Broker-Dealer Settles Reg BI Violations over Share Class Recommendations
Commentary by Jeff Ziesman
A broker-dealer settled FINRA charges for failing to comply with Regulation Best Interest ("Reg BI") and FINRA rules related to mutual fund share class recommendations made to retirement plan customers.
According to the AWC, the broker-dealer recommended higher-cost mutual fund share classes—Class A and Class C shares—to retirement plan customers, even though these customers were eligible for lower-cost Class R shares. The broker-dealer's supervisory system did not ensure that representatives considered whether Class R shares, which had lower ongoing fees, were in the best interest of the customers. As a result, 355 retirement plan customers were directed to share classes that resulted in unnecessary front-end sales charges or higher operating fees, totaling $91,344.52.
FINRA determined that the firm violated Exchange Act Rule 15l-1(a)(1) ("Regulation Best Interest") FINRA Rules 3110 ("Supervision") and 2010 ("Standards of Commercial Honor and Principles of Trade").
To settle the charges, the broker-dealer agreed to (i) a censure, (ii) pay $91,344.52 in restitution to affected customers and (iii) pay a $125,000 fine.
Commentary
Mutual fund share class and fee waiver issues have been plaguing broker-dealers for literally a quarter of a century. In this matter, the alphabet soup exercise of class A v. C v. R shares continues. As FINRA's well-worn mutual fund template has stated, Class A shares typically impose a front-end sales charge and annual fund expenses, including ongoing distribution and service fees, that are usually lower than other share classes. Class C shares, by contrast, typically do not impose a front-end sales charge, but have higher distribution and service fees than Class A shares and may be subject to a contingent deferred sales charge. Finally, Class R shares typically do not impose a front-end sales charge, but have higher operating fees than Class A shares and lower operating fees than Class C shares. These sales charges and fees affect mutual fund investors' returns.
In this matter, FINRA found that the firm's supervisory system was deficient because it did not prescribe specific steps to take in a situation where a customer did not qualify for a Class A sales charge waiver. In such a situation, according to FINRA, the firm's procedures were deficient because they failed to describe the steps the firm should take to evaluate whether recommendations to purchase Class A shares or Class C shares were in the client's best interest, rather than Class R shares. Per the AWC, because of this deficiency the firm did not assess whether it would have been better for certain retirement plan customers to purchase Class R shares, and the firm did not provide supervisors with guidance or information necessary to make this assessment.
FINRA charged the firm with Regulation BI violations. Prior to the compliance date for Regulation BI, this would have been charged as simply a suitability and supervision matter. Mutual fund share class issues continue to challenge the broker-dealer industry for at least the following reasons: (1) prospectuses and/or SAI's do not always provide clear, unambiguous language on this topic; (2) charges, fees and breakpoints can change over time; and (3) there can conceivably be certain situations in which it is not clear whether one share class is superior over the other. Nevertheless, so long as different share classes exist, these types of challenges for broker-dealers will exist.