by Howard Haykin

Wells Fargo Clearing Services and Wells Fargo Advisors Financial Network agreed to pay more than $3.4Mn in restitution to affected customers to settle charges that their registered reps made unsuitable recommendations of volatility-linked exchange-traded products ("Volatility ETPs" or “VETPs”) without fully understanding their risks and features.

No fines were issued in this case, owing to the following considerations: (i) in May 2012, prior to detection by FINRA, Wells Fargo corrected its supervisory deficiencies relating to Volatility ETPs; (ii) the firm was previously fined $2.1Mn in May 2012 – after the misconduct and its remediation herein – for similar violations relating to Non-Traditional ETPS; and, (iii) the firm provided substantial assistance to FINRA by, among other things, engaging at its own expense a consulting firm to review, compile, and calculate large amounts of data pertaining to sales of Volatility ETPs for use in determining the appropriate restitution to be provided.

BACKGROUND.  St. Louis, MO-based Wells Fargo Clearing Services engages in a general securities business, has around 9,327 registered reps, and maintains 727 branch offices nationwide. WFCS is the successor firm to several related broker-dealers, including Wells Fargo Advisors, Wells Fargo Investments. Wells Fargo Advisors Financial Network, also based in St. Louis, MO, engages in a general securities business, has around 1,404 registered reps, and maintains 663 branch offices nationwide.

FINRA FINDINGS.    From July 2010 to May 2012 (the "Relevant Period"), certain Wells Fargo registered reps recommended Volatility ETPs to brokerage customers without fully understanding their risks and features. Certain reps mistakenly believed that VETPs could be used as a long-term hedge on their customers' equity positions in the event of a market downturn. In fact, VETPs are generally short-term trading products that degrade significantly over time and should not be used as part of a long-term buy-and-hold investment strategy.

Where Did Wells Fargo’s Supervision Falter?   Beginning in 2009, Wells Fargo created supervisory systems and procedures designed to place certain restrictions on recommendations and purchases of Non-Traditional ETPs. 

-  e.g., the firm implemented a systematic “hard block” that prevented retail brokerage customers from purchasing Non-Traditional ETPs unless they had the most speculative investment object. It also required firm supervisors to contact retail brokerage customers who held Non-Traditional ETPs for longer than 30 days and explain the risks of continuing to hold the products.

However, Wells Fargo did not consider or implement similar restrictions regarding Volatility ETPs, or provide reasonable guidance to registered reps regarding their recommendations of Volatile ETPs until May 2012. By July 2010, when it was widely acknowledged that Volatility ETPs’ cost structure created unique risks, the firm’s existing system to supervise its reps’ recommendations and sales of Volatility ETPs was not reasonable in light of those heightened and well-known risks. This continued until May 2012, when the firm enhanced its procedures by, among other things, restricted the purchase of Volatility ETPs.

In late 2016, Wells Fargo further restricted sales of Non-Traditional ETPS including Volatility ETPs, by prohibiting all purchases of these securities in any retail brokerage customer accounts.

Where Else Did Wells Fargo’s Oversight Falter?    Wells Fargo’s supervisory systems did not include reasonable training for registered reps and supervisors regarding the features and risks associated with Volatility ETPs. As a result, certain retail brokerage customers were uninformed about the features and risks associated with Volatility ETPs prior to purchasing them.

FINANCIALISH TAKE AWAYS.    FINRA's decision not to fine Wells Fargo was tempered, in part, by the firm's cooperation in the case and by the firm's remediation efforts before FINRA detected the regulatory violations and supervisory failures. It also helped that Wells Fargo had deep pockets to shoulder the considerable costs. 

Cooperation between FINRA and its member firms is essential for a robust regulatory environment. And as I have frequently said, cooperation is a two-way street. Such a relationship requires transparency and empathy (not recrimination) on both sides of the table. That is something that FINRA must initiate and nurture throughout its organization - and President and CEO Robert Cook and his team are to commended for their positive efforts to date. I look forward to more of the same from FINRA. It's only a matter of time before more member firms feel comfortable enough to contribute fully toward a constant and credible partnership. 

[For further details on this case, go to ...  FINRA Disciplinary Actions Online, and refer to Case #2014042465601.]