At the very least, member firms should review their 529 Plan recommendations to see if they have exposure and then take action to remediate. Because of the broader implications of an enforcement action and individual liability, we recommend consulting counsel about whether to self-report.
FINRA has proposed changing the suitability standard so that brokers could have liability for excessive trading even if the broker did not exert control or discretion over the client’s account. Current FINRA rules require a showing of control before FINRA could charge a broker with churning. FINRA questions whether this control element puts a “heavy and unnecessary burden on customers by, in effect, asking them to admit that they lack sophistication or the ability to evaluate a broker’s recommendation.” FINRA says that this control element may not be appropriate in light of the recently proposed SEC’s Regulation Best Interest. FINRA would evaluate churning based on the total facts and circumstances including turnover rate (e.g. greater than 6), cost-to-equity ratio (e.g. greater than 20%), or the use of in-and-out trading.
OUR TAKE: Brokers, and their compliance officers, have long relied on the regulatory distinction between accounts over which they exercised discretion versus directed accounts. This proposal eliminates that ostensible compliance bright line which really has very little meaning in the real world where retail clients rely on broker recommendations. Acting in a client’s best interest should not depend on how much control a broker exercises.
The SEC fined a large IA/BD $8 Million because it failed to implement compliance policies and procedures for the sale of single-inverse ETFs. Following warnings from FINRA and SEC OCIE staff, the respondent adopted policies and procedures requiring (i) every client to sign a Client Disclosure Notice and (ii) a supervisor to review all recommendations for suitability. However, over a 5-year period thereafter, the SEC maintains that 44% of clients did not sign a Disclosure Notice and most did not undergo adequate supervisory reviews. Consequently, the firm made several unsuitable recommendations including to retirement account clients. The SEC cites violations of the Adviser’s Act’s compliance rule (206(4)-7), which requires advisers to adopt and implement policies and procedures reasonably designed to ensure compliance with the Advisers Act.
OUR TAKE: The SEC will severely punish recidivists who were notified of deficiencies during a prior exam. In this case, the IA/BD specifically undertook to fix the identified suitability concerns but failed to implement those policies, thereby allowing the violative conduct to continue.
A large broker-dealer agreed to pay over $15 Million in disgorgement and fines for failing to adequately train its reps about the risks of structured notes sold to retail investors. The SEC maintains that its rep training did not include sufficient information about volatility and breach risk such that the reps could satisfy their reasonable basis suitability obligations. Over a 3-year period, the firm sold over $500 Million (notional amount) in the subject structured notes to more than 8,000 retail customers. The SEC charges the firm with failure to supervise.
OUR TAKE: What is interesting about this case is that the SEC holds the firm accountable for failure to properly train the reps, rather than pointing the finger at the compliance department or the reps themselves. This continues the trend of holding organizations and senior executives accountable for compliance failures. Also, firms have a high regulatory burden when selling complex financial products to retail investors.