On January 28, 2019, FINRA issued Regulatory Notice 19-04 (the “Notice”), announcing the launch of its 529 Plan Share Class Initiative (the “Initiative”). The Initiative intends to encourage member firms to examine their current supervisory systems for 529 plans, identify and remedy any defects, and compensate investors who have been harmed [see alert dated January 30, 2019].
On February 27, FINRA released a video interview with its Executive Vice President of Enforcement, Susan Schroeder, to address the most common questions FINRA has received regarding the Initiative. In addition to the information summarized below, Ms. Schroeder also announced that FINRA is considering extending the current deadline to self-report (April 1, 2019) in light of the high volume of questions it has received.
Q: Is FINRA asking firms to review all of their 529 plan sales and identify unsuitable transactions before self-reporting?
A: No. FINRA is asking firms to conduct a qualitative assessment of supervisory systems rather than a quantitative analysis. Then, if a firm identifies supervisory problems, FINRA wants to have a conversation about fixing the problem and identifying affected customers.
Q: Should all firms conduct this assessment?
A: The Initiative is completely voluntary. If a firm does not engage in the Initiative, and FINRA later conducts an investigation that identifies supervisory problems with respect to 529 plans, there will not be a penalty for failing to self-report through the Initiative. Instead, the matter will be handled as a normal enforcement action, and any potential fines would be the same as those that would have occurred without the Initiative.
*This answer clarifies a statement in Notice 19-04 that violations later identified by FINRA “likely will result in the recommendation of sanctions beyond those described under the initiative.”
Q: Does FINRA take the position that certain 529 share classes are per se unsuitable? For example, are class C shares inappropriate for 529 plans because they are a long-term investment?
A: No. FINRA recognizes that investment recommendations within a 529 plan are individually tailored, and there is no share class that is per se unsuitable.
Q: Is FINRA establishing a new rule regarding suitability of 529 share plan classes?
A: No. The rules in play are the same; there are longstanding obligations for financial advisors to recommend suitable share classes and for firms to supervise those transactions.
Q: What if a firm identifies a potential supervisory issue but determines there was no customer harm. Should the firm self-report?
A: Yes, because the firm can then have a conversation with FINRA about how to address the problem. While firms might be concerned that self-reporting will lead to an enforcement action, that is not necessarily the case. If there are no impacted customers, no action may be necessary.
Q: FINRA examiners previously reviewed a firm’s supervision of 529 plans and did not recommend any action. Should the firm self-report? A: It is up to the firm. As a result of the examination, the firm might feel comfortable with their supervisory practices. However, if the examination only focused on one area or if changes have been made since the examination, the firm still may wish to self-report.
Q: The Initiative asks firms to provide information regarding the time period January 2013 – June 2018. When calculating customer harm, should firms use this same period?
A: FINRA chose the time period to reach a fair result for customers without asking firms to take on an onerous review. Firms first need to review supervision, and if it is unreasonable, then FINRA will talk to the firm about the best way to identify affected customers and calculate harm. The focus will be on customers during the relevant time period who paid more in fees than they would have with a different share class.
Q: If firms identify concerns that relate to 529 plans, but are unrelated to share class recommendations, should they report these concerns? A: The Initiative is focused on share class recommendations. If a firm identifies another issue during the course of its review, it should assess whether it has a reporting obligation under Rule 4530 or whether it wishes to self-report in order to cooperate with FINRA.
Q: Does FINRA believe that the option that is least expensive for the customer is always correct? If a firm is conducting a self-review, should it evaluate factors beyond cost to customer?
A: FINRA recognizes that transactions in 529 plans are complex and individualized. FINRA is asking firms to review their supervisory practices.
Q: Will FINRA run an analysis on firms that recommend single state programs for out-of-state investors? A: The focus of the Initiative is on share-class recommendations. FINRA is not asking for a broad review of all securities a firm offers.
Q: How does FINRA suggest firms treat the calculation of potential restitution to customers enrolled in automatic investment plans and customers who make subsequent deposits directly to the fund company? A: If automatic investments or direct deposits are pursuant to a broker recommendation, the firm should include those amounts in a restitution calculation.
Q: If a customer changes the broker-dealer of record to the member firm after the initial investment has been made, does FINRA believe the new member firm still has to offer restitution?
A: No, the obligation to offer restitution arises from supervision of a firm’s own recommendation. If the firm did not make the recommendation, it would not be fair for them to pay restitution.
Q: Is there a de minimis amount of client restitution that a firm can address without joining the Initiative?
A: The firm does not have to “join” the Initiative. It is helpful to self-report and have a conversation with FINRA no matter how small the impact on customers. It is not automatic that every self-report will result in an enforcement action, and the amount of customer harm is something that will be considered when determining whether there will be an enforcement action.