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Sutherland Focus Report #4: FINRA Suitability Sanctions Rise in 2011

March 16, 2012

WASHINGTON (March 16, 2012) – In an annual review conducted by Sutherland Asbill & Brennan LLP, suitability cases led to the fourth largest amount of fines for the regulator in 2011.1 FINRA reported $7.7 million in fines from 106 cases involving alleged suitability violations in 2011.2 Although suitability has consistently landed on Sutherland’s Top Enforcement Issues list (second in 2008 and 2009; fourth in 2010 and 2011), 2011 saw a record number of suitability cases. The 106 suitability cases reported in 2011 doubled the 53 that FINRA announced in 2009 and 2010. This Sutherland FINRA Focus dives deeper into the regulator’s recent enforcement actions and examines a few of the key 2011 suitability cases.

The chart below shows the total number of suitability enforcement actions and fines FINRA has reported during each of the past six years.3

FINRA’S Suitability Statistics, 2006 - 2011 

 

 Fines Reported

 Percentage Change 

 Percentage of Total
FINRA Fines 

 Cases Reported 

 Percentage Change

2006

 $30.1 million

--- 

27% 

42

--- 

2007

 $4.2 million

 (86%)

5%

38

 (10%)

2008

 $4.5 million

 7%

 13%

40

5%

2009

 $11.9 million

 164%

 24%

53

 33%

2010

 $3.75 million

(68%) 

8%

53

0%

2011

 $7.7 million

 105%

 11%

106 

 100%


These statistics reveal that suitability cases routinely make up a significant percentage of FINRA’s enforcement fines each year. In fact, nearly 15% of all FINRA sanctions since 2006 have stemmed from cases involving suitability allegations. The large increase in the number of suitability cases in 2011 may evidence that suitability is also a “hindsight" issue that garners additional attention from regulators in the wake of a substantial market decline.

One firm was fined $2 million in 2011 for allegedly selling unsuitable reverse convertible securities to retail customers.4 Brad Bennett, FINRA’s Chief of Enforcement, noted that deficiencies in the firm’s structured products business enabled “unsuitable recommendations of concentrated positions in risky reverse convertibles – sometimes using funds that the firm helped customers borrow – to proceed without detection or review." FINRA cited a number of transactions that were inconsistent with investors’ objectives and that exposed them to more risk than they desired. Apart from the FINRA settlement, the firm settled with 17 clients, paying them more than $6.9 million.

In another case involving a complex product, a firm was fined $2.5 million for allegedly selling Principal-Protection Notes (PPNs) offered by Lehman Brothers to individuals for whom these investments were allegedly unsuitable.5 FINRA noted that the firm did not have risk profile requirements for some PPNs, which resulted in these notes being improperly sold to certain investors, including those with conservative or moderate risk tolerances. FINRA indicated that this case highlighted that financial advisors must understand the complex securities they sell and that a firm “need[s] to be clear and comprehensive in disclosing risks of the structured products it sells to retail investors." Mr. Bennett further noted that in some instances the firm’s “financial advisors did not even understand the complex products they were selling." FINRA also ordered the firm to pay $8.25 million of restitution to investors.

For allegedly failing to properly supervise the sale of collateralized mortgage obligations (CMOs) to retail customers, FINRA fined a firm $600,000 in 2011.6 The firm’s exception reporting system did not cover CMOs and the firm did not review transactions for potentially unsuitable levels of concentration in CMOs. FINRA claimed that failing to monitor the suitability of these investments led to 26 elderly customers having more than half of their assets at the firm invested in CMOs.

In light of the substantial sanctions FINRA has imposed in suitability cases involving complex securities, firms may wish to review their policies and procedures regarding complex products.7 Representatives may also wish to pay especially close attention to these issues since nearly 30 individuals were barred from the industry by FINRA in 2011 for recommending allegedly unsuitable transactions.  

1 Sutherland has already released a FINRA Focus for the other three 2011 Top Enforcement Issues: advertising, short selling, and Auction Rate Securities. Click here.
2 Many of these cases also involved other allegations making it difficult to attribute the exact amount of any particular fine attributable to an alleged suitability violation.
3 The number of cases reported and the amount of corresponding fines come from the Disciplinary and Other FINRA Actions report that FINRA publishes each month.
4 FINRA Press Release, April 12, 2011, click here.
5 FINRA Press Release, April 11, 2011, click here
6 Acknowledgement, Waiver & Consent, No. 2009018771601, June 1, 2011.
7 See Complex Products, FINRA Regulatory Notice 12-03, Jan. 2012, click here.

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