A March 2017 consent order between the Massachusetts Securities Division and a broker-dealer serves as a useful reminder of sales practices that are best avoided in sales of complex instruments, whether in Massachusetts or any other state. The order focuses in particular on how improper incentives provided to registered representatives can lead to improper or unsuitable sales.
The Broker and Its Products
In the case at issue, a broker based in another state had partnered with local community banks, including several in the state of Massachusetts, to offer bank customers a variety of investment products. The broker occupied space within these community banks to offer products, and would share a portion of its revenues with the relevant banks. Among the products offered were market-linked certificates of deposit, non-traded REITs, non-traded business development companies and variable annuities. All of these products have been scrutinized in the past by FINRA and other regulators due to their potential complexity or potential risks.
Supervisory Procedures and Incentive Sales
The broker maintained supervisory procedures that limited its ability to award sales for particular financial products, that would serve as a "luxury" for the relevant persons or that would reward their spouses or other family members. Under the supervisory procedures, trips and other similar activities were chiefly designed to consist of training for the relevant representatives. Trips and similar activities required approval from the chief compliance officer. The procedures, citing relevant FINRA notices, also stated that the broker would not engage in sales contests that favored any one particular product or type of product over others.
However, in reality, the broker did, in fact, award vacations as a prize to its top ranking financial consultants. The broker also awarded accommodations to a guest of winners at its training sessions in the Caribbean. An official of the brokerdealer suggested to regional directors that they should use an upcoming contest to motivate sales. The broker also awarded baseball tickets, together with dinner and drinks, as a tool to spur additional sales. These prize programs were approved by executive officers of the broker. Needless to say, the consent order suggests that these prizes were believed to have incentivized representatives to sell the relevant products.
Sales to Vulnerable Investors
Financial representatives that received prizes under these programs made sales of a variety of complex instruments, including market-linked certificates of deposit, to elderly investors. In one case, the market-linked CD was purchased with the proceeds of a traditional non-market-linked CD. The Massachusetts secretary of state alleged that an elderly investor did not understand all of the risks of the market-linked CD, including that it would need to be held to maturity to guarantee a return of principal.
Violation of Law and Takeaways
As a result of these circumstances, the state of Massachusetts alleged that the broker did not properly supervise its representatives.
The case is a reminder that written supervisory procedures are only truly useful if followed. Sales incentives can compromise the judgment of registered representatives, and result in inappropriate recommendations. Broker-dealer compliance professionals are encouraged to exercise caution when approving them, and to consider whether and how they might steer investors to unsuitable investments.