Broker-Dealer Faces Big Fine for Failure to Supervise
Last week, the Financial Industry Regulatory Authority (FINRA) fined LPL Financial LLC, one of the country’s largest networks of independent broker-dealers, $950,000 for its failure to supervise sales of alternative investment products, including non-traded real estate investment trusts (REITs), oil and gas partnerships, business development companies (BDCs), hedge funds, managed futures and other illiquid pass-through investments. FINRA also ordered LPL to conduct a comprehensive review of its policies, systems, procedures and training to correct the failures. Many states set limits on the percentage of an investor’s overall portfolio that may be invested in these kinds of risky products. Similarly, many alternative investments, like REITs, limit the concentration of alternative investments in their offering documents. LPL, further, had set its own concentration guidelines for alternative investments. But none of these safeguards is a substitute for appropriate supervision by the brokerage firm.
FINRA found that from January 1, 2008 to July 1, 2012, LPL failed to sufficiently supervise sales of alternative investment products that violated the various concentration limits. During that time period, LPL had two different systems to oversee its alternative investment products. First, it used a manual process to determine whether an investment met suitability requirements, but this system relied on information that was often outdated and inaccurate. LPL then employed an automated system, but that database used flawed programming and was not timely updated with accurate suitability standards. FINRA also found that LPL failed to train its supervisory staff to consider state suitability standards when reviewing alternative investments. As a result, LPL exposed its customers to unacceptable risks by failing to tailor its supervisory system to the products it sold.
LPL agreed to pay the fine to settle the case against it, but it did not admit nor deny FINRA’s charges.
The Wall Street Journal reports that this is not the first time LPL has faced regulatory fines because of its sales of REITs. In May 2013, Massachusetts regulators fined LPL $500,000 for violating a state regulation prohibiting an investor from investing more than ten percent of their liquid net worth in REITs. In the same ruling, the Massachusetts regulators also ordered LPL to pay $4.8 million in restitution to clients. That penalty was part of a larger action by Massachusetts regulators against firms that sold REITs. In total, Massachusetts regulators collected more than $11 million in restitution and fines from six firms: LPL, Ameriprise Financial, Inc., Lincoln National Corp., Commonwealth Financial Network, Royal Alliance Associates, and Securities Americas.
If you are investing in alternative investments, especially non-traded REITS, you should check the concentration limits for these alternative investments in your offering documents and in your state. If you believe your investments exceed the legal concentration limits, you should consider discussing your options with an attorney.