FINRA sanctioned Morgan Stanley Smith Barney and ordered the firm to pay over $13 million—$3.25 million in fines and an additional $9.78 million in restitution to over 3,000 customers—for failing to supervise its representatives' short-term trades of unit investment trusts (UITs), which FINRA cited as affecting more than $5.2 billion-worth of UIT transactions involving "early rollovers."
The latest $13 million penalty follows several notable actions FINRA has taken against individual ex-Morgan Stanley representatives that regulators say engaged in unsuitable, excessive, or unauthorized UIT trading in customer accounts.
For instance, FINRA recently sanctioned former Morgan Stanley broker Elaine Diones LaCerte of Colorado Springs for an "unsuitable pattern" of short-term UIT trading in over 100 customer accounts, resulting in unnecessary sales charges. LaCerte also faces a number of customer disputes alleging unsuitability and misrepresentation related to the UIT sales.
In July, FINRA barred ex-Morgan Stanley broker Kim Dee Isaacson of Utah for defrauding an elderly customer, and attempting to conceal the fraud. In 2016, one of Isaacson's former clients won a $3.6 million award against Morgan Stanley after arbitrators found that the firm failed to supervise Isaacson. Among the purchases and sales allegedly effected without the customer's consent were equities, bonds, futures, variable annuities (VAs), mutual funds, and UITs.
In concluding that Morgan Stanley failed to establish and maintain an adequate supervisory system and written supervisory procedures designed to detect and prevent short-term UIT trading, FINRA wrote that Morgan Stanley's deficiencies manifested in multiple ways that proved costly to customers.
For instance, because UITs impose a variety of sales charges—FINRA found that a "typical" 24-month UIT sold at Morgan Stanley imposed a 1% initial sales charge, 2.5% deferred sales charge, and a 0.5% creation and development fee—a representative who repeatedly recommended short-term UIT sales before maturity would cause the customer to incur increased sales charges.
In the AWC, FINRA used the example of a hypothetical customer who purchased a 24-month UIT, who rolled over the UIT into a new UIT after six months, repeating the process after the 12th and 18th months, such that by the end of the two-year period, that customer would have wound up paying total sales charges of approximately 12.8%.
By contrast, had the customer simply held the 24-month UIT until maturity, the sales charge would have been just 3.95%.
Investigators found that although Morgan Stanley's compliance procedures themselves stated that, "UITs are intended to be long-term investments," those same procedures insufficiently addressed how supervisory personnel should monitor and review UIT transactions to detect unsuitable short-term trading, such as short-term UIT rollover transactions.
Additionally, FINRA wrote that even though Morgan Stanley had a process to identify short-term UIT switches, the firm specifically excluded UIT rollovers from the definition of "switch" in its policy documents. Thus, reasoned FINRA, if a representative identified or justified a UIT switch as a "rollover," such transactions were not sent to supervisors for review and approval.
FINRA also cited Morgan Stanley for failing to include UIT rollovers as part of its trade confirmation disclosures, and found that rollovers were omitted from switch reports that these short-term transactions should have been included on.
If you have invested with Morgan Stanley, Elaise Diones LaCerte, Kim Dee Isaacson, or with any broker or financial adviser whose unsuitable recommendations for short-term unit investment trust (UIT) trading or rollovers prior to maturity caused you to incur financially damaging sales charges or fees as a result, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.