I have often used these posts to lament the fact that FINRA consistently acts as an enforcement driven group of crazed examiners, hell-bent on writing firms up for technical violations, at best, uncaring about the dramatic ramifications of their seemingly ceaseless attack on well-meaning broker-dealers and their owners. While I still harbor those feelings, occasionally a case comes out that makes me say, oh, maybe they got that one right.  I read last week about a new disciplinary complaint that FINRA issued against Berthel Fisher regarding sales of UITs, and when I went back and read the complaint itself – even acknowledging that these are nothing but unproven allegations, that the firm is presumed innocent, and that FINRA owns the burden of proof – I could not help but think, this one is bad.  Allegedly.  But, like a lot of cases involving bad facts, there are lessons that good firms can glean from the allegations in how to avoid ending up in the same situation.

The problems with Berthel are manifold. First, beyond the particular facts of this case, it has a bit of a history of supervisory issues.  FINRA has a loooong memory when it comes to things like this.  It does not easily forget prior supervisory failures, and these memories color how the examiners approach any subsequent exams they conduct.  Knowing that Berthel had previously been found to have supervisory shortcomings would have been regulatory catnip to the examiners that did the UIT exam.

Second, Berthel basically handed FINRA the complaint on a silver platter. The alleged problems with the firm’s supervisory procedures were so patent it is difficult to imagine even the most incompetent of examiners missing them.  Moreover, the specific issue at hand – the firm’s failure to have taken the necessary steps to ensure that customers received the appropriate breakpoints and sales discounts relating to their purchases of UITs – is something that has been the subject of a considerable amount of prior attention ( in both mutual fund and UIT cases).  Thus, the examiners already knew what to look for, what questions to ask, what documents to request.  For an entity like FINRA that thoroughly enjoys stumbling across a “low hanging fruit” case, Berthel presented very easy pickings here.

So, what did Berthel allegedly do wrong? It basically failed to have any procedure that ensured that customers got their breakpoints.  Consistent with that, it also failed to designate any supervisor who was responsible for reviewing UIT sales for breakpoints.  In other words, this was a case of omission – Berthel simply not doing something it was reasonably supposed to have done.  Such cases are way easier for FINRA to prove than other supervisory cases where the issue is whether the firm did enough.  In these latter cases, as defense counsel, I am nearly always able to argue that while what my client did may not have been perfect, and that there were things that it certainly could have also done, it remains that my client acted “reasonably,” which is all that the law requires.  But, that argument quickly becomes untenable if, in fact, there was no procedure and nothing was done.

Lesson one, therefore, is always to be sure that there is no disconnect between, on the one hand, the products that the firm sells to earn its revenues, and, on the other hand, the firm’s supervisory procedures, as there was here. In its defense, a Berthel spokesperson pointed out to Investment News that its sales of UITs only comprised 1% of its business.  That is no excuse, unfortunately.  There is no such thing in FINRA’s eyes as a de minimus amount of revenue, for anything.  If you are selling UITs, then you must make sure that your procedures specifically address UITs, even if your sales of UITs don’t amount to much.

Second, Berthel failed to appoint anyone – either an individual or a department – to be responsible to review its UIT sales for proper application of breakpoints and sales discounts. As a result of this failure, because no one was specifically looking for it, the problem was not caught for over four years.  And, the longer a problem continues, the easier it is for FINRA to decide that the only appropriately remedial measure to take is the filing of a formal disciplinary action.

Lesson two, therefore, is not only make sure that there is a pertinent procedure for every product you sell, but also that there is a supervisor who has been delegated the responsibility to review the sales of each product. And, it goes without saying that this supervisor should have the requisite degree of training on the product, so the review is meaningful; otherwise, the delegation is a bit of a charade.

Third, FINRA alleged that even if someone had been delegated the responsibility to supervise the UIT sales, the firm provided no guidance or direction that was reasonably designed to determine whether UIT sales were eligible for discounts, whether discount were actually applied on eligible trades, and whether transactions were structured in a way to avoid the application of an appropriate discount. In short, Berthel principally relied on the sales reps themselves to identify when discounts should be applied; but, that is akin to supervising yourself, a regulatory no-no since the dawn of time.  And, as a result of this, Mr. Dragon, one of Berthel’s reps – also named as a respondent in the complaint – allegedly took advantage of this situation by focusing his sales efforts on UITs and robbing his customers of over $650,000 in discounts to which they were entitled, yielding more than $421,000 in improper sales concessions to the rep and Berthel.

Lesson three: follow the money.  If you have a rep who is making his money by selling something that is outside the firm’s norm, pay particular attention to that rep.  According to the complaint, in a two-year period, Mr. Dragon executed over 600 UIT trades.  If, as the Berthel rep maintained, the sale of UITs represented only a tiny fraction of the firm’s overall business, Mr. Dragon’s apparent focus on that product was atypical.  That alone should have garnered attention to what he was doing.