FINRA Fines Broker-Dealers $1.65 Million for Supervisory Failures

The Financial Industry Regulatory Authority (FINRA) recently announced that it has fined five bank broker-dealers a total of $1.65 million for deficient supervision and procedures related to variable annuity (VA), mutual fund or unit investment trust (UIT) transactions.

Brokers at each of the firms operated out of branches of affiliated banks, selling VAs, mutual funds or UITs to bank customers (investors), who, in many instances, were elderly. The brokerage customers were referred by bank personnel, and sales of these financial products represented a significant portion of each firm’s business.

The five firms that FINRA fined for deficient systems and procedures relating to VA, mutual fund or UIT sales, and the amount of their fines, are:
• McDonald Investments (now KeyBanc Capital Markets, Inc.) – $425,000
• IFMG Securities – $450,000
• Wells Fargo Investments, LLC – $275,000
• PNC Investments – $250,000
• WM Financial Services, Inc. (now Chase Investment Services Corp.) – $250,000

McDonald Investments, now KeyBanc Capital Markets, also was charged with unsuitable variable annuity sales to elderly customers.

In the case against McDonald, FINRA found that, between June 2004 and January 2006, a former broker at the firm made 32 unsuitable sales to 25 elderly bank customers, recommending each customer purchase a VA with an enhanced death benefit rider. The customers, all 78 years old or older, were either too old to be eligible for the rider, or very close to the ineligible age. Those customers who purchased the VA with the enhanced death benefit rider received little or no benefit from the rider despite paying higher fees for it over the life of the annuity.

FINRA ordered the firm to offer the 25 affected customers the opportunity to rescind their unsuitable transactions and receive the initial value of their purchase, plus interest and any surrender charges required, adjusted for any withdrawals made.

FINRA also found that McDonald failed to take adequate remedial steps in response to red flags indicating that the broker was engaging in unsuitable VA transactions, including nine customer complaints filed against the broker about her annuity sales, and the broker’s practice of consistently engaging in a pattern of selling elderly bank customers the same variable annuity with the same enhanced death benefit rider.

The firm placed the broker under heightened supervision, but while under heightened supervision, the broker undertook all 32 unsuitable transactions and the firm approved them. FINRA also found that McDonald failed to implement adequate VA supervisory systems and procedures.

As for IFMG Securities, FINRA found that the firm used trade blotters to assess suitability and approve VA and mutual fund transactions that did not capture key information, such as the customer’s investment time horizon, risk tolerance and other financial assets – all details that are necessary for the principal to conduct an adequate suitability review. Also, important suitability information on the blotters was presented in a way that did not reflect customers’ true income or net worth; the blotter reflected only the highest number in the range of values from which it was taken.

In addition to the blotter review, IFMG’s Compliance Department performed a review of account documents approximately 10 days after transactions had been completed to further assess suitability and to ensure that all paperwork had been completed. However, because the transactions had been completed by that time, the Compliance Department often had difficulty obtaining the requested information and completing its review. As a result, FINRA found, a large backlog of unapproved transactions developed at IFMG from 2004 through 2006. That backlog delayed final approval of transactions for weeks, months and in some cases, for over a year. Despite knowledge of the growing backlog, IFMG failed to take effective action to address the problem, which continued until the firm changed to a pre-approval suitability review system between May and August of 2006. IFMG no longer operates as a broker-dealer.

In the Wells Fargo, PNC Investments and WM Financial Services cases, FINRA found that the firms did not provide adequate guidance to principals who approved variable annuity transactions, or in the case of WM Financial, UIT transactions.

Prior to November 2004, Wells Fargo provided no factors to guide principals in determining suitability. From November 2004 to September 2006, it instructed principals to consider such factors as a client’s liquidity needs, tax deferral needs and time horizon, without providing guidance on how to apply such factors to determine suitability, and did not capture information relevant to such factors. After September 2006, Wells Fargo removed its list of factors to consider when recommending VA transactions, leaving its principals and brokers without any guidance on how to determine suitability in VA transactions.

FINRA found that PNC Investments instructed its principals to consider factors such as a customer’s source of funds, health and investment time horizon without collecting or recording all the information necessary for principals to assess suitability and to consider factors such as the client’s age, need for tax deferral and liquidity without providing guidance on how to apply such factors in their suitability review. Principals therefore applied inconsistent definitions. Firms are required, if they include such factors in their procedures, to have systems in place to implement the factors.

In the case of WM, the firm had no procedures specific to determining suitability of UIT transactions, and provided no guidance on how to review exception reports concerning exchanges from VAs and mutual funds intoUITs. Compliance personnel, therefore, were provided no criteria to identify patterns of exchanges over time or whether such exchanges were suitable. WM also required certain paperwork to be completed for exchanges, capturing the rationale for the exchange and all fees, including surrender changes, but provided no guidance to principals to use the information to determine if the exchange was suitable.

Wells Fargo, PNC and WM also failed to detect patterns of potentially questionable transactions, which could indicate a broker’s failure to properly tailor recommendations to each customer’s investment needs and situations. At Wells Fargo and PNC Investments, these included patterns of brokers selling the same guaranteed minimum income benefit rider to all or nearly all customers who purchased certain VA carriers’ products. WM Financial Services failed to adequately investigate certain brokers’ potentially unsuitable VA exchanges into UITs, despite concerns raised by the firm’s compliance department.

In settling each of these matters, none of the firms admitted nor denied the charges, but consented to the entry of FINRA’s findings.

If you have questions about an investment you made in a variable annuity (VA), mutual fund or unit investment trust (UIT), or if you believe that you have been the victim of a securities fraud, The White Law Group may be able to help. To speak to a securities attorney, please call our Chicago office at 312-238-9650 for a free consultation.

The White Law Group is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

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