The Financial Industry Regulatory Authority (“FINRA”)1 recently initiated a sweep examination of broker-dealers that may be targeting “potential or early retirees.” In particular, FINRA appears to be focusing on customer accounts that utilize Section 72(t) of the Internal Revenue Code to withdraw money from qualified retirement accounts prior to age 59 ½. FINRA’s sweep examination is a significant expansion into this area, which has been the subject of several regulatory actions during the past year.
Section 72(t) of the Internal Revenue Code imposes a 10% tax penalty on withdrawals from qualified retirement plans (e.g., Individual Retirement Accounts) made prior to the age of 59 ½.2 However, Section 72(t) exempts from the penalty early withdrawals from qualified retirement plans that “are part of a series of substantially equal periodic payments.” IRS rules govern what constitutes “substantially equal periodic payments” and prescribe the mechanics for calculating these payments.
Previous Regulatory Actions
During the past year, early retirement investment programs and Section 72(t) withdrawals have been the subject of several regulatory actions, including the following:
In September 2006, NASD brought an enforcement action against a firm for failing to supervise a registered representative who induced 32 former employees of Exxon Corporation to retire prematurely based on exaggerated and misleading sales presentations that promised the employees could use monthly Section 72(t) withdrawals to replace their current incomes and sustain their retirements.3 NASD fined the firm $2.5 million and ordered it to pay the customers restitution of more than $13.8 million, which corresponds to the compensatory damage and interest component of a customer arbitration award. NASD charged the broker with securities fraud in a separate complaint.
On that same day, NASD issued an Investor Alert titled “Look Before You Leave: Don’t Be Misled By Early Retirement Investment Pitches That Promise Too Much” that warned the public to be skeptical of early retirement investment sales pitches.4
More recently, in June 2007, NASD brought an enforcement action against a firm for, among other things: (1) failing to supervise a team of registered representatives who used misleading sales materials in retirement seminars for BellSouth employees; and (2) using misleading sales materials.5 NASD found that as a result of sales presentations, many BellSouth employees came to believe that they could afford to retire early by relying upon monthly withdrawals from their retirement savings pursuant to the provisions of Section 72(t). NASD fined the firm $3 million and ordered it to pay over $12 million in restitution through the settlement of a state court class action brought on behalf of the BellSouth employees. Three brokers and two managers were also disciplined.
FINRA’s Sweep Examination
The earlier enforcement actions may have stemmed from customer lawsuits, which are referenced in the press releases announcing the disciplinary settlements. Now FINRA is conducting a sweep examination of multiple firms, possibly in an attempt to uncover similar conduct at other firms. Among other things, the sweep letter, which covers the period from January 1, 2005 to June 30, 2007, requests information regarding:
- Seminars directed at “potential or early retirees.”
- Self-directed IRA accounts or variable annuity IRA accounts where the owner received monthly systematic withdrawals and was under the age of 59 ½.
- Written communications sent by the firm or its registered representatives where Section 72(t) is discussed. Interestingly, FINRA requested more than simply correspondence and emails. The sweep letter also calls for the production of metadata (also referred to as embedded data) as retained by each firm.
- Complaints, lawsuits or arbitration claims relating to withdrawals from qualified retirement accounts.
- All firm exception reports. This request is not limited to qualified retirement accounts or Section 72(t) issues.
- The firm’s procedures relating to (1) accounts set up to provide Section 72(t) withdrawals, and (2) the review and approval of seminar material relating to Section 72(t) withdrawals.
It is too early in FINRA’s sweep examination to speculate as to whether any formal investigations or disciplinary proceedings will result. However, FINRA’s interest in this area mirrors the interests of the SEC, state regulators and Congress in inquiring into sales practices directed at seniors or early retirees. FINRA has a substantial interest in and capacity to take aggressive action to combat what it may perceive as abusive sales practices directed at early retirees or seniors. Among the rules that could be implicated by FINRA’s sweep examination are:
- NASD Rule 2110 (misleading statements or omissions)
- NASD Rule 2120 (use of manipulative, deceptive or other fraudulent devices)
- NASD Rule 2210(b)(1) (use of unapproved advertisements or pieces of sales literature)
- NASD Rule 2210(b)(2) (failure to maintain adequate records relating to advertisements and pieces of sales literature)
- NASD Rule 2210(c) (failure to file advertisements or sales literature)
- NASD Rule 2210(d) (use of false, misleading, exaggerated, unfair or unbalanced communications with the public)
- NASD Rule 2310 (unsuitable recommendations to customers)
- NASD Rule 3010(a) (failure to reasonably supervise representatives)
- NASD Rule 3010(b) (failure to establish, maintain or enforce written procedures)
- NASD Rule 3110 and SEC Rule 17a-4 (failure to preserve electronic communications)
Based on prior sweep examinations, if the staff uncovers any concerns, it is likely that certain firms will be referred to the Enforcement Department for a formal investigation. At that stage, Enforcement will probably request additional documents and take on-the-record testimony. If enforcement actions result, it is possible that a second round of sweeps will occur. In the meanwhile, since FINRA is clearly interested in sales practices relating to early retirement investment programs and Section 72(t) withdrawals, firms should consider whether to review their own conduct, regardless of whether they have received the sweep letter. It is likely that FINRA’s interest in this area will continue.