Q:
My firm encouraged — in a documentable way — the conversion of A-share mutual funds into a new class that could be held in wrap accounts (and be charged the wrap fee). It is now asking for written reasons from advisors as to why certain low-activity clients are in wrap accounts. Are we, as brokers, responsible for this state of affairs?
A:
The simple answer to your question is yes, the brokers are responsible. NASD and NYSE rules clearly require both the registered rep and the member firm to review all investment recommendations for suitability. Both have equal responsibility to ensure recommended investments are suitable for their clients.
I'm guessing from your question that your firm has either changed managers or now must respond to a request from a regulatory authority to explain this activity. Increasingly, regulators are examining mutual fund accounts and wrap accounts to determine customer suitability. You must respond completely and truthfully to your firm's request for the reasons underlying placement of certain clients in wrap accounts.
Any attempt to “understate” the facts is to invite disaster. Feel free to describe the sales meetings, account lists and emails that your firm sent to you at the time of the investments. You can also detail the role firm managers played in making presentations, sending correspondence or approving transactions.
A definitive answer to your liability questions depends upon the individual customer and investment activity. If a claimant's lawyer believes the investments were unsuitable or customer overcharged, the customer will likely commence arbitration. However, you will have the opportunity to defend these claims. It is a big “if” whether the customer would be successful.
Respond fully to your firm's information requests, and then prepare to defend customer claims although the arbitrations may never come.
Ernest E. Badway
Saiber Schlesinger Satz & Goldstein
Newark, N.J.
973-622-3333
[email protected]
A:
It sounds like the firm pressured you to improve its bottom line by doing something contrary to your clients' interests, and now it wants to make it look like it was your idea.
You should respond by telling the firm, in writing, you did as the firm instructed. You relied on its recommendations being in your clients' best interest (if that was your belief), and if it no longer believes its recommendations were in your clients' best interest, it should restore your clients' accounts to the condition they'd be in today, if the recommendations hadn't been followed.
That said, both you and your firm may be liable. Laws exist to encourage socially desirable conduct and discourage undesirable conduct. Letting people who engage in undesirable conduct off the hook runs contrary to that purpose.
Some states' labor laws may require the firm to reimburse you for any liability you incur by doing your job. Some representatives have pursued damage claims against their firms, when the firms' recommendations damaged the representatives' books of business.
Scot Bernstein
Law Offices of Scot Bernstein
Sacramento, Calif.
800-916-3500
[email protected]
Q:
Do you feel it is irresponsible for a financial planner to take a qualified account, such as 401(k), and roll it into a qualified annuity, when employment is severed? Most new annuities guarantee principal, of course with a cost, and there are a larger number of financial planners selling qualified annuities, and, for that matter, nonqualified annuities, to young clients.
A:
Short answer: Yes, it's irresponsible. In rare cases, exceptions may exist.
Let's reexamine the cost structure of an annuity. The annuity adds a “wrapper” on mutual funds. This wrapper can cost 1 percent to 1.5 percent above the mutual fund fees (subaccount fees). Using a 1 percent cost on $100,000 at 8 percent over 15 years, the additional cost will be approximately $42,000. Did you advise the client of the commission and surrender period? Failure to advise of the commission is fraudulent.
Now let's reexamine some of the NASD guidance on annuity sales. First, NTM 99-35 notes three reasons for sales of annuities: Tax-deferred growth, guaranteed payments and life insurance. There is no financial advantage placing a tax-deferred product in a tax-deferred account. It would be akin to opening an umbrella in the house.
Second, can a bond portfolio more efficiently produce the same guaranteed payment stream? If so, there is no need for the additional expense of the annuity.
Third, does the client need life insurance? The sales pitch for the annuity may be to “guarantee principal.” But for whom? The life insurance component does not help your client (it benefits the client's heirs). Who is your client and what does he need (a fundamental know-your-client question)?
Gail Boliver
Boliver Law Firm
Marshalltown, Iowa
641-752-7757
[email protected]
A:
The last two words of your question provides the answer: “young clients.”
Given that a client cannot unwind an annuity without fee until the age of 59.5, this fact pattern is easily resolved in favor of not recommending that the client incur additional fees for the death benefit that the client may be able to duplicate elsewhere via a term insurance policy at less cost. Annuities are very hot potatoes, regulatorily speaking. All close calls should be resolved in favor of not having the client incur the fees associated with them, no matter how perfectly clear your disclosures may be.
Recently, a number of firms have learned this lesson the hard way, by being disciplined and paying fines. Rolling a tax-deferred account into a tax-deferred product is the type of transaction that keeps compliance officers glum and regulators employed.
Anthony Paduano
Paduano & Weintraub LLP
New York City
212-785-9100
[email protected]
Ethical Rep is a monthly feature in which more than 30 prominent securities attorneys, experts and law school professors help Rep. readers deal with work-related ethical quandaries. Have you encountered a situation at work that makes you uncomfortable? Are you confused about how your responsibilities to clients might change as regulations continue to evolve? Drop a line to Rep.'s contributing editor, Ann Therese Palmer, and our group of experts will help you work through the problem.
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