The Financial Industry Regulatory Authority launched Monday a program to allow broker-dealers to self-report share class violations related to 529 plans.
The 529 Plan Share Class Initiative, as set out in Regulatory Notice 19-04, states that over the past several years, FINRA has found that some firms have failed to reasonably supervise brokers’ recommendations of multi-share class products.
As with mutual fund share class concerns, the broker-dealer self-regulator states that it has raised concerns specifically regarding firms’ supervision of share-class recommendations to customers of 529 savings plans.
Shares within 529 plans are commonly sold in different classes with differing fee structures, FINRA explains, with Class A shares typically imposing a front-end sales charge but lower annual fees compared with other classes. Class C shares typically impose no front-end sales charge but impose higher annual fees than Class A shares.
“These classes have a differing cost impact depending on the length of time the customer holds the securities,” FINRA states.
The 529 Plan Share Class Initiative is designed to “promote firms’ compliance with the rules governing 529 plan recommendations, to promptly remedy potential supervisory and suitability violations related to recommendations that customers of 529 plans buy share classes that are inconsistent with the accounts’ investment objectives, and to return money to harmed investors as quickly and efficiently as possible,” the notice states.
Susan Schroeder, head of FINRA enforcement, stated in a video message that “529 plans are incredibly important investment vehicles for a lot of Americans who are trying to save for the education of beneficiaries like their children, and FINRA has learned through the course of reviewing some firms’ 529 plan sales that this can be a blind spot for some firms.”
Schroeder added that if firms self-report via the initiative, “a settlement under this initiative would be a supervisory settlement and would not trigger” a statutory disqualification.
To encourage voluntary reporting under the initiative, FINRA’s Department of Enforcement will recommend that FINRA accept favorable settlement terms for firms that self-report these potential violations and provide FINRA with a detailed remediation plan.
To be eligible for the initiative, firms must self-report by providing written notification to FINRA Enforcement by noon on April 1.
Notification can be made by email to 529Initiative@finra.org or by mail.
A firm that has timely self-reported must, by May 3, 2019, confirm its eligibility for the 529 Plan Share Class Initiative by submitting information for the period of January 2013 through June 2018.
Brian Rubin, a partner at Eversheds Sutherland in Washington, told ThinkAdvisor that “FINRA took a similar approach for mutual fund sales charge waivers.”
Now, Rubin continued, “FINRA appears to be copying from the SEC’s playbook regarding mutual fund share class disclosures.”
The overall message: “Regardless of the product, firms should consider focusing on available share classes, and knowing why certain share classes are being recommended,” Rubin said.
Because 529 plans are municipal securities, the sale of 529 plans are governed by the rules of the Municipal Securities Rulemaking Board MSRB Rule G-19 (Suitability of Recommendations and Transactions).
The Notice points to Internal Revenue Code amendments that took effect in Jan. 2018, which expanded the use of 529 plans for tuition for grades K-12, subject to certain limitations.
FINRA explained that while 529 plan distributions were tax-free when used to pay for qualified higher education expenses (i.e., expenses incurred at or around the time the beneficiary is college-aged, typically 18 years or older), now, in addition, up to $10,000 per year in 529 plan withdrawals would be tax-free if used for elementary or secondary educational expenses (e.g., expenses incurred when the beneficiary is as young as four or five years old).
“These additional considerations underscore the importance of recommending a share class that is tailored to the unique circumstances and needs of the customer, as well as the importance of supervising such recommendations,” FINRA states in the notice.
Broker-dealers should 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,” the notice states.
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.
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