Bates News,Bates Research,Compliance and Regulatory Alerts - 02-25-19

Planning Your Response to FINRA’s 529 Initiative — Q&A with Bates Managing Director Alex Russell

Bates Research recently conducted a Q & A session with Alex Russell, Managing Director of Securities Litigation & Regulatory Enforcement at Bates, to discuss FINRA's new 529 Share Class Initiative. Alex talks about responding by FINRA's deadline and potential pitfalls firms should keep in mind when preparing their response.

Bates Research: What is FINRA's 529 Plan share class initiative -- and deadline?

Alex Russell: FINRA is providing firms with an opportunity to review their activity in and around 529 plans, allowing firms to self-report where supervisory violations may have occurred during the period of January 2013 through June of 2018. Similar in nature to the SEC’s Share Class Selection Disclosure Initiative last year, FINRA is concerned that share class recommendations were made to clients that are inconsistent with the accounts’ investment objectives. In particular, FINRA is asking firms to ensure that 529 plan recommendations took into account breakpoint discounts, sales charge waivers, and other fees in determining suitability. Depending on the facts and circumstances of each client (in particular the age of the plan beneficiary) FINRA believes that economically disadvantageous share classes may have been selected, wherein the expenses incurred by the client are greater than they need to be. Firms must provide a response by April 1, 2019 in order to participate in the self-reporting initiative. 

BR: What is required to be included a firm's response?

AR: Firms must provide written notification to FINRA by 12:00am EST on April 1, 2019 of their intent to self-report.  A firm that has submitted their intent to self-report then has until May 3, 2019 to provide the following information back to FINRA:

  1. A list of the 529 plans sold by the firm, including the 529 plan name and the dates the firm offered each 529 plan.
  2. The total aggregate principal amount invested in each 529 plan sold by the firm during the disclosure period.
  3. A description of the firm’s supervisory systems and procedures relating to 529 plan sales during the disclosure period.
  4. A description of the changes to the firm’s supervisory systems and procedures that the firm has implemented or will implement in order to strengthen compliance with its supervisory obligations. To the extent the firm identifies changes that have not yet been implemented, the firm should identify the individual supervisor at the firm who is responsible for the implementation.
  5. The firm’s assessment of potential impact on customers of supervision weaknesses, including a description of the firm’s methodology for assessing impact on customers and a description of the firm’s proposal to make restitution payments to harmed customers.
  6. Any other information the firm believes would assist Enforcement in understanding the firm’s assessment of an account’s expected investment horizon, the suitability of the firm’s recommendations, or the reasonableness of the firm’s supervisory system regarding share class recommendations

Bates has been actively assisting clients with item 5 above.

BR: What are some of the nuances/pitfalls in planning a firm's response?

AR: There are a number of challenges firms face in assessing the potential impact on clients related to 529 plan share class purchases.  One of which is data availability from plan sponsors – sponsors may have difficulty producing the relevant data, especially for older time periods, given different record retention policies, plans changing hands, etc.  Of particular note, while the review period is January 2013 to June 2018, FINRA notes that the period for calculating restitution may extend further into the past (as alluded to in footnote 16 to Notice 19-04) making getting data all the more difficult.  Beyond that firms must also decide whether to review for possible supervisory failures on a client specific basis, or to apply a “statistical approach” that would group multiple clients into different impact categories and proceed to analyze the potential harm to those clients on an aggregated basis.  Considerations such as whether to use a standard estimate for fee differentials, or breakpoints as of a certain point in time, versus using the exact fee rate differentials during the entire review period as well as the breakpoints in place at the time of purchase give firms even more to consider.  Careful curation of the data, as well as access to historical information on share classes, are crucial to successful reporting and are both areas Bates can assist with.

BR: What are the risks for not responding?

AR: FINRA’s Member Supervision and Enforcement divisions will continue to examine and investigate member firms’ activity around 529 plans throughout 2019.  Firms who choose not to self-report that are later found to have supervisory failures related to 529 plans during the course of an exam will likely result in additional sanctions beyond those made available for firms that do self-report under the initiative.  Under the umbrella of the initiative Enforcement will recommend that participating firms make restitution payments to all impacted clients and accept a censure, but will face no fine.  In some instances, Enforcement may decide that no formal action is necessary and may resolve the matter informally or with no further action taken.  Both the potential for an informal resolution, no further action, or the absence of a fine in the event that action is taken, create a strong incentive for firms that believe they may have had 529 plan supervisory failures during the relevant period to self-report.


Support for Firms:

Bates has deep and proven experience and expertise in share class disclosure matters. Most recently, on behalf of over a dozen major national and regional financial institutions, Bates provided important assistance to firms and counsel participating in the SEC’s Share Class Selection Disclosure Initiative and related SEC Examinations.

To support firms facing FINRA’s 529 Plan disclosure and remediation initiative, Bates Group can help by providing solutions to identify and address accounts and clients impacted by share class selection. Bates performs data analysis, examines regulatory reporting, reviews share class selection policies and disclosure practices, identifies methodology and impacted accounts, performs calculations and provides remediation amounts. Most importantly, after consultation with counsel, Bates' disclosure and remediation plan culminates in a report which can be used directly with regulators. For more information, see our original alert here.

Bates is ready to help you and your firm. Please contact us today.

Alex Russell, Managing Director, Securities Litigation and Regulatory Enforcement 
email: phone: 971-250-4353
David Birnbaum, Managing Director
email: phone: 917-273-2682
Robert Lavigne, Managing Director, Bates Compliance Solutions
email: phone: 508-868-6741
Scott Lucas, Managing Director, Regulatory and Internal Investigations
email: phone: 971-250-4344


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