FINRA Files LPL Financial for Failures to Supervise Alternative Investments

LPL Financial LLC has been hit again for supervisory failures stemming from the recommendation of non-traded real estate investment trusts (REITs), as well as other illiquid investments, begging the question whether the fines are large enough to deter future bad conduct. According to a news release dated March 24, 2014, the Financial Industry Regulatory Authority (FINRA) announced that LPL Financial has been fined $950,000 for the firm’s failures in supervision over alternative investments, including non-traded REITs, oil and gas partnerships, business development companies, hedge funds, managed futures and other illiquid pass-through investments.

LPL Financial submitted a Letter of Acceptance, Waiver and Consent No. 2011027170901 (AWC), in which it admitted to “fail[ing] to have a reasonable supervisory system and procedures to identify and determine whether purchases of [alternative investments] caused a customer’s account to be unsuitably concentrated in Alternative Investments in contravention of LPL, prospectus or certain state suitability standards.” LPL also admitted in the AWC that though it had a computer system to assist and supervision, this computer system did not consistently identify alternative investments that fell outside of the firm’s suitability guidelines. Additionally, LPL stated that its written compliance and written supervisory procedures failed to achieve compliance with NASD Rule 2310 and state suitability standards.

NASD Rule 2310 has since been superseded by FINRA Rule 2111. The current rule establishes the industry standard that FINRA members and their employees must have a reasonable basis to believe their recommendations are suitable for their customers. The Rule further dictates that the firm must establish suitability for each customer by considering the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information, though this list is not exclusive.

LPL Financial’s AWC was not the first time it was fined for selling non-traded REITs. In the AWC, LPL Financial disclosed that it entered into a prior settlement with the Massachusetts Securities Division wherein it consented to a $500,000 fine and approximately $2 million in restitution for the firm’s role in selling such products in contravention of state rules concerning prospectus net worth, annual income requirements and state concentration limits.

Many State securities divisions limit the percentage of investors’ investible assets that may be invested in such alternative investments such as REITs. Ohio, for instance, sets its concentration limit to 10%. The Ohio Division of Securities has in the past noted in a Securities Bulletin that Direct Participation Programs such as non-traded REITs involve substantial risks, including “severe restrictions on liquidity, … upfront fees and expenses ranging between 12%-18% of the initial offering price and substantial ongoing fees thereafter,… and distributions to shareholders paid from borrowings or a return of the shareholder’s investment after deducting fees paid to insiders. Broker-dealers are highly incentivized to sell these products by the 7%-10% commissions commonly charged to investors, some of the highest selling commissions of any investment product available.”

Due to the very risky nature of alternative investments such as non-traded REITs, it is imperative that firms conduct appropriate suitability inquiries to determine whether a recommendation for the purchase of such a product is actually appropriate for each customer. According to FINRA Rules, it is also imperative that an investor be informed of all risks and costs associated with such an investment, though this is rarely done. If you believe you were not properly informed of the risks associated with alternative investments, or were recommended such an investment that may not be suitable for you, please contact the attorneys at Malecki Law to determine if you have a claim for damages.