Finra is Giving Some Rule Violators a Break … For Now
Is Finra – which has been criticized for regulating by enforcement – softening its stance?
On Monday, the self-regulator announced its first ever self-reporting initiative that it says “stresses restitution and rapid remediation” while waiving fees that would otherwise be imposed on violators.
The initiative is specifically for violations of rules governing the recommendation of 529 savings plans. These 529 plans – usually used by parents thinking ahead for their children’s college education – are tax-advantaged municipal securities. They are designed to encourage saving for the future educational expenses of a designated beneficiary, and shares are commonly sold in different classes with fees and expenses that vary widely from plan to plan, according to Finra.
Under Finra’s 529 Plan Share Class Initiative, announced via Regulatory Notice 19-04, broker-dealers are encouraged to review their supervisory systems and procedures governing 529 plan share-class recommendations, self-report supervisory violations and provide Finra with a plan to remediate harmed customers.
If the broker-dealers complete all those required steps under the 529 Initiative, Finra’s Department of Enforcement will recommend the self-regulator accept a settlement which includes restitution for the impact on affected customers and a censure, without imposing any fine.
To be eligible for the 529 Initiative, broker-dealer firms must self-report by providing written notification to Finra’s Department of Enforcement by 12:00 a.m. E.T. on April 1, 2019.
This initiative underscores the importance and popularity of 529 plans and the need to ensure investors in these plans are well-protected, says Finra.
The self-regulator insists it’s concerned some broker-dealer firms are not providing supervision that’s “reasonably designed” to ensure representatives recommend a 529 plan share class tailored to the unique circumstances and needs of each customer.
“By focusing on restitution and rapid remediation through the 529 Initiative, Finra is working with firms that demonstrate a commitment to fixing potential problems and making customers whole promptly,” Susan Schroeder, head of Finra’s Department of Enforcement, says in a statement.
“Finra’s highest priority in an enforcement action is to first seek restitution to any harmed investors. We also seek to ensure that systemic deficiencies are remediated,” she adds.
If a broker-dealer firm does not self-report under the 529 Initiative and Finra later identifies supervisory failures by that firm, any disciplinary actions will likely result in the recommendation of sanctions beyond those described under the 529 Initiative, according to Finra.
In a video posted on Finra’s website, Schroeder notes that 529 savings plans “are incredibly important investment vehicles for a lot of Americans” and “Finra has learned through the course of reviewing some firms’ 529 plan sales that this can be a blind spot for some firms.”
Schroeder says in the video that Finra believes “it makes sense to tell firms what we’re seeing and what we’re concerned about and ask firms to be proactive about making sure they’ve got everything right.”
According to Finra, the potential areas of concern include the failure to:
- Provide training regarding the costs and benefits of different 529 plan share classes;
- Understand and assess the different costs of share classes for individual transactions;
- Receive or review data reflecting 529 plan share classes sold; and
- Review share-class information, including potential breakpoint discounts or sales charge waivers, when reviewing the suitability of 529 plan recommendations.
FA-IQ previously reported that Merrill Lynch is on the hook for $19 million in restitution over alleged failures in supervising its agents on the opening of 529 college savings plans, according to the Portland Press Herald.
Maine’s state regulators have said the wirehouse let its agents put investors who wanted to open college savings plans in its NextGen Fund into Class C shares. Merrill Lynch earns more in fees from Class C shares than Class A shares, but Class C shares are designed for investing with a shorter time horizon, according to the state.
The wirehouse detected the inappropriate allocation itself and reported it to Finra, Bill Norbert, a spokesman for the Finance Authority of Maine, told the paper.
Merrill Lynch is currently facing a proposed class-action lawsuit involving the Maine 529 savings plans. Sources familiar with the 529 Initiative tell FA-IQ that lawsuits "are separate from and not applicable to this initiative."
Last year, the SEC offered amnesty for advisors who self-reported by June 12 share-class fee violations and returned funds to harmed investors. Under the Share Class Selection Disclosure Initiative announced by the SEC in February of last year, the regulator said it would "agree not to recommend financial penalties” for advisors who self-reported failure to disclose receipt of 12b-1 fees in recommending mutual fund share classes when lower-priced share classes of the same mutual fund were available. Instead, the SEC said it would "recommend standardized, favorable settlement terms to advisors who self-report[ed] by June 12” of 2018.