The Financial Industry Regulatory Authority this week slapped LPL Financial, an independent broker-dealer, with a $950,000 fine for supervisory lapses related to the sales of several alternative investments.

“FINRA's findings provide a useful case study as to the types of issues that a firm should consider in evaluating its own processes for sales of complex products,” stated a Morrison & Foerster client alert. “Firms should consider using FINRA findings in cases like this one as a checklist in its regular evaluation of its supervisory systems and procedures.” 

The investments at the center of FINRA's enforcement action include a laundry list of products, including:

Non-traded real estate investment trusts (REITs);

Oil and gas partnerships;

Business development companies;

Hedge funds;

Managed futures; and

Other illiquid pass-through investments.

“In order to sell alternative investments, a broker-dealer must tailor its supervisory system to these products,” said Brad Bennett, FINRA Executive Vice President and Chief of Enforcement. “LPL exposed customers to unacceptable risks by not having an adequate system in place that could accurately review whether a transaction complies with suitability requirements imposed by the states, the product issuers, and the firm itself, and it failed to train its registered representatives to apply all the suitability guidelines appropriately.”

Many alternative investments, such as REITs, set forth concentration limits for investors in their offering documents. In addition, certain states have imposed concentration limits for investors in alternative investments. LPL also established its own concentration guidelines for alternative investments.

According to FINRA, from January 2008 to July 2012, LPL failed to adequately supervise the sales of alternative investments that violated these concentration limits. “For example, FINRA identified 25 instances of REIT transactions that were approved in contravention of state suitability standards or prospectus suitability standards,” the client alert stated.

“At first, LPL used a manual process to review whether an investment complied with suitability requirements, relying on information that was at times outdated and inaccurate,” FINRA stated. LPL later implemented an automated system for review, “but that database contained flawed programming and was not updated in a timely manner to accurately reflect suitability standards. LPL also did not adequately train its supervisory staff to analyze state suitability standards as part of their suitability reviews of alternative investments.”

As part of the sanction, LPL must also conduct a comprehensive review of its policies, systems, procedures, and training, and remedy the failures. In reaching a settlement, LPL Financial neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

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