LPL Financial (LPL) is the largest organization of independent financial
advisors in the United States, with more than 13,000 advisors under its
wing. It has a responsibility to provide training and supervision to all
of these advisors so that their clients' portfolios will contain only
investments that are considered suitable for them.
According to the Financial Industry Regulatory Authority (FINRA, an independent
regulatory body monitoring securities firms and brokers), LPL didn't
do that. Its system for monitoring alternative investments was heavily
flawed throughout a 4-1/2-year review period (January 2008 through June 2012).
"Alternative investments" is a broad term used for investment
strategies that are different than those employed by typical stocks and
bonds. These strategies seek to outperform the market and to provide diversification
to a portfolio by having a low correlation to traditional investments.
While some SEC-registered investments follow alternative strategies ("liquid
alternatives"), most alternative investments are not registered.
These unregistered investments carry significantly greater risk, are more
complex, are less liquid, and are not appropriate for many investors.
To protect unsophisticated investors and investors with limited assets,
the SEC, FINRA, and state regulatory agencies set standards that must
be met before advisors under their purview can invest a client in an unregistered
investment. Advisors must determine that a client meets suitability standards
such as liquid net worth and investment objectives, and then ensure that
the concentration of various types of unregistered investments in a portfolio
does not exceed specified percentages for that client.
What Got LPL in Trouble?
FINRA looked at the supervisory systems and procedures that LPL had in
place to monitor whether advisors were appropriately allowing clients
to invest in unregistered investments during the review period. It found
numerous systemic deficiencies, which were born out in its review of a
sampling of transactions. In a
Letter of Acceptance, Waiver and Consent (AWC, #2011027170901) that FINRA signed on March 24, 2014, LPL agreed to
a censure and a $950,000 fine.
FINRA reviewed how LPL handled non-traded real estate investment trusts
(REITs), oil and gas partnerships, business development companies ("BDCs"),
real estate limited partnerships, hedge funds, managed futures and other
illiquid pass-through investments. Starting with the grid that advisors
used to determine suitability for alternative investments through each
step of a three-level review process, LPL's system was flawed. The
problems that caused the first level of review to be insufficient tainted
the subsequent layers as well.
The AWC said that FINRA found "deficiencies in each layer of the supervisory
system for processing and reviewing Alternative Investment transactions,
in its transaction paperwork and in its Alternative Investments training
for its registered representatives and supervisory personnel." The
system was so flawed that one advisor "was able to enter false customer
financial information and process these Alternative Investment transactions
In addition to supervisory failures, LPL failed to establish and maintain
an adequate system for ensuring that advisors, supervisors, and the operations
department could rely on current information when making suitability determinations.
Changes in state suitability guidelines and securities prospectuses were
often not reflected in the materials advisors and reviewers relied upon.
Other topics that the AWS mentioned repeatedly were failing to properly
calculate net worth, failing to factor client age into determinations,
and miscalculating or failing to monitor the appropriate percentage of
alternative investments that clients could be allowed to include in their
Specifically, LPL was found to have violated NASD Rules 2110, 2310, and
3010, FINRA Rule 2010, and various state suitability guidelines. To bring
the company into compliance, LPL has agreed to a number of changes including
augmenting and improving its entire supervisory system, improving its
written supervisory procedures (WSPs), increasing supervisor and advisor
training, revising its suitability guidance, and improving its operations