The SEC recently entered a cease-and-desist order against an SEC-registered investment adviser Federal Prep Advisors, Inc. (“Federal Prep”) and its principal regarding its rollover recommendations from Thrift Savings Plan (“TSP”) accounts to advisory Individual Retirement Accounts (“IRAs”). The SEC determined that Federal Prep did not adequately evaluate and disclose the costs associated with the TSP and its services or the available investment options under the TSP, among other things.[1]
The Thrift Savings Plan is a defined contribution retirement plan for federal employees and members of the uniformed services, and generally has lower fees compared to private employer-sponsored 401(k) plans. From at least June 2020 until around June of 2023, Federal Prep advised approximately 300 clients to rollover assets from a TSP account to an IRA managed by Federal Prep.
TSP accounts have the option of investing in one of TSP’s various funds, which have total expense ratios ranging from approximately 0.048% to 0.079%. TSP accounts may also invest up to 25% of account balance in mutual funds through a mutual fund window, each of which has an expense ratio detailed in its prospectus. TSP accounts may also purchase life annuities, which do not charge fees.
When recommending IRA rollovers from TSP accounts, Federal Prep allegedly often told investors that TSP fees were 0.5%, which was many times higher than the average fee charged by TSP funds. At one point, Federal Prep relied on third-party software to generate comparisons of industry average costs for plans of the same size for this information. However, that data was based on private employer-sponsored plans, which have costs that are significantly higher than the TSP.
By contrast, Federal Prep clients typically pay advisory fees of 1%, plus third-party money manager and underlying investment fees of 0.5% to 1%, often totaling 1.5% to over 2% per year. As a result of its lack of research, the SEC alleged that Federal Prep did not adequately consider information about the total fees and expenses associated with the TSP compared to its recommended IRA option and did not provide clients with sufficient disclosures regarding these costs.
The SEC also alleged that Federal Prep did not adequately understand or consider how the investment options available in the TSP compared to the investments available in a rollover advisory IRA. Federal Prep often allegedly told clients that the TSP did not offer flexible investment options and did not fully explain the various options available, including in the TSP mutual fund window. According to the SEC, this resulted in a lack of adequate consideration of how the advisory IRA was better for the client than the TSP account and in the client’s best interest.
In addition to the above, the SEC alleged that Federal Prep failed to adopt and implement policies and procedures designed to ensure advice was in the client’s best interest and failed to maintain sufficient books & records. Specifically, Federal Prep failed to use its IRA rollover checklist until pointed out by the SEC in a 2022 deficiency letter, and then from that point, it was used inconsistently and not always provided to the clients. It was also not always fully completed. The checklist provided that each rollover would be reviewed and approved by the CCO, but in some instances, there was no record of the CCO having reviewed the checklists.
As a result of these and other actions, the SEC determined that Federal Prep had engaged in violations of Sections 206(2), 206(4) and 204 of the Advisers Act and Rules 206(4)-7 and 204-2 thereunder. Federal Prep and its principal agreed to pay civil penalties totaling $280,000, as well as to engage an independent compliance consultant to conduct a review of its policies, procedures and disclosures, among other penalties.
This enforcement proceeding is interesting as it gives some insight into the SEC’s expectations for rollover recommendation documentation and disclosure by investment advisers. RIAs should try to obtain information regarding plan fees and expenses, as well as available investment options, from the client where possible. If relying on comparison software or other industry averages that may not be as accurate, the disclosure needs to clearly explain the limitations involved with the data relied on, and any assumptions used. Similar documentation and disclosures are required under DOL PTE 2020-02 as well.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our Investment Adviser Group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our Investment Adviser Practice Group page for more information.
[1] https://www.sec.gov/files/litigation/admin/2024/ia-6732.pdf