Six Most Common FINRA Arbitration Claims In 2018 Silver Law Group

Suitability for Retail Customers

FINRA rule 2111 ensures that firms and people associated with firms deal with customers fairly. The rule is composed of three main parts: reasonable basis suitability, customer-specific suitability, and quantitative suitability. FINRA will observe unsuitable recommendations to retail investors and also deficiencies in some firms; supervisory systems.

In the past, FINRA has observed situations where customers’ financial needs were not considered. Registered representatives failed to think about cumulative fees, sales charges, and commissions. Failure to understand the specific features and terms of products recommended to customers was a common contributor to the problems that FINRA observed.

In years of experience, FINRA noted that successful firms have specific rules and regulations to avoid problems. Successful firms have well-developed policies and systems that have been made specifically for a certain customer base. Some firms go as far as to create methods to verify the source of funds for variable annuity transactions. In some cases, registered representatives must receive training on specific products to ensure they know risks and performance characteristics, as well as investors who might be suitable in the future.

FINA has stated that some firms face challenges based upon quantitative stability. When a broker has any kind of control over a customer’s account, there has to be legitimate reasons that a number of transactions are occurring, and are not excessive. Some firms have developed a means to keep track of trading volume and cost.

Overconcentration

Some firms maintained accounts that were concentrated in complex structured notes or sector-specific investments. Some accounts were overconcentrated non-traded real estate investment trust (REITS), which ultimately resulted in customer losses. Some representatives recommended structured notes or sector-specific investment strategies to customers who might not have completely understood the suggestion. Some representatives do not take a clients’ financial situation into consideration before making a suggestion. For example, illiquid securities with limited price transparencies make it difficult for investors to know the actual value of their investment, and often lead investors to believe that their investments will not fluctuate in value. In some cases, firms do not have the means or procedures to supervise this issue in customers’ accounts.

Excessive Trading

Some firms fail to establish and enforce a supervisory system to prevent potential excessive trading. They fail to review account alerts and don’t use certain compliance tools designed to detect excessive trading, churning, or trading losses in customer accounts.

Some firms maintained written supervisory procedures (WSPs) that showed key indicators of excessive account activity, but didn’t establish threshold values for the indicators. For example, the indicators allowed the firms to identify accounts based solely on the quantity of trades executed, but failed to consider other important criteria like margin balances, total fees paid, equity ratios, and profit and loss.

There were cases in which firms had an “active account” letter, but didn’t formally supervise the process, which resulted in letters that were too general and didn’t include relevant information regarding account activity. The letters didn’t address information like trading details, number of trades, commissions, or account losses.

Unsuitable Variable Annuity Recommendations

FINRA has recognized that some firms have failed to establish, maintain, and enforce WSPs and supervisory systems that ensure representatives’ recommendations of variable annuities compiled with suitability obligations. For example, some firms have given unsupervised recommendations to retail customers to exchange one annuity product for another. In some cases, FINA reviewed that the suggested change was inconsistent with the customers’ needs and ultimately resulted in increased fees for the customer and loss of material.

Some firms experienced challenges while training their representatives. The people who were hired to supervise variable annuity transactions, assess fees, and surrender charges were not fully understanding how to complete the job during their training period. FINRA observed that a representative was incorrect about the cost of variable annuity riders through disclosure forms. FINRA remains wary of the accuracy of firms’ data, including general product information, share class, riders and exchange-based activity.

Reasonable Diligence for Private Placements

There have been situations in which firms that have suitability obligations under FINRA rule 2111 (Suitability) failed to conduct reasonable diligence on private placements and did not meet their supervisory requirements under FINRA rule 3110 (Supervision). FINRA Regulatory Notice 10-22 describes why firms have an obligation to conduct an investigation by evaluating the issuer and its management, as well as the assets held by the issuer.

FINRA has observed that some firms did conduct reasonable diligence, indentified red flags, and resolved concerns that would be relevant to a potential investor. Depending on the size of the firms, some diligence processes need a committee.

In situations where the issuers were affiliates of the firm and the control person was also employed by the firm, reasonable diligence was used to mitigate conflicts of interest, and to ensure that offerings were suitable for investors. Insight from diligence analysis was used to establish post-approval comprehensive disclosures.

FINRA reminds firms that they must document both the process and results of reasonable diligence analysis.

Abuse of Trustee Status

Some registered representatives have convinced investors to establish trusts and appoint that representative as the trustee or co-trustee in order to direct the funds themselves. FINA remains concerned about representatives having significant roles in customer accounts.

Silver Law Group is a nationally-recognized securities law firm representing investors worldwide with their claims for losses due to securities and investment fraud. The firm has successfully recovered multi-million dollar awards for its clients through securities arbitration and the courts. To contact Scott L. Silver to discuss your legal matter, call toll-free (800) 975-4345 or e-mail him at SSilver@silverlaw.com.