A large dual registrant agreed to pay over $15 Million in fines, disgorgement and penalties for failing to convert inactive fee-based advisory accounts into traditional brokerage accounts. The firm had policies requiring its financial advisers to conduct ongoing suitability reviews and flag those accounts without significant trading activity during the prior 12 months. According to the SEC, the FAs, without an imposed deadline, failed to respond to requests from the Compliance Department to complete the reviews. As a result, over a 5-year period, the firm failed to properly review nearly 8,000 accounts. Once the SEC began an investigation, the firm converted 1700 accounts to brokerage and closed an additional 2000 accounts. The SEC faults the firm for failing to have specific escalation procedures when they failed to respond to compliance inquiries and for neglecting to impose deadlines. The SEC also charged the firm with unsuitable UIT recommendations.
Dual registrants (and parent companies of dual registrants) have this unique suitability compliance obligation that overrides the specific compliance programs for the investment adviser and its broker-dealer affiliate. The firm must determine which product line – fee-based account or traditional brokerage – is suitable and then continuously monitor the accounts to avoid either churning or, as in this case, reverse churning (i.e. inactive fee-based accounts). Many industry observers used to think that fee-based accounts would displace bad brokers who churned accounts. We have now come full circle as the regulator targets reverse churning.