[ by Howard Haykin ]

RR Breaks Even after FINRA Sanctions, while Customer Up for next 30 Years and is worth more dead than alive - sorry to say.

FINRA Has 9 (nine) priorities.  Click the linked titles to read #'s 1 and 2.  #3 is in this posting. 

All others are accessible at:   [FINRA Quarterly Review, October 2012].

1. Sharing Commissions With an Unregistered Individual and Providing False Information to Firm.  [posted Friday]
2. Fraudulently Misappropriating Customer Funds.  [posted Monday]
3. Recommending Unsuitable Transactions to a Customer  [posting now, Monday]
4. Willfully Failing to Disclose Material Information on a Form U4
5. Exercising Discretion Without Customer and Firm Approval
6. Improperly Engaging in Outside Business Activities, Improperly Accepting Gifts From a Customer, and Misrepresenting to a Member Firm the Receipt of Monetary Gifts From a Customer
7. Recommending Unsuitable Transactions to a Customer
8. Improperly Borrowing From a Customer and Misrepresenting Facts to a Member Firm
9. Selling Away

FINRA Priority #3 for October - Recommending Unsuitable Transactions to a Customer.   This violation has been around so long and has been the subject of countless arbitration hearings.  These days, there can be enormous risk associated with a broker making inappropriate recommendations to his or her clients.

• Many investors do not have enough cushion in their portfolios to withstand significant losses of principal. 
• Many investors, desperate for some sort of decent interest or dividend income have been drawn to junk bonds and other low rated investment.  Because demand has so far outstripped supply, many of these investors are caught up in these lesser-quality investments in 2 ways:  (i)  these investors hold too much junk and other low-rated securities relative to their more conservative holdings are weighted too heavily in their portfolios;  and, (ii) they are not adequately compensated for the risks they incurred by buying these low-rated securities - i.e., risk of being repaid their capital).  

That said, he's what FINRA had to say on the topic:

FINRA settled a matter involving a registered rep ("RR") who recommended unsuitable transactions to a customer, whose profile, when she first joined his, was as follows: 

• widow, 53, working as an administrative assistant for a public school system; 
• earned $55,000/year.
• owned her home, valued at $500K;  no mortgage.
• her investment portfolio consisted of:  $160,000 in retirement accounts;  $100,000 in CDs. 
• customer intended to retire wtihin 7 years - at age 60.
• her retirement income would consist of a pension and Social Security benefits.

The RR recommending that the customer take a mortgage on her home and invest the proceeds.  Customer received a fixed rate loan at 6-1/8% rate on a $315,000 mortgage;  RR got referral fee of $1225.  Customer received $311,000 - which was net closing costs and had a 30 year term with monthly payments of $1,900.

RR recommended customer put $300,000 into a variable annuity, and he made certain fund allocations for the annuity.  The RR's commission was $4,725 - so he, so far has earned $5950 with this client.   Yet, RR knew at the time of the recommendations, that could not pay her monthly mortgage without using her other investment assets.

FINRA concluded the RR did not have a reasonable basis for his recommendations given that:

• customer encumbered her primary residence with a mortgage.
• a $300,000 variable annuity did not provide sufficient income for a person retiring in 7 years, because of her monthly mortgage.
• RR's actions violations violated NASD Rules 2110 (ethical standards) and 2310 (recommendations to customers), and IM-2310-2. 
• RR agreed to a $5,000 fine and 10-day suspension.  

C-I Note: So what we know at this point about the customer: 

• customer has shelled out $4000 in closing costs; 
• customer holds a variable annuity and thus, will incur annual administrative and life benefit charges each year.
• her VA is invested in who knows what - some sub-account portfolio with no stated risk level, which probably no one will monitor.
• customer is obligated to make mortgage payments of $1,900 a month for the next 30 years. for the next 30 years of her life to pay $1,900 a month in mortgage payments, or nearly $23,000 a year.
• customer will have to generate at least 8% returns, net of tax, each year - just to cover her costs.  Forget about those years when her investments drop in value.  Then she's really under water.
• finally, if customer wants to get out of annuity sometime in the next 7 years, she will have to pay penalties for early redemption.

So what we know about the Broker (RR):

• He's earned nearly $6,000 on the account.
• He must pay a $5K fine- so, let's say he's broker even.
• He gets 10 days in "suspension, vs. his customer's 30 years under mortgage.
• After 10 days, he moves on with his life and burdens another customer.

Thank you, FINRA.