RIA Compliance Blog
FINRA has announced a new self-reporting initiative covering potential violations by its Member Firms of various rules governing share class recommendations relating to 529 Plans. See FINRA Regulatory Notice 19-04 (Jan. 28, 2019). Similar to the SEC’s recent self-reporting initiative regarding mutual fund share class selection in connection with 12b-1 marketing fees (which we have blogged about last month and in May of 2018), this new FINRA initiative (the “Initiative”) offers potential leniency in return for Member Firms coming forward to self-report likely violations pursuant to the terms of the Initiative.
529 Plans are tax-advantaged municipal securities that are structured to facilitate saving for the future educational needs of a designated beneficiary. While the sale of 529 Plans is governed by the rules of the Municipal Securities Rulemaking Board (“MSRB”), FINRA is responsible for enforcing the MSRB’s rules. These rules, in turn, require that recommendations of 529 Plans be suitable in light of the customer’s investment profile, and that Member Firms selling 529 Plans have a supervisory system in place to achieve compliance with the MSRB’s rules.
In its announcement of the Initiative, FINRA noted that it had developed concerns over the last few years about the suitability and lack of supervision of its Member Firms’ share-class recommendations to customers of 529 Plans, which are typically sold in share classes with differing fee structures. In general, Class A shares carry a front-end sales charge but have lower annual fees as compared to other classes. Class C shares, on the other hand, impose no front-end sales charge but carry higher annual fees than Class A shares. In this regard, the overall cost to the customer is a function of how long the customer will hold the securities, which, in turn, is largely determined by the age of the designated beneficiary at the time of the sale (i.e., how long it will be until the funds are needed to pay for his/her educational expenses).
Accordingly, the aim of the Initiative is to “promptly remedy potential supervisory and suitability violations related to recommendations that customers of 529 Plans buy share classes that are inconsistent with the accounts’ investment objectives, and to return money to harmed investors as quickly and efficiently as possible.” To facilitate this goal, FINRA’s Department of Enforcement (“Enforcement”) will offer leniency in the form of favorable settlement terms for firms that self-report and provide a detailed remediation plan. Specifically, Enforcement will “recommend that FINRA accept a settlement that includes restitution for the impact on affected customers and a censure, but no fine.”
As a roadmap in guiding a Member Firm’s assessment of the Initiative, FINRA identified as potential areas of concern, a Member Firm’s failure to: (i) provide training regarding the costs and benefits of different 529 Plan share classes; (ii) understand and assess the different costs of share classes for individuals; (iii) receive or review data reflecting 529 Plan share classes sold; and (iv) review share-class information, including potential breakpoint discounts or sales charge waivers, when reviewing the suitability of its 529 Plan recommendations.
The deadline for self-reporting under the Initiative is midnight on April 1, 2019, at which time written notification must be made to Enforcement. For Member Firms having timely met this deadline, such firms must then “confirm eligibility” for the Initiative by submitting, no later than May 3, 2019, a number of specific items as requested by FINRA in the Notice announcing the Initiative. The information required by FINRA in order to confirm eligibility is quite extensive, and includes not only raw data relating to the firm’s offering of 529 Plans for the period of January 2013 through June 2018, but detailed remedial steps intended to be taken in the future.
Member Firms should carefully assess the terms of the Initiative in light of their past 529 Plan activities. Member Firms that have already been contacted by Enforcement regarding possible violations in this area are not eligible for the Initiative. However, Member Firms that are subject to pending examinations by FINRA are still eligible to self-report pursuant to the Initiative. Understandably, FINRA has warned its Member Firms that they should carefully consider the Initiative as, for those foregoing the Initiative for whom violations are ultimately discovered by Enforcement, “any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the Initiative.” Any firm considering the Initiative should, of course, seek competent legal advice and/ or counsel on this matter.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.