ATTENTION INVESTORS

Five B-Ds Affiliated With Banks Settle SRO Allegations on Sales Supervision

Five broker-dealers have agreed to be fined by the Financial Industry Regulatory Authority after the self-regulatory organization charged them with having "deficient supervision and procedures" related to variable annuity, mutual fund, or unit investment trust transactions.

In a July 23 statement, FINRA identified the firms as McDonald Investments (now KeyBanc Capital Markets Inc.), which agreed to be fined $425,000; IFMG Securities, $450,000; Wells Fargo Investments LLC (WFC) , $275,000; PNC Investments (PNC) , $250,000; and WM Financial Services Inc. (now Chase Investment Services Corp.) (JPM) , $250,000. All the firms settled the allegations without admitting or denying liability.

The SRO said brokers at each of the broker-dealers operated out of branches of affiliated banks, selling VAs, mutual funds, or UITs to bank customers. The brokerage customers were referred by bank personnel, and sales of these financial products "represented a significant portion of each firm's business." Susan Merrill, FINRA's enforcement director and executive vice president, said that with such a set-up, "[p]roper care must be taken to appropriately supervise sales to those customers, particularly the elderly, who can be unfamiliar with securities products as they seek alternatives to certificates of deposit and other bank offerings."

'Unsuitable' Sales

In addition to deficient supervision and procedures, McDonald Investments was alleged to have made "unsuitable" VA sales to elderly customers. Specifically, the SRO said that between June 2004 and January 2006, a former broker at the firm made 32 unsuitable sales to 25 customers 78 years old or older. The broker recommended each customer purchase a VA with an enhanced death benefit rider, even though all were either too old or very close to being too old to be eligible for the rider.

FINRA said that the 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. As part of the settlement, McDonald Investments agreed 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.

The SRO alleged further that McDonald "failed to take adequate remedial steps in response to red flags" that indicated the broker was engaging in unsuitable VA transactions. Among the indicators, FINRA said, were nine customer complaints filed against the broker about her annuity sales, and the broker "consistently engaging" in a pattern of selling elderly bank customers the same variable annuity with the same enhanced death benefit rider.

Enhanced Supervision

FINRA noted that the firm placed the broker under extra supervision, but that it was while under that watch that she undertook all 32 unsuitable transactions, with the firm approving all of them. FINRA also found that McDonald failed to implement adequate VA supervisory systems and procedures.

Regarding IFMG Securities, FINRA explained that in assessing suitability for VA and mutual fund transactions, the firm used trade blotters "that did not capture key information," including the customer's investment time horizon, risk tolerance and other financial assets. In addition to the blotter reviews, IFMG's compliance department performed reviews of account documents; however, those reviews took place approximately 10 days after transactions had been completed. As such, the department "often had difficulty obtaining the requested information and completing its review," FINRA said. IFMG no longer operates as a broker-dealer, according to FINRA.

Inadequate Guidance

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

Since September 2006, according to the SRO, Wells Fargo has lacked a list of factors to consider when recommending VA transactions, thus leaving its principals and brokers without any guidance for determining suitability in VA transactions. PNC Investments, meanwhile, instructed its principals to consider several factors, but without collecting or recording all the relevant information. It also failed to provide guidance on how to apply the factors in their suitability reviews. Firms are required, if they include such factors in their procedures, to have systems in place to implement the factors, FINRA said.

No Guidance

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 into UITs, the SRO said. Compliance personnel, therefore, "were provided no criteria to identify patterns of exchanges over time or whether such exchanges were suitable."

The firm 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," FINRA said.

FINRA's Merrill said the actions "underscore the need for firms operating bank branches to have effective systems and procedures in place to monitor sales of variable annuities, mutual funds, and UITs."