by Howard Haykin

Trident Partners agreed to pay a $50K fine to settle FINRA that it failed to establish, maintain, and enforce a reasonable supervisory system and WSPs to ensure that recommendations were suitable for its sale of steepeners, a complex, structured product.

[Note:  I found it Interesting that FINRA did not raise the issue of paying restitution in this case - as it had in previous cases involving steepeners. Perhaps Trident customers didn't lose on these transactions.]

BACKGROUND.    Trident, which is based in Woodbury, NY, has been a FINRA member since 1996. The firm engages in general securities business and has 33 registered reps operating out of 4 branch offices.

FINRA FINDINGS.    From January 2010 through January 2012 (the “Relevant Period”) – when the sale of steepeners became a significant part of Trident’s business (approximately 1,600 customer transactions and generating at least 10% of commissions) - Trident permitted its registered reps (“RRs”) to recommend steepeners without their having a reasonable basis to make such recommendations.

Steepeners are a type of interest rate swap, … where one party agrees to pay the other a fixed rate in exchange for a floating rate, which is derived from the difference between long and short-term rates. They typically are longer-term notes and certificates of deposit with maturities that can span 10 to 30 years.

Steepeners are typically available by the issuers after a relatively short, pre-specified period of time (e.g., one year). Steepeners pay interest rates that are initially fixed and float thereafter based on the “steepness” of the yield curve, which is dictated by the spread between longer- and shorter-term rates.

While the initial fixed interest rates can be higher, if the steepener is not called after a year, the floating rates may drop significantly, to even as low as zero, earning no return for the remaining term of the steepener and the secondary market for steepeners may be illiquid.

What were Trident’s supervisory deficiencies?   According to FINRA, Trident …

• had no WSPs or supervisory system specific to steepeners or tailored to this line of the firm’s business;
• failed to have any process in place to evaluate and conduct due diligence on steepeners it intended to sell to the public;
• did not have and did not provide to its sales force any training or guidance to determine the risks of purchasing steepeners or to evaluate the suitability of this type of structured product for its customers; and,
• did not employ a reasonable system to supervise its steepener business to monitor for, among other things, suitability and over-concentration of positions in customer accounts.

Reasonable-Basis Suitability.   NASD/FINRA regulations require a broker-dealer and its RRs to perform reasonable diligence to understand the nature of a recommended security, as well as the potential risks and rewards. A key element to the reasonable-basis suitability determination is an understanding of the product.

During the Relevant Period, Trident permitted its RRs to recommend steepeners to their customers even though Trident failed to ensure that its RRs had sufficient knowledge of steepeners prior to offering those products for sale.

Fact is, Trident itself didn’t have sufficient knowledge of the product, particularly the risks associated with steepeners, including the risks associated with interest rate resets, the possibility that the reset interest rate could drop to as low as zero, and the potentially illiquid nature of steepeners in the secondary market, among other risks.

FINANCIALISH TAKE AWAYS.    This case isn’t the first time that FINRA has addressed the unsuitability of steepeners. For example, in December 2016, FINRA reported disciplinary actions against Investors Capital Corp. for unsuitable sales of steepeners. The firm was fined $250,000 in fines and ordered to pay $841,000 in restitution – in addition to $224,000 in restitution that it previously paid). [FINRA Case #2013035035901]

In October 2014, FINRA EVP Susan Axelrod warned a SIFMA Complex Products Forum about “new and emerging complex products” -  most notably, steepeners.

And in a November 2011 Investor Alert, FINRA discusses the pitfalls of ‘Chasing Return in a Challenging Investment Environment’ with structured retail products, such as steepeners.

This case was reported in FINRA Disciplinary Actions for September 2017.

For details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2012030775201.