FINRA self-reporting 529 plan program yields $2.7 million in customer restitution

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The Financial Industry Regulatory Authority's voluntary reporting 529 plan initiative has resulted in some $2.7 million of restitution to customers, the bulk of that from two firms.

Morgan Stanley and B. Riley Wealth Management agreed to pay a combined more than $1.9 million in restitution and be censured while neither admitting or denying FINRA’s findings that they violated Municipal Securities Rulemaking Board Rule G-27 on supervision. Neither firm was fined.

FINRA announced those settlements and some less serious cautionary actions as an initial report on the progress of its 529 Plan Share Class Initiative. Launched in January 2019, the program aimed to encourage broker-dealers to review their supervisory systems and procedures governing 529 plan share-class recommendations, self-report supervisory violations and provide FINRA with a plan to remediate harmed customers. In turn, FINRA enforcement said it would recommend a settlement with no fine.

But if a firm doesn’t self-report and FINRA later finds supervisory failures by that firm, it will result in enforcement recommending sanctions.

The initiative has so far resulted in settlements with the two firms and 17 matters resolved via cautionary action letter, FINRA said.

The purpose of the 529 initiative is to remedy potential supervisory and suitability violations and return money to harmed investors as quickly as possible, said Jessica Hopper, executive vice president and head of FINRA’s Department of Enforcement.

“We are very pleased with the substantial progress made thus far, are encouraged by the level of cooperation of member firms that self-reported, and expect to resolve the remaining matters in the coming year,” said Jessica Hopper, executive vice president and head of FINRA’s Department of Enforcement.

529 plans are tax-advantaged municipal securities regulated by the MSRB that are designed to encourage saving for the future educational expenses of a named beneficiary. The plans are sponsored by states, state agencies, or educational institutions. States offer them either directly, through designated broker-dealers, or both.

When FINRA’s program first started, broker-dealer groups worried it would be similar to a Municipalities Continuing Disclosure Cooperation Initiative created by the Securities and Exchange Commission in 2014. Bond Dealers of America urged firms to self-report back when FINRA's 529 plan initiative was first announced.

MCDC promised underwriters and issuers that they would receive lenient settlement terms if they self-reported instances involving materially inaccurate statements related to continuing disclosure obligations in Rule 15c2-12.

It led to SEC settlements with 72 underwriters representing 96% of the underwriting market as well as 72 issuers.

From January 1, 2013 through June 30, 2018, FINRA found, Morgan Stanley failed to establish and maintain a supervisory system reasonably designed to supervise recommendations to customers to buy certain share classes of 529 savings plans.

Specifically, Morgan Stanley didn’t have a supervisory system reasonably designed to supervise 529 share-class recommendations in certain Smith Barney accounts — part of Citigroup Global Markets which merged with Morgan Stanley’s Global Wealth Management Group in 2009. The firm also didn’t have a supervisory system reasonably designed to supervise 529 plan share-class recommendations in transactions made directly with plans.

Shares of 529 plans are sold in different classes with different fee structures. Applying the fee structure of one 529 plan commonly sold by Morgan Stanley during the relevant period would mean a customer who initially invested $10,000 in Class C shares and held those shares for 18 years would pay about $1,300 more in fees and expenses than if the customer had investment the same amount in Class A shares, FINRA found.

“Moreover, the customer’s 529 plan account for this period would be worth approximately $1,500 less than an account that instead was invested in Class A shares,” FINRA said.

Gaps in Morgan Stanley’s supervisory system caused over $180 million of 529 plan Class C share purchases that were not subjected to the firm’s guidelines, FINRA found.

Morgan Stanley will pay $1.7 million in restitution and interest.

“We are pleased to have resolved this matter,” a Morgan Stanley spokesperson said.

B. Riley Wealth Management also settled with FINRA Wednesday, agreeing to pay $250,000 in restitution and interest to 529 plan customers. During the same time period as Morgan Stanley, BRWM also didn’t establish and maintain a supervisory system reasonably designed to supervise representatives’ recommendations to customers to buy certain classes of 529 savings plans.

Specifically, BRWM’s supervisory system was not reasonably designed since it didn’t give adequate guidance to representatives regarding the importance of considering share-class differences when making recommendations, provide supervisors with adequate guidance on how to evaluate the suitability of 529 share-class recommendations, establish controls designed to ensure consistent supervisory review with the opening of an account or supervise those recommendations executed through transactions made directly with plan fund companies.

During the five years, BRWM was a designated broker-dealer for 25 state-sponsored 529 plans. During that time, about $32.9 million in BRWM customer assets were held in 529 plan accounts.

A BRWM spokesperson said upholding trust and confidence to its clients remains its upmost priority and that the firm is committed to continued transparency.

“B. Riley has continued to enhance its supervisory procedures, as well as training, guidance and policies for its registered representatives since acquiring BRWM’s legacy firm in 2017," the spokesperson said. "As noted by FINRA, BRWM voluntarily self-reported its findings, immediately took corrective actions and proposed a plan to efficiently remediate the small number of potentially affected accounts."

Correction
B. Riley Wealth Management agreed to pay $250,000 in restitution and interest. That amount was not included in the original version of the story.
December 30, 2020 1:49 PM EST
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FINRA Enforcement Financial regulations Broker dealers Washington DC 529 plans
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