FINRA Slams LPL Financial with Almost $1 Million Fine
By David Meyer
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 without detection."
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 portfolios.
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 processes.