WASHINGTON--()--As reported on March 13, 2013, in Sutherland’s annual analysis of FINRA’s disciplinary actions, suitability cases generated the highest amount of fines for the regulator in 2012.1 This past year, FINRA reported $19.4 million in fines from 117 cases involving alleged suitability violations.2 Although suitability has consistently landed on Sutherland’s Top Enforcement Issues list (second in 2008 and 2009; fourth in 2010 and 2011), 2012 saw a record number of suitability cases for FINRA. The 117 suitability cases reported in 2012 represented a 10% increase from the 106 cases filed in 2011 and more than double the 53 cases FINRA reported in 2009 and 2010. This Sutherland FINRA Focus delves into the regulator’s recent enforcement actions and examines a few of the key 2012 suitability cases.
“[f]irms must conduct a thorough suitability analysis before selling products, and make accurate disclosure of risks and features at the point of sale, especially with alternative investments such as non-traded REITs.”
The chart below shows the total number of suitability enforcement actions and fines FINRA has reported during each of the past seven years.
FINRA’s Suitability Sanctions Statistics, 2006 - 2012
|Reported||Change||Total FINRA Fines||Reported||Change|
These statistics reveal that suitability cases routinely make up a significant percentage of FINRA’s enforcement fines each year. In fact, nearly 18% of all FINRA sanctions since 2006 have stemmed from cases involving suitability allegations. Suitability cases may continue to become more prevalent in times of limited yields and increasing product complexity. Many of the 2012 suitability fines were assessed in cases involving products that could be considered complex, such as real estate investment trusts (REITs), unit investment trusts (UITs), and collateralized mortgage obligations (CMOs).
One firm was fined $2.3 million for its allegedly unsuitable sales of a non-traded REIT to thousands of elderly investors.3 FINRA also ordered the firm to pay $12 million of restitution to investors. Brad Bennett, FINRA’s Executive Vice President and Chief of Enforcement, said the firm "targeted unsophisticated and elderly customers, grossly failing to comply with basic standards of suitability in selling Apple REIT Ten to thousands of customers.”4 More generally, Mr. Bennett warned that “[f]irms must conduct a thorough suitability analysis before selling products, and make accurate disclosure of risks and features at the point of sale, especially with alternative investments such as non-traded REITs.” The President and CEO of the firm was also fined $250,000 and suspended from the securities industry for a year for allegedly making false statements at firm seminars and in letters to customers, including describing the REIT as a “fabulous cash cow” and a “golden opportunity.” Susan Axelrod, FINRA’s Executive Vice President of Member Regulation Sales Practice, said “[t]his case stands for the proposition that senior officers of firms, even at the CEO level, will be held accountable for systemic, detrimental harm to customers. Protection of the investing public remains the most important goal of the examination and enforcement teams throughout the country.”
The allegedly unsuitable sales of UITs and floating-rate loan funds led to a $1.7 million fine for another firm.5 The firm also was ordered to reimburse the affected customers $1.9 million. FINRA found that the firm’s representatives recommended these investments to investors who had conservative risk tolerances and little to no investment experience. FINRA also noted that the firm did not reasonably supervise the sales of UITs and floating-rate loan funds. The firm allegedly failed to provide adequate training to its representatives about the risks and suitability of UITs and floating-rate loan funds. This led to nearly 260 UIT recommendations to customers with conservative risk profiles and little investment experience. When speaking about this case, Mr. Bennett emphasized the increasing use of complex products in recent years and noted that it is “incumbent upon firms to properly train and provide guidance to their brokers about the products that they sell and supervise the sales practices of their brokers.”
Another firm was fined $350,000 for its sales of CMOs and ordered to pay $206,000 in restitution to investors.6 FINRA alleged that the firm, which had only five registered personnel, charged excessive markups when selling CMOs and did not have reasonable procedures in place to monitor the suitability of CMO sales to retail customers. There were no procedures that addressed how representatives were to determine the suitability of potential purchases of inverse floater CMOs. This led to the purchase of these securities by customers who did not understand the risks and who had moderate-risk profiles. A FINRA notice had previously indicated that inverse floaters should be sold only to customers with a high-risk profile, but the firm did not inform its representatives of this requirement.
Suitability has consistently ranked as one of the top enforcement issues for FINRA during the past five years. However, the number of suitability cases has doubled over the past two years from the numbers reported in 2009 and 2010. Firms and their representatives can likely expect that suitability will continue to be a priority for FINRA in the near future. In light of the substantial sanctions FINRA has imposed in suitability cases involving complex products, firms may wish to review their policies and procedures regarding non-traditional securities and review FINRA notices on this issue.7 As demonstrated by the above cases, smaller firms and high-level executives are not immune to severe sanctions and suspensions when suitability issues are involved.
Sutherland Analysis of FINRA Sanctions Shows Number of Enforcement
Actions Rises Slightly in 2012, Fines Jump by 15%
During the next three days, Sutherland will release analyses on the other 2012 Top Enforcement Issues, which include due diligence, research analysts and research reports, and advertising.
2 The number of cases reported and the amount of corresponding fines come from the Disciplinary and Other FINRA Actions report that FINRA publishes each month. Many of these cases also involved other allegations, making it difficult to attribute the exact amount of any particular fine to an alleged suitability violation.
3 FINRA News Release, Oct. 22, 2012, available at http://www.finra.org/Newsroom/NewsReleases/2012/P191729.
5 FINRA News Release, Nov. 15, 2011, available at http://www.finra.org/Newsroom/NewsReleases/2011/P125115.
6 FINRA Letter of Acceptance, Waiver, and Consent, Feb. 8, 2012, No. 20090177697.
7 See Complex Products, FINRA Regulatory Notice 12-03, Jan. 2012, available at http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p125397.pdf.