FINRA wants a member firm to enforce its written supervisory procedures. And FINRA wants a member firm to recommend securities that fit within the customer’s investment objectives. And certainly FINRA wants a member firm to avoid falsification of business records. So what happens when a member firm doesn’t quite live up to FINRA’s expectations? Let’s play the over / under game and try to guess the size of the FINRA sanction when a member engages in the following misconduct:
- Failure to enforce WSPs governing the sale of high-risk mutual funds subject to significant volatility
- Failure to reallocate portfolios to reduce risk or otherwise update investment objectives to correspond with the assumption of additional risk
- Failure to properly investigate exception report alerts
- And here’s the real ugly one: “adjustment” of customers’ risk tolerances and investment objectives without first seeking the customers’ input. Rest assured, it was clever lawyering that got FINRA to delete the word “falsification” and instead use the word “adjustment.”
Well, if the respondent were an individual, as opposed to NY Life, and the broker sold unsuitable securities, disregarded firm policy, and falsified new account forms, what would FINRA do? According to FINRA’s Sanction Guidelines: (a) “recordkeeping violations” can lead to a bar if aggravating factors predominate; and (b) unsuitable recommendations will likely lead to a bar if aggravating factors predominate.
Given that FINRA would wallop an individual, surely they’ll do the same with an institution that can readily pay a sizable fine….right?? Given FINRA’s allegations, we must be talking about a significant seven-figure fine, right?
Well….read on.
Case In Point
In the Matter of NYLIFE Securities LLC, FINRA Matter No. 2016050685102 (click here to read the AWC)
Sanctions
- A fine of $250,000
- Restitution and rescission to 28 customers. The restitution amount equals $76,643. The rescission offer pertains to customers with unrealized losses totaling approximately $250,000.
- Censure
Hmmm….it looks to me like NYLIFE cut a sweetheart deal with FINRA.
Underlying Facts
From September 2014 to December 2016, NYLIFE had procedures for supervising the sale of higher-risk mutual funds as measured by volatility. The procedures, as one would expect, required such sales to align with the customers’ risk tolerances and investment objectives. During this time period, NYLIFE’s automated surveillance system flagged potentially unsuitable trades. For example, an alert was generated if a customer with an investment objective of “income with moderate growth” and a risk tolerance of “moderately conservative” sought to purchase a higher-risk mutual fund in an amount that exceeded 30% of the customer’s overall portfolio.
The alerts were reviewed by a group of “reviewers” who, in conjunction with registered persons, offered customers a choice: reallocate the portfolio to reduce risk, or change your investment profile to reflect a higher risk tolerance and more aggressive investment objective.
All of that was well enough; however, NYLIFE apparently didn’t allocate sufficient resources to the “reviewer” department and un-reviewed alerts began to pile up. To rectify this:
“Respondent’s reviewers adjusted customers’ investment profiles to accommodate a sale of higher-risk mutual funds without determining whether a representative had discussed the option of reallocation with the customer and typically without first contacting the customer. In fact, some customers’ investment profiles were changed before Respondent obtained information about the customers’ true risk tolerance and investment objective.”
The upshot of this was that the portfolio for a number of customers (approximately “four dozen” according to FINRA) with relatively conservative investment objectives was excessively weighted with high-risk mutual funds.
Analysis
I get that a $250,000 is not chump change. And I also recognize that the BD has to offer restitution and restitution, and apparently settled other customer complaints prior to FINRA’s intervention. Nonetheless, the allegations present a fairly damning fact pattern. FINRA alleges a complete breakdown of the system of supervision. And brazenly mismarking a customer’s investment objectives is conduct one expects from a bucket shop, not from a highly regarded financial institution.
Based on the facts alleged, along with the guidance in FINRAs Sanction Guidelines, it really seems like NYLIFE got off easily. According to the Sanction Guidelines:
Failure to Supervise – for systemic supervisory failures, the adjudicator should consider imposing an undertaking, such as engaging an independent consultant to revamp the supervisory systems. Where aggravating factors predominate, the adjudicator should consider suspending or even barring the firm. Additionally, the adjudicator should consider a fine of up to $310,000, or higher if aggravating factors predominate.
Suitability – the adjudicator should consider a monetary sanction of up $116,000 and consider suspecting a firm with respect to a set of activities for up to 90 days.
Herskovits PLLC
Herskovits PLLC has a robust practice defending individuals and entities against regulatory investigations and disciplinary proceedings brought by FINRA and other regulators. Click here for our landing page on FINRA investigations.