Welcome to Financial Advisor IQ


Why Finra Has Zeroed in on College Savings Plans

By Crucial Clips     May 22, 2019
The following text is a transcript of a portion of a speaker's presentation made at an industry conference or during an interview. This transcript solely represents the view of the individual who spoke, and not the view of Financial Advisor IQ or any other group.
Source: FINRA 2019 Annual Conference, May. 15, 2019 

RITA RAAGAS DE RAMOS, SPECIAL PROJECTS MANAGER, FA-IQ: Hi, I’m Rita Raagas De Ramos from Financial Advisor IQ and with me is Christopher Kelly, senior vice president of sales practice enforcement at Finra.

Chris, Finra introduced in January of this year a 529 plan shared class initiative, which is Finra’s first self-reporting initiative. These 529 plans which parents use to save ahead for their children’s college education are essentially tax-advantaged municipal securities. Why did Finra decide to shine a spotlight on this kind of violation?

CHRISTOPHER KELLY, SENIOR VICE PRESIDENT OF SALES PRACTICE ENFORCEMENT, FINRA: For us, it’s really about investor protection. We have a dedicated team of examiners who are out in the field every day examining firms and brokers. And in the course of numerous exams, Finra staff found that some brokers were recommending 529 plan share classes without considering the different cost impacts of different types of share classes, which could result in customers paying thousands of dollars of unnecessary fees.

It’s actually something that’s been on Finra’s radar for quite a while. Every year we put out an exam priorities letter that gives firms an idea of what our areas of concerns are and what areas we’re going to be looking at. And back in January of 2016, we actually highlighted 529 plan sales and the supervision of those sales as an area of concern for Finra.

RITA RAAGAS DE RAMOS: When Finra thought of this initiative, what were you seeing in terms of violations? What were the most common ones?

CHRISTOPHER KELLY: So, brokers have a duty when they make a recommendation to have a reasonable basis to believe that that recommendation is suitable. And part of that reasonable basis means that the broker has to understand the product they’re recommending. And that’s particularly important with respect to 529 plans when, depending on the share classes recommended, could have a substantial impact on the fees that the customer pays.

Just to give you an example, if you have a long-term time horizon, so you’re buying a 529 plan for your three-year-old’s future college expenses, so you anticipate you’re going to hold those shares for about 15 years. You’re probably going to be better off in a Class A share because, over time, Class A shares have lower annual expenses than Class C shares. There’s no hard-and-fast rule, but that is generally a rule of thumb.

What we saw is that some brokers were not considering those different share classes and the different costs in making recommendations. For example, some brokers were only recommending one type of share class for another, without consideration of the different features and costs of each.

RITA RAAGAS DE RAMOS: Since the initiative started until the end of the self-reporting period in April, what findings did you unearth? Did you discover any new findings that you didn’t see before?

CHRISTOPHER KELLY: So it’s a little too early to tell exactly what the findings will be. The initial deadline for firms to indicate whether they wanted to participate in the initiative was April 30th. May 31st is the next date at which time firms have to provide more detailed information about their 529 business, how they supervise 529 plan sales, and whether they think there may have been any customer harm. So we’ll know a lot more after May 31st.

I will tell you anecdotally from our conversation with firms, firm supervision of this area really varies. We’ve seen some firms that do a pretty good job. They have policies and procedures that discuss the different features of the different share classes. They train representatives and their supervisors on these different features, and they supervise specific 529 plan recommendations.

On the other hand, we’ve seen firms that do millions or even billions of dollars of 529 plan sales without any significant supervision of those recommendations at all.

RITA RAAGAS DE RAMOS: What kind of response did you receive? Can you talk a little bit about how many of them actually self-reported?

CHRISTOPHER KELLY: The response has really been fantastic. As you said, this is our first self-reporting initiative so it’s been a learning experience for us, too, and I’m sure there’s some things we’ll take back, but the response from the firms has been positive and overall I’d say we got more firms opting in than we initially anticipated.

RITA RAAGAS DE RAMOS: What are we going to expect in terms of remediation? Are we going to see a significant amount of money going back to harmed investors?

CHRISTOPHER KELLY: A prerequisite to any firm participating in the initiative is that they agree to identify potential customer harm and, if they find any, to remediate those customers. So I do anticipate that we will have a number of firms that provide remediation to harmed customers. It’s a little too early to tell how many firms or what the total amount will be, but I do think it’ll be a significant amount.

RITA RAAGAS DE RAMOS: What’s going to happen now to all the violators who didn’t self-report?

CHRISTOPHER KELLY: So, this is a voluntary initiative, which means there’s no penalty for not self-reporting. That doesn’t mean there may not be a consequence, so if in the ordinary course our Finra examination team finds a 529 plan violation, they will investigate that and potentially refer it for formal action, in which case the firm will not be able to have the automatic fine waiver that’s available through the initiative. So they may be fined. We won’t increase the fine because the firm decided not to participate, but they won’t get the automatic fine waiver for not participating.

RITA RAAGAS DE RAMOS: Lastly, can we expect more self-reporting initiatives from Finra like this?

CHRISTOPHER KELLY: It’s a great question. At this point, I think we’re focused on making sure that our first one is successful. And it’s not something we’ve thought about doing in the future. I think if we did decide to do another self-reporting initiative, it would be in a similar circumstance, where there is a potential widespread issue across the industry that results in customer harm, with the idea that a self-reporting initiative is a way that we can get money back to harmed customers as quickly and efficiently as possible.

RITA RAAGAS DE RAMOS: Thank you, Chris.