Massachusetts Leads the Path for Enforcement of Fiduciary Rule

In court papers filed February 23, 2018, the Office of the Secretary of the Commonwealth alleged Scottrade violated Massachusetts’ securities laws by failing to comply with the impartial conduct standards of the Labor Department’s fiduciary rule.

According to the complaint, the discount broker-dealer knowingly violated the fiduciary rule by running sales contests targeting retail investors’ assets in qualified retirement accounts. The contests also violated the internal compliance policies the company put in place after the impartial conduct standard went into affect in June of 2017, the complaint says.

Broker-dealer Scottrade has been charged with violating the impartial conduct standards of the DOL fiduciary rule. Under the fiduciary rule’s impartial conduct standards, any recommendation to buy a security with assets in IRAs or 401(k) plans must be made in investors’ best interests.

Scottrade ran two sales contests; one launched days before implementation of the impartial conduct standards, and one launched in September of 2017. Those contests, which were common in what the claim says was Scottrade’s “aggressive sales practices” prior to the implementation of the impartial conduct standards, incentivized brokers to bring in new assets from customers, including through rollovers from qualified retirement accounts.

In the first contest, Scottrade offered $285,000 in cash prizes to brokers that satisfied high cold-calling penetration benchmarks. In the second, brokers were awarded weekly cash prizes of $500 and $2,500 for recommending investors move to the firm’s advisory program.

Under the fiduciary standard established by the impartial conduct standards, any compensation arrangement that creates a potential conflict of interest must be disclosed to investors. Massachusetts’ complaint says Scottrade failed to inform clients of the conflicts arising from the incentives in the sales contests.

New FINRA Rules Take Effect to Protect Seniors and Vulnerable Adults from Financial Exploitation

On February 5, 2018, two FINRA rule rules took effect that purport to address the financial exploitation of seniors and vulnerable adults, putting in place a uniform, national standard to protect senior investors. Firms are now required to make reasonable efforts to obtain the name of, and contact information for, a trusted contact person for a customer’s account. In addition, the rule permits FINRA member firms to place a temporary hold on a disbursement of funds or securities when there is a reasonable belief of financial exploitation, and to notify the trusted contact of the temporary hold.

The trusted contact person is intended to be a resource for firms in handling customer accounts, protecting assets and responding to possible financial exploitation of vulnerable investors. The new rule allowing firms to place a temporary hold provides them and their associated persons with a safe harbor from certain FINRA rules. This provision will allow firms to investigate the matter and reach out to the customer, the trusted contact and, as appropriate, law enforcement or adult protective services, before disbursing funds when there is a reasonable belief of financial exploitation. It is a critical measure because of the difficulty investors face in trying to recover funds that they have inadvertently sent to fraudsters and scam artists.

The rule changes were approved by the SEC in February 2017. FINRA set February 5, 2018 as the effective date to provide member firms substantial time to prepare and develop policies and procedures.

FINRA Fines J.P. Morgan Securities LLC $2.8 Million for Customer Protection Rule Violations and Supervisory Failures

On December 27, 2017, FINRA announced that it fined J.P. Morgan Securities $2.8 million for violating the Securities and Exchange Commission’s (SEC) Customer Protection Rule and for related supervisory failures. The SEC rule creates requirements to protect customers’ funds and securities.

To ensure that customers could recover their assets in the event of the broker-dealer’s insolvency, the Customer Protection Rule requires a broker-dealer, which maintains custody of customer securities, to obtain and maintain physical possession or control over certain of those securities. These securities must be segregated in a “control location” and be free of liens or any other encumbrance that could prevent customers from taking possession of their securities. A firm cannot use segregated securities for its own purposes.

FINRA found that from March 2008 to June 2016, J.P. Morgan Clearing Corp. did not have reasonable processes in place to ensure that its possession or control systems were operating properly. Shares that should have been segregated were available for the firm’s use, due to systemic coding and design flaws, recurring and unresolved deficits and unreasonable supervision. By failing to move and maintain securities in good control locations, the firm created deficits in foreign and domestic securities valued at hundreds of millions of dollars. For example, J.P. Morgan failed to move Italian securities to a good control location for nearly two years, and on one sample day, created a deficit in 81 Italian securities worth approximately $146 million.

