NEXT Financial Group has agreed to pay $225,000 to settle Financial Industry Regulatory Authority charges it violated municipal security supervisory rules in ways that caused the firm to fail to detect avoidable losses for its customers.
Houston-based NEXT agreed this week to pay that fine, as well as $500,000 more for alleged violations of FINRA and National Association of Securities Dealers rules, without either admitting or denying FINRA’s findings that the firm’s supervisory system was not reasonably designed to detect and prevent short-term trading of municipal bonds or over-concentration of these bonds in customer accounts.
“From January 2012 through February 2019, NEXT’s supervisory system was not reasonably designed or enforced to detect and prevent short-term trading of municipal bonds or over-concentration of these bonds in customer accounts,” FINRA examiners found.
The conduct FINRA described in the settlement stems from “Broker A” employing short-term trading strategies in Class A mutual fund shares and municipal bonds. Broker A engaged in short-term trading of Puerto Rico bonds in 16 customer accounts and concentrated five customer accounts in Puerto Rico bonds.
Both Class A shares and munis are typically long-term investments due to the up-front costs associated with acquiring them, including a dealer markup.
The report says “Broker A” was barred by FINRA after refusing to testify in 2020. Charles Doraine, a former NEXT broker,
“A recommendation that an investor engage in short-term trading of municipal bonds may be unsuitable due to these costs,” FINRA said.
Dealers are bound by MSRB Rules G-17 on fair dealing and G-19 on suitability require, respectively, that dealers deal fairly with all market participants and that a broker recommending any municipal security transaction have reasonable grounds for believing that the recommendation is suitable for that customer.
MSRB Rule G-27 on supervision requires, among other things, that dealers establish and maintain a supervisory system that is “reasonably designed to achieve compliance with applicable securities laws and regulations and MSRB Rules.” The rule further requires each municipal dealer to adopt, maintain, and enforce written supervisory procedures that are “reasonably designed to ensure that the conduct of municipal securities activities complies with MSRB Rules and the Exchange Act.”
FINRA found that the firm’s written supervisory procedures (WSPs) “did not discuss suitability reviews specific to municipal bonds, address or provide any guidance regarding holding periods for municipal bonds, or address factors to be considered in determining appropriate levels of concentration. The WSPs also did not have any other additional suitability guidance that would be applicable and assist supervisors in analyzing the suitability of municipal bonds. The firm failed to reasonably detect and respond to red flags in Broker A’s trading.”
When another employee did raise concerns about the conduct in late 2016, FINRA found, “he gave misleading explanations to justify the activity and no further review of the transactions was conducted. The firm’s failure to conduct a further review to verify Broker A’s explanations was not reasonable given the inconsistency of those explanations with the multitude of red flags in the customers’ account information and in the firm’s blotter.”
In addition to the fines, the firm agreed to be censured and to submit to FINRA within 120 days a certification that the firm has implemented supervisory systems and written supervisory procedures reasonably designed to address unsuitable short-term trading of mutual funds and municipal bonds in customer accounts and over-concentration of customer accounts in Puerto Rican municipal bonds.
An attorney who signed the settlement on behalf of NEXT did not respond to a request for comment.
