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UITs: Failed Supervision at Hennion and Walsh
April 15, 2019
by Howard Haykin
A unit investment trust (UIT) is a registered investment company that buys and holds a generally fixed portfolio of stocks, bonds, or other securities. UITs are typically designed to be held until their stated termination date: (i) 20-30 years when invested in long-term bonds; (ii) as short as a year to several years when invested in stocks.
Upon termination, proceeds from the sale or redemtion of securities are either paid to unitholders or reinvested in another trust. A customer who sells a UIT before its termination date and buys another UIT incurs new front-loaded sales charges that would otherwise be deferred if the UIT were rolled over to a new UIT at the termination date.
Hennion & Walsh, a Parsippany, NJ-based FINRA member since 1989, is an introducing broker-dealer based with approximately 131 Registered Reps (“RRs”). The firm offered proprietary UITs with approximately 2 dozen different portfolio strategies. Proprietary UITs with the same portfolio strategies and with similar securities were issued in consecutive series.
WHAT WENT WRONG. Between December 2011 and December 2016 (the "Relevant Period"), certain Hennion & Walsh RRs recommended 645 early exchanges of proprietary UITs in the same series (a ‘series-to-series switch’) in 438 customer accounts that had substantially similar investment objectives and portfolios. Such series-to-series switches, which FINRA deemed unsuitable, resulted in over $305,000 in unnecessary sales charges.
- RRs did not reasonably assess whether the alleged benefits to the customers from the switches outweighed the additional sales charges the customers would incur by making the switch – and therefore, they did not have a reasonable basis to recommend these series-to-series switches.
- Hennion & Walsh did not provide reasonable guidance to its sales staff on the special suitability concerns raised by early series-to-series switches.
- While the firm’s written procedures stated that switch forms should be signed by the customer for UIT exchanges, it did not enforce this procedure.
- The firm's supervisory system was not reasonably designed to address early exchanges of a UIT - including a series-to-series switch - even though these are red flags that indicate potentially unsuitable transactions.
- Although the firm’s trade-alert system flagged UIT switches, the firm did not provide reasonable guidance in its procedures, or otherwise to supervisors, on how to evaluate such switches.
- The principal at the firm tasked with much of the day-to-day trade-review responsibilities did not receive training on how to evaluate series-to-series switches and he did not take into account the increased costs associated with an early exchange.
- Thus, although an early exchange of a UIT, including a series-to-series switch, is a red flag of a potentially unsuitable transaction, the Firm's supervisory system was not reasonably designed to address such transactions.
By virtue of the foregoing, the Firm violated NASD and FINRA rules pertaining to suitability and supervision.
Hennion & Walsh agreed to pay over $470,000 in fines and restitution to customers. The firm also agreed to certify to FINRA that it has established and implemented policies, procedures and internal controls reasonably designed to address and remediate the issues identified in the AWC.
AS IF THE BLIND WAS LEADING THE BLIND.
This case was reported in FINRA Disciplinary Actions for March 2019.
For further details, go to ... FINRA Disciplinary Actions Online, and refer to Case #2013039202501.
