Can my firm opt out of FINRA’s 529 Plan Share Class Initiative?

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Q: My firm chose not to participate in the FINRA 529 Plan Share Class Initiative. I’ve heard that the SEC was going to impose harsh penalties on firms that failed to self-report, and I’m now concerned that we didn’t participate. I’ve also been told that since this was a FINRA initiative, the SEC has no jurisdiction over this. Can you clear things up?

A: You may be confusing the SEC’s Mutual Fund Share Class Initiative with FINRA’s 529 Plan Share Class Initiative.

In 2018, the SEC launched a self-reporting initiative whereby the regulator agreed not to recommend financial penalties against investment advisors who self-reported violations of the federal securities laws relating to certain mutual fund share class selection issues and reimbursed clients for the excessive fees they incurred in purchasing more expensive mutual fund share classes when lower-cost share classes were available.

The SEC’s staff took the position that certain investment advisors failed to adequately disclose conflicts of interest related to the sale of higher cost mutual fund share classes — and the advisor’s receipt of Rule 12b-1 fees — when lower-cost shares were available, and had referred some firms to its Division of Enforcement for those violations.

The SEC allowed firms to self-report and reimburse clients for the excess costs they incurred. Those firms that did not self-report and were later found to have been in violation were subject to additional fines and penalties, as well as being ordered to refund clients for the excessive costs. (For more information, visit the SEC website.)

Unlike the SEC’s 2018 initiative, however, FINRA, in January 2019, announced a voluntary self-reporting initiative relating to 529 Plans. (See FINRA Regulatory Notice 19-04.) The FINRA initiative resulted from deficiencies the regulator had observed in connection with brokerage firms’ supervision of 529 plan recommendations. In particular, FINRA was concerned with firms’ failure to keep records of 529 plan transactions, failure to capture relevant suitability information and their failure to adequately train registered reps.

In FINRA’s initiative, unlike the SEC’s, brokerage firms were not required to participate in the initiative, and FINRA has stated that a firm’s failure to do so will not result in any additional penalties.

As noted on its FAQ page: If FINRA later determines that a firm that did not participate in the Initiative failed to reasonably supervise 529 plan sales, it will evaluate that matter in the ordinary course based on the facts and circumstances presented. The firm would not be eligible for an automatic fine waiver. However, FINRA will not increase the sanctions that it otherwise would have imposed solely because the firm did not participate in the Initiative.”

For more information, see FINRA’s FAQ page.

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