On May 6, 2015, LPL Financial LLC (“LPL”) submitted a Letter of Acceptance, Waiver and Consent (“AWC”) to the Financial Industry Regulatory Authority’s (“FINRA”) Department of Enforcement to settle allegations that LPL violated FINRA supervisory rules. The AWC was submitted “without admitting or denying the findings,” and on the condition that, if accepted, “FINRA will not bring any future actions against LPL alleging violations based on the same factual findings.”
LPL has been a FINRA member firm since 1973, is headquartered in Boston, MA and has approximately 18,343 registered representatives operating from approximately 10,702 registered branch office locations and 18,396 non-registered office locations. LPL is the largest organization of independent financial advisors in the United States based on total revenue. In 2007, LPL Financial Holdings, Inc., LPL’s parent company, expanded LPL’s broker-dealer business by acquiring other financial services firms and recruiting registered representatives from other broker-dealers. From 2007 to 2013, the number of registered representatives at LPL more than doubled from 8,322 to 17,601 and LPL’s revenue increased from $2.28 billion to $4.05 billion. According to FINRA, while LPL’s business grew, LPL failed to similarly increase its supervisory resources, resulting in inadequate supervisory systems and procedures.
Specifically, according to FINRA, LPL failed to properly supervise its representative’s sale of non-traditional exchange traded funds (“non-traditional ETFs”), variable annuities, mutual funds, and illiquid or non-exchange-traded real estate investment trusts (“non-traded REITs”). Non-traditional ETFs are a class of complex products that include leveraged, inverse and inverse-leveraged ETFs, which seek to earn a multiple of the performance of the underlying index or benchmark or earn a return inverse to the return of the benchmark’s performance, or both. Generally, non-traditional ETFs utilize swaps, futures contracts, and other derivatives instruments to achieve these objectives. According to FINRA, LPL failed to review the length of time for which these securities were held by customers, despite written supervisory procedures which require monitoring non-traditional ETFs on a daily basis. This is especially important because many of these products “reset” daily and over time, that resetting function can cause the specific non-traditional ETF’s performance to deviate significantly from the index it tracks. Additionally, the short positions taken by inverse ETFs contain more risk than a corresponding long position because the potential for loss in a short position is limitless. FINRA further alleged that LPL failed to enforce its written supervisory procedures with respect to account allocation limits for non-traditional ETFs, and failed to ensure that its registered representatives were adequately trained to sell non-traditional ETFs. FINRA alleged that LPL violated National Association of Securities Dealers (“NASD”) Rule 3010(b) and FINRA Rule 2010, which state that “[a] member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”
In addition FINRA alleged that LPL failed to “reasonably supervise the sales of variable annuities contracts funded by the sale of other annuity contracts or mutual funds.” This failure was demonstrated by the brokers’ inaccurate and incomplete use of LPL’s Annuity Order Entry (“AOE”) system, which was an automated system designed to determine whether customers would incur fees or sacrifice pecuniary benefits when they surrendered their annuities and mutual funds to pay for the variable annuity contracts. FINRA alleges that LPL’s registered representative’s failure to properly employ the AOE system and LPL’s failure to reasonably supervise the sales of variable annuities contracts lead to violation for NASD Rule 3010(b) and FINRA Rule 2010, as well as FINRA Rule 2330(c), which requires further supervision related to the sale of annuity contracts.
Additionally, FINRA alleged that from January 2007 through August 2014, LPL failed to properly supervise and properly disclose the fees associated with mutual fund switching or the sale of Class C Mutual Funds shares by setting its internal suitability threshold triggering review of the transaction too high to be effective. LPL also failed to properly supervise the sale of non-traded REITs and apply volume sales charge discounts. According to FINRA, LPL “did not have adequate procedures in place to identify accounts that would be eligible for volume price discounts.” Further, FINRA alleged that LPL “failed to review low priced equity trades, concentrated positions, actively traded accounts and potential employee front running,” failed to “complete all supervisory tasks in a timely manner,” and failed to adequately review its trade blotter.
Furthermore, FINRA alleged that LPL failed to accurately report trades to the Options Clearing Corporation using the Large Options Positions Reports as mandated by FINRA Rule 2360(b)(5). FINRA also found that LPL failed to accurately report its “correct capacity” to the Real-time Transition Reporting System (“RTRS”) and to the Trade Reporting and Compliance Engine (“TRACE”). The AWC alleges that LPL’s written supervisory procedures did not provide for: 1) identification of persons responsible for supervision of this reporting; 2) supervisory steps to be taken by the person identified; 3) when such supervisory steps were to be undertaken; and 4) how such supervisory steps were to be documented.
FINRA alleged that LPL also failed to deliver confirmations to high net worth customers consisting of various exchange-traded portfolios and mutual funds. According to FINRA, LPL failed to deliver confirmations under a misguided view that it was exempt from complying with the Rule 10b-10(a) delivery requirements as set forth in a series Securities and Exchange Commission (“SEC”) no-action letters. However, LPL was not entitled to that exemption because it never applied for one under the Exchange Act Rule 10b-10(f) and failed to fully comply with the SEC’s industry-wide conditions tor such relief. These confirmation delivery failures affected 47,634 accounts and over 13 million transactions.
According to the AWC, FINRA found that LPL failed to reasonably supervise its advertising and communications with its customers with respect to its production and delivery of consolidated reports. A consolidated report combines information concerning most or all of the customer’s financial holdings regardless of where those assets are held. Consolidated reports are communications with the public that must not be misleading or omit material information. However, since at least 2009, LPL permitted its registered representatives to use third party services to produce these reports and in some cases, allowed its registered representatives to make the reports without any supervision. Further, LPL failed to reasonably supervise radio show broadcasts by two employees, review other advertising materials, review written corresponded in a timely manner, and supervise certain non-solicitation letters. Lastly, LPL failed to comply with Rule 204 of Regulation SHO, which requires a firm that has a fail-to-deliver position at a registered clearing agency in any equity security for a long or short sale transaction in that equity security to close out its fail-to-deliver position by borrowing or purchasing securities of like kind or quality.
As a result of the AWC, LPL consented to 1) censure; 2) a $10 million fine; 3) submit a written plan to review and improve supervision; 4) commission a report and certification regarding its supervision of non-traditional ETFs; 5) pay restitution in connection with LPL’s sale of non-traditional ETFs’ and 6) review and remediate its surveillance systems.
If you have invested with LPL and have any questions about your broker-dealers duty to supervise its registered representatives or believe that your broker may have engaged in other misconduct in your account, please contact Lax & Neville today at (212) 696-1999 to schedule a consultation.