In determining the appropriate monetary sanction, FINRA considered J.P. Morgan’s cooperation in undertaking a plan to address the violations and that it over-reserved cash deposits in an effort to protect customers from its failed segregation of securities. In settling this matter, J.P. Morgan neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

FINRA Disciplinary Action Against FSC Securities Corporation

On December 20, 2017, a Letter of Acceptance, Waiver and Consent was issued in which FSC Securities Coporation was censured, fined $100,000, and required to provide FINRA with a plan to remediate eligible customers who qualified for, but did not receive, the applicable mutual fund sales-charge waiver. As part of this settlement, the firm agreed to pay restitution to eligible customers, which is estimated to total $414,261 (the amount eligible customers were overcharged, inclusive of interest). Without admitting or denying the findings, the firm consented to the sanctions and to the entry of findings that it disadvantaged certain retirement plan and charitable organization customers that were eligible to purchase Class A shares in certain mutual funds without a front-end sales charge. The findings stated that these eligible customers were instead sold Class A shares with a front-end sales charge, or Class B or C shares with back-end sales charges and higher ongoing fees and expenses. These sales disadvantaged eligible customers by causing the customers to pay higher fees than they were actually required to pay.

The findings also stated that the firm failed to reasonably supervise the application of sales-charge waivers to eligible mutual fund sales. The firm relied on its financial advisors to determine the applicability of sales-charge waivers, but failed to maintain adequate written policies or procedures to assist financial advisors in making this determination. In addition, the firm failed to adequately notify and train its financial advisors regarding the availability of mutual fund sales-charge waivers for eligible customers. The firm also failed to adopt adequate controls to detect instances in which they did not provide sales-charge waivers to eligible customers in connection with their mutual fund purchases. As a result of the firm’s failure to apply available sales-charge waivers, the firm estimates that eligible customers were overcharged by approximately $380,520 for mutual fund purchases made since January 1, 2011. If you believe that you have suffered losses as a result of FSC Securities Corporation’s misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

FINRA Disciplinary Action Against Next Financial Group, Inc.

On December 6, 2017, a Letter of Acceptance, Waiver and Consent was issued in which Next Financial Group, Inc. was censured, fined $750,000, and required to retain an independent consultant to conduct a comprehensive review of the adequacy of its policies, systems and procedures (written and otherwise) and training. Without admitting or denying the findings, the firm consented to the sanctions and to the entry of findings that it failed to establish, maintain, and implement a supervisory system reasonably designed to detect and address excessively traded accounts. The findings stated that the supervisory failings resulted from an inadequate corrective action taken by the firm in response to prior FINRA disciplinary actions that included a failure to use exception reports or any other reasonably designed system to detect excessive trading. In addition, the firm failed to identify excessive trading due to lack of clarity regarding supervisory responsibilities. Due to flaws in its supervisory system, the firm did not reasonably supervise a registered representative’s excessive trading activity. If the firm had instituted reasonably designed procedures to ensure branch audits were completed and findings of excessive trading acted upon, it could have prevented this activity.

The findings also stated that the firm failed to implement a supervisory system and procedures reasonably designed to ensure appropriate suitability determinations in its variable annuity sales, including L-share contracts. The firm failed to establish, maintain and enforce systematic surveillance procedures to identify possible inappropriate rates of variable annuity exchanges. The firm also failed to enforce its existing procedures relating to the suitability review of variable annuity transactions. In addition, the firm did not establish, maintain, and enforce a reasonably designed supervisory system and WSPs related to the sale of multi-share class variable annuities. The firm’s WSPs failed to provide representatives and principals with guidance or suitability considerations for sales of different variable annuity share classes. Moreover, the firm failed to establish, maintain, and enforce WSPs or provide sufficient guidance to its representatives and principals on the sale of long-term income riders, such as long-term income riders with L-share contracts. The findings also included that the firm lacked a supervisory system reasonably designed to ensure that information included on consolidated reports provided to customers was accurate. The firm’s supervisory system was inadequate and it failed to enforce its own procedures.

FINRA also found that the firm failed to have supervisory procedures reasonably designed to detect and monitor for misleading communications on its website. As a result, the firm omitted material facts from its website that caused its communications with the public to be misleading. FINRA also found that the firm failed to establish, maintain, and enforce a system and WSPs reasonably designed to achieve compliance with FINRA rule 2310(c) related to maintaining records of all non-cash compensation received by it or its associated persons. As a result, the firm failed to track and verify non-cash compensation received by its representatives that came in the form of direct sponsorship payments by product issuers to vendors/merchants. Emails of representatives reflected multiple occurrences of product issuers paying vendors/merchants for branch client events directly without the firm’s knowledge and approval of the non-cash compensation. If you believe that you have suffered losses as a result of Next Financial Group’s misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

FINRA Hearing Panel Bars Broker for Defrauding Elderly, Blind Customer

On November 9, 2017, FINRA announced an extended hearing panel barred broker Hank Mark Werner of Northport, New York, for fraudulently churning and excessively trading the accounts of his customer, a blind, elderly widow, and for making unsuitable recommendations. The hearing panel also ordered Werner to pay more than $155,000 in restitution to the widow, fined him $80,000 and ordered disgorgement of more than $10,000 representing commissions received for recommending the purchase of an unsuitable variable annuity.

