Key Investor Issues Outlined in FINRA 2021 Exam Priorities – Part Two

We are continuing our discussion of FINRA’s 2021 Report on Risk Monitoring and Examination Activities. In Part Two, we will focus on FINRA’s comments and findings related to Variable Annuities, Outside Business Activities, and Private Securities Transactions and Private Placements. These are all areas of interest that directly affect retail investors, and in which FINRA found deficiencies following its examination of member-firms. 

If you are interested in FINRA’s comments regarding Regulation Best Interest (Reg BI), Communications with the Public, and Best Execution, you can read Part One of our discussion here.

Variable Annuities

Annuities are popular investment products. Before investing in an annuity, it is important to understand any surrender charges, fees and costs, potential tax penalties, and market risk.

FINRA Rule 2330 establishes certain sales practice standards involving the purchase and exchange of deferred variable annuities. A broker making an investment recommendation must have a reasonable belief that a customer has been informed of its various features prior to recommending the purchase or exchange of a deferred variable annuity. This requires that the broker use reasonable efforts to determine the customer’s age, risk tolerance, investment experience, investment objectives, investment time horizon, annual income, and current assets. If a broker-dealer or associated person recommends a purchase or exchange of a deferred variable annuity to a retail customer, Reg BI will also apply.

FINRA Rule 2330 also requires that member-firms conduct surveillance to assess whether any associated person is making deferred variable annuity exchanges at a rate that suggests a rule violation; if so, firms must also implement corrective action.

As part of its exam findings, FINRA identified the following issues:

  • Firms failed to address within their supervisory systems that customers accepting buyouts may be losing valuable benefits associated with their existing products, subject to new surrender charge periods, and paying higher fees and expenses with new products;
  • Firms did not reasonably supervise recommendations of annuity exchanges. These recommendations were unsuitable and inconsistent with a customer’s objectives and time horizon. Often, the recommendations resulted in increased fees to the customer or the loss of material, paid-for accrued benefits;
  • Firms conducted inadequate reviews of the source of funds to purchase new variable annuities; and
  • Firms insufficiently trained brokers and supervisors regarding how to assess fees, surrender charges, and long-term income riders to determine the suitability of exchanges for customers.

Outside Business Activities and Private Securities Transactions

FINRA Rule 3270 requires that registered representatives notify their firms in writing of proposed outside business activities. FINRA Rule 3280 requires that all associated persons notify their firms in writing of proposed private securities transactions. This allows firms to determine whether to limit or allow these activities. A firm that approves a private securities transaction where the associated person has or may receive selling compensation must record and supervise the transaction as if it were executed on the firm’s behalf.

As part of its exam findings, FINRA identified the following issues:

  • Incorrect interpretation of requirements led to the wrong determination that certain activities were not private securities transactions. For example, interpreting “compensation” too narrowly or approving participation in transactions without considering whether firms needed to supervise them;
  • Failure to retain documentation to demonstrate firms’ compliance with their supervisory obligations;
  • Registered persons failed to notify their firms in writing of private securities transactions or outside business activities;
  • Inadequate written supervisory procedures (WSPs) and not monitoring limitations placed on private securities transactions or outside business activities. For example, supervisory procedures prohibiting registered representatives from soliciting firm clients to participate in private securities.

One interesting issue identified by FINRA was related to digital assets and firms’ incorrectly assuming that digital assets are not securities. According to the report, this led to firms not evaluating digital asset activities, including those activities performed by firm affiliates, to determine whether they were private securities transactions. Additionally, for certain digital asset activities that were deemed to be private securities transactions, firms did not supervise activities or record such transactions on the firm’s books and records.

Private Placements

Private placements can be sold to investors by broker-dealers or directly by issuers. FINRA imposes obligations on broker-dealers to conduct reasonable due diligence on private placements it offers and sells to investors. Firms must conduct a “reasonable investigation” into Reg D offerings by evaluating the issuer, its management, the issuer’s business prospects, the assets held by or to be acquired by the issuer, the claims being made, and the intended use of proceeds of the offering.

FINRA members must also meet supervisory requirements and make filings for specified private placement offerings.

As part of its exam findings, FINRA identified the following issues:

  • Firms failed to comply with timely filing requirements because they lacked procedures and supervisory programs to do so; and
  • Firms failed to perform reasonable investigations of private placement offerings prior to recommending the offerings to retail investors. This included failing to conduct additional research about new offerings, relying on experience with the same issuer in previous offerings and not conducting a further inquiry into red flags identified during the investigation process, failing to address red flags, and conflicts of interest.

Our Firm

Iorio Altamirano LLP is a securities arbitration law firm based in New York, NY. We pursue individual FINRA arbitration claims nationwide on behalf of investors to recover financial losses from brokerage firms’ wrongful conduct. Contact our stockbroker fraud attorneys for a confidential and free consultation today.


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