Broker-Dealer Settles SEC Charges for Unsuitable Recommendations
Commentary by Nick Allen
A broker-dealer settled SEC charges related to unsuitable recommendations, material misstatements, and misrepresentations to retail customers involving highly complex variable interest rate structured products ("VRSPs"). A former managing director of the firm was also charged amid an ongoing investigation.
In separate orders (see here and here), the SEC determined that the broker-dealer and multiple registered representatives recommended investments in VRSPs to certain customers who - based on factors such as their financial needs, investment objectives and experience, risk tolerance and liquidity needs - were not suited to invest in such highly complex products given the products' risks. Additionally, the SEC found that - despite implementing policies that prohibited recommending VRSPs to customers that did not fit the pre-determined risk and financial profile - several registered representatives still recommended the investments to customers, including falsely guaranteeing principal protection.
The products were described as being similar to "bank bonds" despite (i) not providing periodic fixed-interest payments, (ii) having interest contingent on formulas tied to differences in the constant maturity swap rate yield curve and/or other reference assets (such as equity indices), and (iii) not guaranteeing a return of principal at maturity.
The broker-dealer was also found to have failed to develop reasonable systems to implement its structured products procedures and policies to prevent federal securities laws violations, specifically Securities Act Section 17(a) ("Fraudulent interstate transactions"), Exchange Act Section 10(b) ("Regulation of the Use of manipulative and deceptive devices"), and SEA Rule 10b-5 ("Employment of manipulative and deceptive devices"). The SEC said the broker-dealer failed to maintain current records indicating that it tailored investment recommendations based on an evaluation of each customer's account and that the customer's profile was assessed each time a recommendation was made.
As a result, the agency determined the broker-dealer and registered representative violated Sections 17(a)(2) and 17(a)(3) of the Securities Act. The broker-dealer was also found to have violated Exchange Act Section 17(a)(1) ("Records and reports") and SEA Rules 17a-3(a)(17)(i)(B)(1) and 17a-3(a)(17)(i)(B)(3) ("Records to be made by certain exchange members, brokers and dealers").
To settle the charges, the broker-dealer agreed to (i) a censure, (ii) a cease-and-desist, and (iii) disgorgement plus prejudgment interest of $220,865 and a civil monetary penalty of $2,300,000. The registered representative agreed to (i) a cease-and-desist, (ii) 12-month associational and penny stock suspensions, (iii) a 12-month investment company prohibition, and (iv) disgorgement plus prejudgment interest of $29,973 and a civil monetary penalty of $25,000.
In the complaint filed against a former managing director of the firm, the SEC alleged that the director engaged in unauthorized trading in addition to disregarding the fiduciary obligation to customers by making unsuitable investment recommendations. The SEC alleged that the managing director violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and SEA Rule 10b-5.
In a statement, SEC Commissioner Hester M. Peirce expressed concern that the SEC's "acknowledgment of, and reliance on, the remedial step taken here by Aegis may be read either as implying that an absolute prohibition on the sale of a specific product is the only acceptable remedial measure here or as an expectation for other firms dealing with retail clients."
Commentary
FINRA has repeatedly reminded members of their obligations with respect to complex products, such as the VRSPs. A consistent theme of those notices is that such products typically require more scrutiny and supervision, both during the vetting process of new products and in the recommendation of any such products. Failure to adopt and/or adhere to those policies and make appropriate recommendations can lead to a range of violations, particularly when the risks of a complex product are either misunderstood or misrepresented.