FINRA hit Wells Fargo Investments with a $2 million fine and ordered the firm to pay restitution for making unsuitable sales of reverse convertibles to elderly clients and for not providing breakpoints on unit investment trust sales to eligible customers.
The regulatory agency also issued a complaint against former Wells Fargo registered rep, Alfred Chi Chen, who allegedly recommended the reverse convertibles and made unauthorized trades in several client accounts, including accounts of dead customers.
In the separate disciplinary complaint against the former rep, FINRA alleged that “Chen was so relentless in switching his customers, including the reverse convertible notes (RCN) customers, into reverse convertibles that he was Wells Fargo Investments second highest reverse convertible revenue producer in 2007, and in 2008 was the firm’s highest reverse convertible revenue producer.”
He was so successful, FINRA alleged, that Chen, who worked out of Wells Fargo bank branches, was promoted and given the title of vice president and senior financial consultant in April 2007.”
In a statement from Wells Fargo, a spokesman said via e-mail: "The issue involves conduct at a legacy firm which has been merged into Wells Fargo Advisors. Wells Fargo Advisors will continue to support the processes and procedures in place to prevent this kind of activity from happening. We are glad to have this behind us."
According to FINRA, Wells Fargo neither admitted nor denied the charges, but consented to FINRA’s findings.
Neither Chen nor his attorney could not be immediately reached for comment.
In the complaint against the former rep, FINRA alleged “Chen continued aggressively promoting reverse convertibles until approximately July 2008, when Wells Fargo demanded that he reduce his customers’ concentrations in the products.”
Chen allegedly made significant income from these sales, the FINRA complaint against him stated.
Chen was terminated by Wells Fargo around Nov. 26, 2008 and is no longer registered or associated with a FINRA member firm, the complaint stated.
According to the letter of acceptance, waiver and consent between FINRA and Wells Fargo, between January 2006 and July 2008, the firm through Chen made of “hundreds of unsuitable reverse convertible transactions in the accounts of 21 customers.” Many of those clients were elderly.
In fact, 15 were more than 80 years old and four were over 90, FINRA said. “As of May 2008, each of the 21 customer accounts held over 50% of investible assets in reverse convertibles.”
Furthermore, FINRA said in the letter, Chen “generated over $1 million in commissions from reverse convertible sales alone and at the end of 2007, over 75% of his total commissions were derived from reverse convertible sales.”
FINRA said that Wells Fargo failed to reasonably supervise Chen “despite numerous reasons for concern about the suitability” of his sales practices for these notes. From 2007 through mid-2008, “there was no adequate investigation into whether there were any suitability concerns given the large volume of sales in one product, and the large number of elderly customers in [Chen’s] book of business.”
Finally, in June 2008, Wells Fargo compliance “alerted Chen’s supervisor of excessive concentrations of reverse convertibles in his branch’s accounts and instructed the supervisor to investigate,” the FINRA letter said. At that time, Chen had 172 accounts that held the notes and 148 of those accounts held concentrations of RCNs of more than 50% and 46 had concentrations of more than 90%.
“Despite these red flags, the firm, through its supervisors, failed to take sufficient steps to determine whether the transactions identified in the report were suitable for [Chen’s] customers,” it said.
In one case, a client had an IRA account, which was non-discretionary, with Wells Fargo Investments in December 2005. The client died on Sept. 29, 2008 and about a week after the death on Oct. 7, 2008, Chen allegedly placed eight trades in the IRA account, buying almost $29,000 in securities and “all but depleting the available case in the account,” the FINRA complaint alleged.
Another customer had an investment account, also non-discretionary, with Wells Fargo beginning in January 2002. When that client died on Feb. 29, 2008, several days later on March 3, 2008, Chen allegedly sold 112 shares of Celgene Corp., stock, “generating proceeds of $6,201.91.”
In a third case, a client who was a self-employed accountant, had a trust account in December 2006 with Wells Fargo. It too was a non-discretionary account. On Sept. 2, 2008, this trust account held more than $20,000 in RCNs maturing on Oct. 3, 2008 as well as more than $35,000 in stocks and nearly $75,000 in cash in a money market fund. On that date, the client allegedly told Chen “that he was not to invest any of the cash in that account, for several reasons,” the FINRA complaint stated.
The client allegedly told Chen that she needed that cash to pay quarterly taxes and that she intended to use cash from the trust account to invest in her SEP IRA account. “In direct contravention of [the client’s] explicit instructions, on or about Sept. 24, 2008, Chen used the cash in [her] trust account to purchase a total of approximately $75,000 in mutual funds,” the FINRA complaint said. “These trades were unauthorized,” the complaint said.
And another client who was 83-years-old when she opened an account with Wells Fargo Investments in May 2002, bought a fixed annuity in the account based on Chen’s recommendation. In June 2007, the octogenarian opened a trust account and Chen recommended that she surrender the annuity and use the proceeds to buy RCNs in the new trust account. She was 88 at the time and “over the next 13 months, based on Chen’s recommendations, [she] purchased 46 RCNs.”
FINRA alleged that Chen made the recommendation despite the client’s instructions that she didn’t want to invest in equities. One of the risks of RCNs is that exposes investors to risks traditionally associated with equities, because repayment of principal is linked to the performance of an underlying asset—often a stock, a basket of stocks or an index.
Chen also had a retired interior designer as a client. In 2007, when the client was 70, her husband, a retired painter, died. The woman continued to keep her IRA and retail accounts with Chen. Right before the husband’s death, Chen allegedly recommended that they sell all of their securities at the firm and use the money to buy RCNs. When the husband died, Chen allegedly told the widow to sue the proceeds of her late husband’s fixed annuity (which was held outside the firm) to buy more RCNs.
By September 2007, virtually all of her investible assets totaling $409,000 “were concentrated in reverse convertibles or equities that had been underlying reverse convertibles…” Between May 2007 and July 2008, she bought 97 RCNs, FINRA stated. “These purchases were inconsistent with [her] investment profile and risk tolerance,” FINRA said.
FINRA also cited Wells Fargo Investments on its sale of unit investment trusts, alleging that between January 2006 and July 2008, the firm “failed to provide certain eligible customers with the “breakpoint” and “rollover and exchange” discount to which they were entitled.”
As part of the settlement, Wells Fargo must pay restitution to those clients who didn’t receive the UIT sales charge discount as well as to those customers who bought RCNs between January 1, 2006 and June 20, 2008 that “are deemed unsuitable.”
The firm also has to submit to FINRA a plan to review all RCNs sold during that period as well as a plan to review all customer UIT purchases during that period.
Frances McMorris is editor in chief of On Wall Street.
