Back in December, the State of Massachusetts filed a Complaint against LPL and one of its big producers alleging that the producer, Roger Zullo, defrauded his clients and lied to his supervisors in connection with the sale of variable annuities. What struck me when I read the Complaint, and what has still stuck with me, is the sheer number of alleged supervisory mistakes that LPL made. Now, granted, it has been reported, and accurately so, that the State of Massachusetts has had LPL squarely in its regulatory crosshairs for several years, resulting in the payment by LPL of millions of dollars in fines relating to its sales of nontraded REITs. But, assuming these current allegations are true, it certainly seems like LPL has not done nearly enough to get out of the regulatory doghouse. A review of LPL’s purported failures and mistakes serves as a helpful reminder of what it takes to establish that one’s supervision is, in fact, “reasonable” enough to satisfy regulators.

  1. To conduct its suitability review of an annuity purchase, LPL relied solely on its advisors voluntarily to supply information about other annuities that the customer already owned. Zullo, apparently, declined to provide such information, thus hindering LPL’s ability to determine suitability. Clearly, LPL could have avoided this if it required the customer to disclose the existence of other annuities.
  2. Zullo fabricated certain suitability information, particularly customers’ ages and net worth, on annuity applications. One might ask, how LPL was to have known this? I mean, ordinarily, when a customer completes a new account form, the broker-dealer is not required to verify the accuracy of any of that information, including relatively easily verified things like net worth and income. So, given that, how did this become LPL’s problem? The answer is that LPL possessed prior account applications that also disclosed the customers’ birth dates and net worth data, and a simple comparison of the information on the new application with the existing customer profile information would have readily revealed the discrepancies. In short, it does not seem to be much of a stretch to insist that a broker-dealer actually pay attention to information it possesses about its customers.
  3. Even when LPL did notice a big jump in one customer’s net worth – from $1 million to $4 million – as disclosed in the annuity application vs. prior account documentation, it failed to push Zullo for a reasoned explanation. Indeed, all Zullo did in response to the inquiry was claim the existence of some supposed Vanguard account worth $2.4 million, but he was not asked to supply any documentation or explain why that account was not reflected on the prior documents.
  4. When the customer filed a complaint with Zullo, Zullo failed to report it immediately to LPL, in contravention of LPL policy. LPL learned of the complaint only when FINRA – which got a call to its Senior Hotline! – informed LPL. But, after learning of the complaint, LPL (1) did not contact the complaining customer, (2) did not look at its records for the complaining customer (which would have revealed the discrepancy in the age and net worth on the annuity application), (3) did not request any documentation from Zullo, and (4) did not review Zullo’s emails with the customer, or his client notes. Instead, all LPL did was ask Zullo to justify the recommendation he had made to the customer (which LPL allegedly then adopted “wholesale” and denied the complaint). I don’t think it’s necessary for me even to say anything about what LPL could have done differently.
  5. LPL failed to notice serial purchases by Zullo’s customers of the same annuity in relatively short timeframes. On questioning, the supervisors acknowledged that had they seen this, or recalled it, it would have constituted a red flag. Unfortunately, LPL’s system did not permit the supervisors to see the prior purchases. That is not a helpful system.
  6. Putting aside the questionable documentation and explanations that Zullo provided to justify his recommendations on a customer-by-customer basis, it was fairly obvious, on a macro level, that Zullo basically sold the same product to practically all of his annuity customers. Given the many potential differences between any two customers’ particular suitability profiles, that a single product was somehow appropriate for 98% of Zullo’s customers seems rather dubious.
  7. Finally, and perhaps most potentially damning, LPL failed to take seriously concerns raised by Zullo’s direct supervisor about Zullo’s annuity sales. The supervisor noted Zullo’s “cookie cutter” approach, that most customers were incurring a surrender charge, and recommended that the issue be “escalated.” Instead, the supervisor’s concerns were largely swept under the rug.

Remember, these are just unproven allegations, and I presume that LPL is innocent. But, whatever the ultimate outcome, this Complaint amply demonstrates how certain facts, especially when viewed in the aggregate, make it easy for regulators to conclude that a firm is putting its desire for revenue before its need for compliance. It doesn’t matter who is President, who he appoints to the SEC, or that the FINRA CEO is saying the right things: such behavior will never be countenanced.