The Ever Changing FINRA Enforcement Horizon #3

This last post, in the series of ever changing FINRA enforcement horizon, contains a summary of enforcement actions that the average investor would apt to be exposed to. However, please keep in mind that this list is not exhaustive. Individuals are always trying to come up with new ways to separate an individual from their money. Consequently, it is necessary for you to remain ever diligent and take immediate action if you suspect that something is wrong.

1. Unsuitable Recommendations:

• FINRA settled a matter involving a registered representative who recommended two unsuitable investments to a customer. At the time of the recommendations, the registered representative’s customer was contemplating early retirement in the near future, seeking growth and income, and wanting to withdraw a monthly amount without paying the IRS tax penalties. The representative recommended class A shares of three mutual funds and a cash management trust. The customer invested his entire retirement savings of $530,000 and paid an upfront load of $9,786 for the mutual fund purchases. The annual expenses for the class A shares was $2,934, and the representative received $6,889 in connection with the purchase. Later that same day, the representative learned from a colleague that a particular deferred variable annuity offered an income protection rider. Despite never having sold a deferred variable annuity before, the representative recommended, on the same day as the mutual fund purchases, that the customer liquidate his mutual fund shares to purchase the variable annuity. The customer agreed, and the representative moved all of the customer’s retirement savings into a variable annuity at a total cost to the customer of $10,513. The representative received $21,145 in compensation on the variable annuity purchase. Subsequently, the variable annuity company miscalculated the customer’s monthly withdrawal and failed to factor into the calculation the customer’s tax limitations, thereby rendering the annuity’s income protection rider moot. The representative failed to notice the miscalculation until a later date. FINRA concluded that the representative’s recommendation of these two transactions on a single day was unsuitable for the customer because they resulted in the customer unnecessarily paying an upfront sales charge for the first investment and substantially higher annual fees, and an over-concentration of the customer’s investments in an illiquid deferred variable annuity. FINRA found that the representative’s conduct violated NASD Rules 2310 (recommendations to customers) and 2110 (ethical standards), and NASD IM-2310-2 (fair dealing with customers). As such, FINRA suspended the registered representative from associating with any member firm in any capacity for one month and fined the representative $5,000.

2. Improper Exercise of Discretion, Unsuitable Recommendations and Failure to Disclose Risks:

• FINRA settled a matter involving a registered representative who improperly exercised discretion in a husband and wife’s joint account, recommended unsuitable transactions and failed to disclose to the husband and wife the risks associated with the trading strategy he recommended. For more than two years, the registered representative exercised discretionary authority in a husband and wife’s joint account without obtaining their prior written authorization and his employer firm’s written acceptance of the account as discretionary. FINRA found that this conduct violated NASD Rules 2510 (discretionary accounts) and 2110 (ethical standards). During that same period, the representative engaged in excessive and unsuitable trading in the account, which generated substantial losses. The representative’s trading strategy involved high transaction costs that resulted over time in an annualized cost-to-equity ratio of 35 percent. The representative also used margin to trade in the account and recommended that the customers use funds borrowed against their primary residence and vacation home to engage in active trading. FINRA found that the representative’s unsuitable and excessive trading violated NASD Rules 2310 (recommendations to customers) and 2110 (ethical standards), and NASD IM-2310-2 (fair dealing with customers). In connection with these recommendations, the representative also failed to disclose to the customers the risks associated with trading on margin and engaging in high-frequency trading. FINRA found that the representative’s conduct in this regard violated NASD Rule 2110 (ethical standards). As such, FINRA barred the representative from associating with any member firm in any capacity.

3. Conversion of Customer Funds:

• FINRA settled a matter involving a registered person who utilized his position as a chief compliance officer at a member firm to convert approximately $14,000 from two firm customers. First, the registered person arranged for the transfer of securities and cash worth $4,000 from a customer account to a personal trust account that he had established at his firm using a fictitious letter of authorization that he drafted. He also used the firm’s systems to temporarily change the address on the customer’s account to his own work address. The customer neither knew about nor authorized the transfer. One month later, the registered person arranged for the transfer of various securities and cash worth approximately $10,000 from a customer’s IRA account to his account. The registered person used a fictitious retirement account distribution form and letter of authorization to effectuate the transfer. The registered person used the converted funds for his own personal benefit. FINRA concluded that the registered person’s conduct violated FINRA Rules 2150(a) (improper use of customer funds or securities) and 2110 (ethical standards). As such, FINRA barred the registered person from associating with any member firm in any capacity.