FINRA has published a list of frequently asked questions advisers and other industry stakeholders have put forward about the self-regulatory organization’s newly launched 529 Plan Share Class Initiative.
The FAQ document has been published in response to questions FINRA has received after it announced in January (via Regulatory Notice 19-04) that it was kicking off a sweeping “529 Plan Share Class Initiative,” encouraging advisers to self-report client duty of care violations in the selection of investments in tax-advantaged college savings accounts. FINRA’s self-reporting program has a stated goal that is similar to the recently closed program run by the Securities and Exchange Commission (SEC), which encouraged advisers to self-report potential 12b-1 fee disclosure violations.
FINRA launched the 529 violation initiative after repeatedly finding evidence during examinations showing some firms have failed to reasonably supervise brokers’ recommendations of multi-share class products, especially within 529 college savings plans.
As described in the regulatory notice, FINRA’s goal is to encourage voluntary reporting under this initiative, and as such, FINRA’s Department of Enforcement will recommend that FINRA accept favorable settlement terms for firms that self-report potential violations and provide FINRA with a detailed remediation plan. Important for brokers and advisers to note, participating firms must provide FINRA enforcement staff a notice of their self-report by April 30, 2019, and then the firm must confirm their eligibility by submitting the additional information specified in Regulatory Notice 19-04 by May 31, 2019.
The most common areas where FINRA has found violations include failures to keep records of 529 plan transactions, making it impossible for firms to review 529 plan client transactions for suitability; failures to capture information relevant to the suitability determination, including the age of the beneficiary and the number of years until the funds are needed to pay for the beneficiary’s qualified education expenses; failure to have a process or procedures in place to review 529 transactions for suitability; and failures to provide training or guidance to registered representatives regarding 529 share classes and the suitability factors to consider, such as beneficiary age.
Given the complexity and sensitivity of this subject, the FAQ list, which is lengthy and detailed, should be reviewed closely by brokers and advisers contemplating participating in this program.
Key Answers from FINRA
One important distinction explained in the FAQ document is that FINRA is not asking firms to review all of their 529 plan sales and to identify individual unsuitable transactions. Rather, firms that choose to participate in the initiative “should review how they have supervised sales of 529 plan shares since January 2013.” FINRA says firms should assess for such matters as whether their procedures require that appropriate supervisory personnel review share class suitability and obtain the information necessary to do so; whether they actually conducted reviews for share class suitability; and whether the firm provided training to its registered representatives so that they could make suitable recommendations.
“If a firm reviews its supervisory systems and procedures and concludes that they were reasonably designed and implemented, that is the end of the assessment,” FINRA says. “There is nothing more to do. A firm might choose to test some transactions according to risk-based criteria as part of its review concerning the reasonableness of its supervision, but that is not required. FINRA is encouraging firms to undertake a qualitative review, not a quantitative analysis.”
If, however, a firm discovers that there was a weakness in its systems, procedures or training, so that the firm concludes that it may not have had a supervisory system reasonably designed to achieve compliance with its suitability obligations, then the firm should self-report to take advantage of the initiative. FINRA will then discuss with the firm how the firm has responded or plans to respond to the issue, including different ways to assess impacts on customers.
“Assessing customer impact is likely to require firms to review transactions,” the FAQ document explains, “but FINRA would work with firms to identify an appropriate, risk-based way to analyze transactions.”
According to FINRA, should a firm choose not to participate in this program and then later FINRA finds a violation at the firm, the firm would not be eligible for an automatic fine waiver. However, FINRA will not increase the sanctions that it otherwise would have imposed solely because the firm did not participate in the initiative.
FINRA says the main benefit of participating in the program will be that firms can avoid fines that FINRA might otherwise impose in an enforcement action concerning the firm’s failure to supervise the suitability of 529 plan share class recommendations. FINRA says it will be open to issuing “cautionary actions” in cases where advisers or brokers made only minimal or insignificant unwitting violations, and it’s also possible that FINRA could close referred matters with no formal action.
Another area explored in the FAQ document has to do with cases where a firm identifies a potential supervisory deficiency related to its sale of 529 plan shares but determines that there was no resulting customer harm; should the firm still self-report? In this case, FINRA encourages the firm to participate in the initiative.
“After self-reporting, the firm can discuss with FINRA how it has changed its supervisory system to address the problem, and FINRA may be able to provide the firm with additional guidance or observations to help the firm achieve compliance,” the FAQ document says. “While that is a clear benefit of self-reporting, some firms may be concerned that the self-report would also trigger a formal enforcement action. But not all self-reports will necessarily result in formal disciplinary action.”
The FAQ document closes with a few procedural questions. One points to the fact that Regulatory Notice 19-04 advises firms to provide certain information regarding their 529 plan share class supervision for the period January 2013 through June 2018. When calculating customer harm, should firms use that same period?
“As a first step, firms choosing to participate in the initiative need only determine whether there was a potential supervisory violation; they need not calculate customer harm,” the FAQ document says. “After the self-reporting due date of April 30, FINRA will confer with self-reporting firms on an acceptable methodology and period for calculating restitution. Our focus will be on the firm’s customers who paid more in fees than they would have if they purchased a different share class during that relevant time period.”
FINRA adds that firms that cannot complete their supervisory review before the new April 30 deadline may request an extension by emailing 529Initiative@finra.org. Firms may also request an extension of time to provide FINRA the additional information due by May 31, 2019.