchase amount from date-of-purchase up through the date remediation was made, or until the shares were sold, in addition to the daily compound interest on that amount. And based on the assumption that clients sold the shares, they also have to refund the contingent deferred sales charge (CDSC), which is the back-end load that mutual fund investors pay when selling Class-B fund shares before the end of a designated period.

Confused enough yet?

There’s more … Identifying and calculating fee waiver oversights is only half the story. FINRA expects firms to be able to demonstrate that they’ve strengthened their protocols for mutual fund trade compliance.

A smart approach to fee waiver remediation is to take a more holistic view, and simultaneously invest in a post-trade supervisory system that can capture high-quality data and monitor ongoing trades – which, by the way, would have prevented these issues in the first place.

Solution Options

Broker-dealers who don’t have their own dedicated technology team will find that the most practical option is to partner with a data solutions specialist that can guarantee a quick turnaround. They’ll be able to provide a comprehensive list of eligible shares and supporting compliance documentation that’s already been approved by FINRA. And software as a service (SaaS) tools, built around finely-honed mutual fund industry data, can automate remediation calculations in the event that any restitution has to be paid. Moreover, it’ll give them confidence that FINRA will accept their letter of acceptance, waiver and consent.

For those broker-dealers that are putting off doing anything until they receive a notification from FINRA, the clock is ticking. To encourage the industry to put waiver remediation behind it, FINRA is stepping up its oversight and is continuing to bring enforcement actions through sweeps, routine examinations or procedural reviews.

So why put off the inevitable, and risk reputational damage, when the right partner could settle this issue painlessly in only a month or two and help your firm stay ahead of any future regulatory change?

Learn more on our website or contact Delta Data to get your questions answered.