The Financial Industry Regulatory Authority has fined HSBC Securities Inc. $375,000 for failing to provide retail clients with accurate information surrounding the sale of inverse floating rate collateralized mortgage obligations.
According to the regulator’s announcement Thursday, HSBC allegedly dropped the ball in its attempts to closely monitor their brokers who did not provide sufficient and detailed information to customers regarding the risks involved when allocating money to an inverse floating rate or other potentially risky CMO investment.
FINRA said in a statement that HSBC also paid customers restitution of $320,000, in addition to the fine.
HSBC has addressed the issues raised by FINRA, which occurred prior to June 2007, and are pleased to resolve this matter, said an HSBC spokesperson, who declined to comment further on the issue.
Based on the HSBC’s procedures, any sales over $100,000 required a supervisor’s pre-approval. But, FINRA contends that while 25 of the 43 transactions exceeded $100,000 about five customers lost money after investing in their CMO.
FINRA also found that the firm did not enforce and put in place an adequate supervisory system relating to CMO sales. Six of HSBC’s brokers carried out a total of 43 inaccurate sales of inverse floaters to retail customers who were not financially prepared for high-risk investments, FINRA said in a statement.
A CMO is commonly referred to as a fixed income security that combines mortgages and issues tranches with various characteristics and risks.
CMOs make principal payments throughout the life cycle of the security with the maturity date being that last day where all of the principal must be returned. However, the timing of the return of principal payments is variable because of the fluctuating interest rate changes. And investors should have been told about those risks, FINRA said.
Since 1993, FINRA has advised firms that inverse floating rate CMOs "are only suitable for sophisticated investors with a high-risk profile."
HSBC also failed to inform its registered representatives of the risks associated with inverse floaters and the type of clients who should invest in CMOs, FINRA contended.
FINRA’s probe further revealed that HSBC failed to provide proper guidance for its brokers regarding the risks and suitability of CMOs.
HSBC was not in compliance with a rule the regulator adopted in 2003 where firms must provide educational materials to retail investors prior to the sale of a CMO. FINRA states that the materials should include a breakdown of the risks that can be incurred after the sale of a CMO and the risks involved with different tranches.
The regulator reports that not only did the brochures not meet its content standards, HSBC brokers did not even supply investors with those educational brochures regarding CMOs.
“Firms must adequately train their brokers on all of the products that they are selling and must reasonably supervise them to ensure that every security recommended is suitable for the particular customer,” James S. Shorris, FINRA’s executive vice president and acting chief of enforcement, said in a press release. “The losses incurred by HSBC's customers likely would have been avoided had the firm sufficiently trained its brokers on the suitability and risks of inverse floating rate CMOs and reasonably supervised their brokers to ensure that they were making suitable recommendations.”
Aarti N. Maharaj writes for
