July 14, 2020

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July 14, 2020

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July 13, 2020

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FINRA’s 529 Plan Share Class Initiative to Self-Report

On January 28, 2019, FINRA released its Regulatory Notice 19-04 announcing its 529 plan self-reporting initiative. FINRA Notice Summary explained that “FINRA’s 529 Plan Share Class Initiative Encourages Firms to Self-Report Potential Violations.”

To qualify for this initiative, firms must self-report by providing written notification to FINRA Enforcement by 12:00 a.m. E.T. on April 1, 2019. Firms must then provide FINRA with all required information by May 3, 2019. The qualifying reporting period is January 2013 through June 2018.

FINRA seeks to address its finding that “some firms have failed to reasonably supervise brokers’ recommendations of multi-share class products.” Specifically, FINRA believes there have been “suitability violations related to brokers recommending 529 plan share classes that were inconsistent with the accounts’ investment objectives and were, therefore, unsuitable for the investors.

FINRA’s goal in this initiative is to encourage firms to:

  1. promptly remedy potential supervisory and suitability violations related to recommendations as to share classes for 529 plans;
  2. quickly and efficiently return money to harmed investors; and
  3. voluntarily report past lapses to FINRA’s Department of Enforcement (“Enforcement”) with a detailed remediation plan.

To encourage this self-reporting, Enforcement “will recommend that FINRA accept favorable settlement terms for reporting firms.” Specifically, should a firm self-report and timely provide the information requested and Enforcement determines to recommend a formal enforcement proceeding against that firm, FINRA would recommend “a settlement that includes restitution for the impact on affected customers and a censure, but no fine. Recommended settlements also will include either an acknowledgement that the firm has voluntarily taken corrective actions or undertakings to do so. Enforcement anticipates that settlements entered into pursuant to this 529 Initiative will include charges under MSRB Rule G-27 (Supervision). Settlements under this rule would not result in a firm’s “statutory disqualification” as that term is defined in Section 3(a)(39) of the Securities Exchange Act of 1934.”

NOTE: If a firm does not self-report, they should be aware that “[i]n 2019, FINRA’s Member Supervision and Enforcement departments will continue to examine and investigate firms’ supervision of share-class recommendations to customers of 529 plans.” If FINRA identifies supervisory failures by a non-self-reporting firm, “any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the initiative.” Presumably, such disciplinary action may result in “statutory disqualification.”

Because 529 plans are municipal securities, they are governed by the Municipal Securities Rulemaking Board (MSRB) Rule G-19 (Suitability of Recommendations and Transactions) and Rule G-27 (Supervision) which requires a supervisory system reasonably designed to achieve compliance with applicable securities laws, regulations, and MSRB rules. Therefore, brokers must have a reasonable basis to believe their recommendations are suitable in light of the investor investment profile and firms must have systems in place to ensure such suitable recommendations. Specifically, in articulating its concern FINRA mentions that different share classes have different fee structures and suitability is dependent upon “the age of the beneficiary and the number of years until the funds will be needed to pay qualified education expenses of the beneficiary.”

A January 2018 amendment to the federal tax code now permits 529 plans for tuition for grades K-12, subject to certain limitations. FINRA believes these changes underscore the importance of recommending the appropriate share class to an investor in light of that investor’s goals for the funds.

FINRA is concerned that because of the unique features of 529 plans, some member firms may not provide adequate supervision. For example, 529 plan transactional data, including account asset levels, may not be available in the systems that firms use to monitor other types of transactions. This initiative is intended to encourage firms to assess their supervisory systems and procedures governing 529 plan share-class recommendations, to identify and remediate any defects, and to compensate any investors harmed by supervisory failures.

FINRA is explicit in what it expects firms to do as part of this initiative:

Firms are encouraged to review their supervisory systems and procedures governing 529 plan share-class recommendations and self-report to FINRA areas where their supervision may not have been reasonable. Potential areas of concern include the failure to:

  • provide training regarding the costs and benefits of different 529 plan share classes;
  • understand and assess the different costs of share classes for individual transactions;
  • receive or review data reflecting 529 plan share classes sold; and
  • review share-class information, including potential breakpoint discounts or sales charge waivers, when reviewing the suitability of 529 plan recommendations.

Firms that identify and self-report issues with 529 plan share-class supervision should also assess and self-report the potential impact of such supervisory failures.

FINRA suggests that the potential impact analysis can be achieved by either undertaking customer-specific analysis or using a statistical approach.

© 2020 Faegre Drinker Biddle & Reath LLP. All Rights Reserved.National Law Review, Volume IX, Number 31


About this Author

Sandra Dawn Grannum, Finance, Securities Lawyer, Drinker Biddle Law Firm

Sandra Dawn Grannum concentrates her practice on securities, broker/dealer arbitration, litigation, mediation and regulatory defense.

Sandy has tried complex multimillion-dollar arbitrations before FINRA, AAA and JAMS across the country. She has tried more than 50 arbitrations before the NASD and FINRA through award represented brokerage firms, banks, clearing firms, and associated persons. In addition, she has successfully pursued cases in state and federal courts and in adversarial proceedings before bankruptcy courts.

James G. Lundy, Drinker Biddle, regulatory investigations lawyer, financial services compliance attorney

James G. Lundy represents clients in Securities and Exchange Commission (SEC), Commodities Futures Trading Commission (CFTC), self-regulatory organization, and other financial regulatory agency investigations and examinations, and compliance and governance counseling, white collar criminal investigations, and complex business litigation.

With 12 years of senior SEC experience and more than two years of in-house experience at a futures and securities brokerage firm, Jim has developed an in-depth working knowledge of the various regulatory bodies with enforcement, examination, and policy oversight of the securities and futures industries.

Fred Reish, Drinker Biddle Law Firm, Los Angeles, Labor and Employment Law Attorney

Fred Reish represents clients in fiduciary issues, prohibited transactions, tax-qualification and Department of Labor, Securities and Exchange Commission and FINRA examinations of retirement plans and IRA issues.

Fred works with both private and public sector entities and their plans and fiduciaries and represents plans, employers and fiduciaries before federal agencies such as the DOL and IRS. He consults with banks, trust companies, insurance companies and mutual fund management companies on 401(k) recordkeeping services, investment products and...

(310) 203-4047
Jamie L. Helman Securities lawyer Drinker Biddle
Senior Attorney

Jamie L. Helman concentrates her practice on securities, broker-dealer arbitration, litigation, mediation, employment matters, and regulatory defense. She has experience first-chairing FINRA arbitrations, defended on-the-record testimony of broker-dealer employees before FINRA, and is presently involved in the representation of broker-dealers in several pending FINRA cases as well as regulatory matters.

Prior to joining private practice, Jamie worked as in-house counsel at Bear, Stearns & Co. Inc. in both the Litigation Department and Equities...

(973) 549-7016