Werner had been the elderly widow’s broker, and that of her blind husband until his 2012 death, since 1995. According to the hearing panel decision, Werner plundered his customer’s accounts by engaging in such an active trading strategy that, when the high commissions he charged were taken into account, it was impossible for the customer to make money. The panel found Werner frequently bought and sold a security within a week or two, and charged exorbitant commissions even though the blind widow’s financial circumstances required that Werner invest her assets with a minimum amount of risk. She was 77 and in ill health when Werner began churning her accounts. Werner engaged in more than 700 trades from October 2012 to December 2015, generating approximately $210,000 in commissions while the customer lost more than $175,000 as a result of his reckless trading. The decision also noted that it was apparent to the Hearing Panel that Werner took advantage of the customer’s vulnerability after her husband died in September 2012.

The hearing panel concluded that Werner engaged in egregious misconduct and is unfit to work in the securities industry.

Legend Securities, Inc., which was also named in an amended disciplinary complaint, failed to respond and accordingly was held in default. The complaint charged that Legend failed to reasonably supervise Werner, which allowed him to engage in churning his customer’s account, and failed to establish, maintain, and enforce an adequate supervisory system to ensure that Werner was subject to heightened supervision. The hearing officer issued a default decision censuring and fining the firm $200,000. Legend voluntarily paid $20,000 in partial restitution to the customer.

Wells Fargo Broker-Dealers Ordered to Pay $3.4 Million in Restitution and Reminds Firms of Sales Practice Obligations for Volatility-Linked Products

On October 16, 2017, FINRA announced that it had ordered Wells Fargo Clearing Services, LLC and Wells Fargo Advisors Financial Network, LLC to pay more than $3.4 million in restitution to affected customers for unsuitable recommendations of volatility-linked exchange-traded products (ETPs) and related supervisory failures. FINRA found that between July 1, 2010, and May 1, 2012, certain Wells Fargo registered representatives recommended volatility-linked ETPs without fully understanding their risks and features.

Volatility-linked ETPs are complex products that could be misunderstood and improperly sold by registered representatives. Certain Wells Fargo representatives mistakenly believed that the products could be used as a long-term hedge on their customers’ equity positions in the event of a market downturn. In fact, volatility-linked ETPs are generally short-term trading products that degrade significantly over time and should not be used as part of a long-term buy-and-hold investment strategy.

FINRA found that Wells Fargo failed to implement a reasonable system to supervise solicited sales of these products during the relevant time period. However, FINRA found that Wells Fargo took remedial action to correct its supervisory deficiencies in May 2012, prior to detection by FINRA and around the time that the firm was fined for similar violations relating to sales of leveraged and inverse ETPs. In addition, Wells Fargo provided substantial assistance to FINRA’s investigation by, among other things, engaging a consulting firm to determine the appropriate restitution to be provided to affected customers. FINRA took Wells Fargo’s previous corrective actions and cooperation into account when assessing the sanctions in this matter, and encourages member firms to assess their own sales and supervision of volatility ETPs.

In settling with FINRA, Wells Fargo neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

Morgan Stanley Sanctioned $13 Million in Fines and Restitution for Failing to Supervise Sales of Unit Investment Trusts

On September 25, 2017, FINRA announced that it had fined Morgan Stanley Smith Barney LLC $3.25 million and required the firm to pay approximately $9.78 million in restitution to more than 3,000 affected customers for failing to supervise its representatives’ short-term trades of unit investment trusts (UITs).

A UIT is an investment company that offers units in a portfolio of securities that terminates on a specific maturity date, often after 15 or 24 months. UITs impose a variety of charges, including a deferred sales charge and a creation and development fee, that can total approximately 3.95 percent for a typical 24-month UIT. A registered representative who repeatedly recommends that a customer sell his or her UIT position before the maturity date and then “rolls over” those funds into a new UIT causes the customer to incur increased sale charges over time, raising suitability concerns.

