Morgan Stanley Smith Barney agreed to pay over $13 million in fines and restitution to settle FINRA charges that it failed to supervise its registered reps’ short-term trades of unit investment trusts (UITs).

In setting the level of its sanctions, FINRA recognized Morgan Stanley’s cooperation in this case. The firm initiated an internal investigation that included, among other things: (i) interviewing more than 65 firm personnel; (ii) retaining an outside consultant to conduct a statistical analysis of UIT rollovers at the firm; (iii) identifying customers affected and establishing a plan to provide remediation to those customers; and, (iv) providing substantial assistance to FINRA in its investigation.

A Unit Investment Trust (“UIT”) … is an investment company that offers units in a portfolio of securities that terminates on a specific maturity date, often after 15 or 24 months. UITs impose a variety of charges, including a deferred sales charge and a creation and development fee, that can total approximately 4% for a typical 24-month UIT. Because of the long-term nature of UITs, their structure, and upfront costs, short-term trading of UITs may be improper and raises suitability concerns. Such is the case with a registered rep who repeatedly recommends that a customer sell his or her UIT position before the maturity date and then “rolls over” those funds into a new UIT – that customer will incur increased sale charges over time.

BACKGROUND.    Morgan Stanley, a FINRA member since May 2009, was formed by the combination of the Global Wealth Management Group of Morgan Stanley and the Smith Barney Division of Citigroup Global Markets. The firm has around 23,600 registered individuals and 757 branch offices.

FINRA FINDINGS.    From January 2012 through June 2015 (the “Relevant Period”), hundreds of Morgan Stanley reps executed more than $33.4 billion in UIT transactions in 3,020 customer accounts that generated over $650 million in sales credits and commissions. The $33.4 billion in UIT transactions included more than $5.2 billion in “early rollovers,” defined by the firm as UITs rolled over more than 100 days before maturity.

Morgan Stanley failed to adequately supervise sales of UITS by its registered reps:

• MS provided insufficient guidance to supervisors as to how they should review UIT transactions to detect unsuitable short-term trading;
• MS failed to implement an adequate system to detect short-term UIT rollovers (♦ - see further explanation below);
• MS failed to provide for supervisory review of rollovers prior to execution within the firm’s order entry system.
• MS failed to conduct training for registered reps specific to UITs.

     ♦   Re: failure to detect UIT rollovers:  During the Relevant Period, the firm’s order entry system alerted supervisors to short-term UIT “switches” – defined as the purchase of a UIT within 60 days of the sale of either an open-end mutual fund or UIT. Detection by the system prompted follow-up actions by the rep, the supervisor and the firm’s back office. Unfortunately, the firm excluded UIT rollovers from the definition of a “switch” so that, if a registered rep selected “rollover” as the justification for a UIT switch in the firm’s order entry system, UIT rollovers were not routed to supervisors for review and approval prior to execution. This in turn, led to other supervisory shortcomings.

FINRA POST SCRIPT.    As a result of this case, FINRA launched a targeted exam in September 2016 focused on UIT rollovers. In addition, in its 2017 Exam Priorities Letter, FINRA highlighted that it was evaluating firms’ ability to monitor for short-term trading of long-term products.

[Click here to access FINRA AWC #2016048805501.]