FINRA recently issued a Letter of Acceptance, Waiver and Consent against Morgan Stanley Smith Barney LLC which provides an instructive case study on how FINRA securities firms should and should not carry out their supervisory duties over their financial advisors and customer accounts.
As discussed in the AWC here, from 2012 to 2017 one of Morgan Stanley's representatives carried out hundreds of short term trades in corporate bonds and preferred securities in the accounts of ten customers. The AWC states that due to these investments’ upfront sales charges, they were typically only suitable for customers if held long term.
FINRA Rule 3110 requires that firms such as Morgan Stanley must take "reasonable steps" to ensure that their representative's activities comply with securities laws and regulations. This includes investigating red flags of potential misconduct, and taking action where necessary.
Many firms, similar to Morgan Stanley, have automated systems to raise red flags when certain criteria are met - such as the turnover in customer accounts from the buys and sells of securities. Churning, which is also known as quantitative suitability, involves unsuitable high turnover trading in an account to typically generate commissions for the broker.
Although Morgan Stanley's system correctly identified the red flag and potential problems of this turnover with nearly one hundred alerts / red flags, the problem according to FINRA was what they did or did not do with this information.
According to the AWC, Morgan Stanley discussed the alerts with the broker and contacted customers. However, when contacting the customers, it does not appear they advised the customers of the unsuitable churning, but instead did what many firms do - they asked whether the customer was "satisfied with KG and his recommendations."
The Morgan Stanley compliance department then conducted a review and concluded that the high turnover trading was costing the clients more money than they were making, but still the firm did not take sufficient action to halt the trading, and the high turnover and alerts continued. Clearly Morgan Stanley had a system in place to identify red flags, but it chose not to take action to ensure compliance with laws and regulations, in contravention of Rule 3110.
The AWC states that the activity in the accounts lost $900,000 in ten customers' accounts. FINRA Ordered Morgan Stanley to pay a fine of $175,000 and $774,574 to the eight customers that had not settled their claims.
If you believe that your financial advisor, broker, or advisory firm has churned your account, traded in unsuitable securities, or the firm has failed to supervise your broker, please contact W. Scott Greco for a free attorney consultation.