FINRA found that from January 2012 through June 2015, hundreds of Morgan Stanley representatives executed short-term UIT rollovers, including UITs rolled over more than 100 days before maturity, in thousands of customer accounts. FINRA further found that Morgan Stanley failed to adequately supervise representatives’ sales of UITs by providing insufficient guidance to supervisors regarding how they should review UIT transactions to detect unsuitable short-term trading, failing to implement an adequate system to detect short-term UIT rollovers, and failing to provide for supervisory review of rollovers prior to execution within the firm’s order entry system. Morgan Stanley also failed to conduct training for registered representatives specific to UITs.

In settling this matter, Morgan Stanley nether admitted or denied the charges, but consented to the entry of FINRA’s findings.

SunTrust Charged with Improperly Recommending Higher-Fee Mutual Funds

On September 14, 2017, the Securities and Exchange Commission announced that it had charged the investment services subsidiary of SunTrust Banks with collecting more than $1.1 million in avoidable fees from clients by improperly recommending more expensive share classes of various mutual funds when cheaper shares of the same funds were available.

SunTrust Investment Services agreed to pay a penalty of more than $1.1 million to settle the charges.  SunTrust separately began refunding the overcharged fees plus interest to affected clients after the SEC started its investigation.  SEC examiners cited the practice during a compliance review of the firm in mid-2015.  More than 4,500 accounts were affected.

According to the SEC’s order, the Atlanta-based firm breached its fiduciary duty to act in its clients’ best interests by recommending and purchasing costlier mutual fund share classes that charge a type of marketing and distribution fee known as 12b-1 fees.  Investors were not informed that they were eligible for less costly share class options that did not charge 12b-1 fees.  The avoidable fees flowed back to SunTrust in the form of higher commissions from the funds.

The SEC’s order found that SunTrust violated Sections 206(2), 206(4) and 207 of the Investment Advisers Act of 1940 and Rule 206(4)-7.  Without admitting or denying the findings, SunTrust agreed to pay the penalty totaling $1,148,071.77 as well as disgorgement plus interest on any leftover amount of the avoidable 12b-1 fees that are being refunded to clients.  The firm also agreed to be censured.

21st Century Changes Needed for FINRA Form U4 – Part I

The Form U4 is the basic application for any person seeking to become registered with a FINRA member firm. Although updated in 2009, the U4 is an antiquated document in need of overhaul. In order to consider revisions to the U4, it is important to understand its role in today’s financial services world. Historically, the U4 was an administrative document used by self-regulatory agencies and state agencies for determining whether to grant requests for securities licenses. While the U4 retains this original purpose, that purpose has evolved. All of the information contained within a U4 application is submitted to the Central Registration Depository system, operated by FINRA. According to FINRA, Web CRD® “contains the registration records of more than 4,015 registered broker-dealers, and the qualification, employment and disclosure histories of more than 642,980 active registered individuals.” All of the information contained on the U4 becomes public, but only some of that information is available through FINRA’s BrokerCheck® website (which obtains its information from Web CRD®). Prior to the advent of BrokerCheck®, it was very difficult for a consumer to review a broker’s background. BrokerCheck® changed that. BrokerCheck® serves as “a free tool which is part of FINRA’s ongoing efforts to help investors make informed choices about brokers and brokerage firms.”

Because the U4 serves as BrokerCheck’s template, the U4 must be evaluated in the context of one of its purposes, helping investors make informed choices about brokers. With this purpose in mind, the U4, as well as BrokerCheck®, are ripe for change.

So what information is missing from the U4 that investors would find helpful in making informed choices about brokers? The first glaring absence from the U4 is any question about the applicant’s education. The only context in which education is mentioned is in the instructions to question 12, in which an applicant is asked to provide his employment history for the past ten years. According to the instructions, if an applicant was engaged in “full time education” within the past 10 years, that information should be provided in the employment history section. The applicant is not asked whether he or she finished the sixth grade, graduated from high school or college, or has a graduate school degree. The reason this information is not requested is because the securities industry has no minimum education criteria for the various licenses that permit individuals to manage client assets. To the extent FINRA wants BrokerCheck® to help investors make informed choices, an Education History section needs to be added to the U4. How many people would knowingly trust the management of their life’s savings to a person who did not graduate from high school? Or only finished one year of college? The answer is few, if any. So why hide this information? In order for the U4, as the template for BrokerCheck®, to be relevant in the 21st century, it should be revised in order to require the disclosure of an applicant’s entire education history. Stay tuned for Part II!

← Older posts