FINRA scrutinizes UITs as IBD settles case for $1.6 million

Failure to establish and maintain a supervisory system cost SagePoint Financial, Inc. a $1.6 million payout to the Financial Industry Regulatory Authority (FINRA).

What happened to SagePoint?

From January 2013 through December 2017, SagePoint failed to establish and maintain a supervisory system or to establish, maintain, and enforce written supervisory procedures (WSPs) to oversee the suitability of its representatives’ recommendations to customers for the early rollover of Unit Investment Trusts (UITs).

A FINRA member since May 2005, SagePoint is headquartered in Phoenix, AZ and fields approximately 1,800 registered reps across nearly 815 branch offices. And to date, the firm has not had any relevant disciplinary history with the Securities and Exchange Commission (SEC), any state securities regulators, FINRA, or any other self-regulatory organization. Until now. The firm violated NASD Rule 3010 (for its conduct before December 1, 2014), FINRA Rule 3110 (for conduct on or after December 1, 2014), and FINRA Rule 2010.

What was the UIT issue and exposure?

In this instance, representatives encouraged clients to sell their UITs prematurely. Typically, a UIT is an SEC-registered investment company offering investors shares or “units” in a fixed portfolio of securities in a one-time public offering. UITs terminate on specified maturity dates, often after 15 or 24 months. At this point, the underlying securities are sold and the resulting proceeds paid to the investors.

A UIT’s portfolio typically is not actively managed during this period – start to the maturity date. Sponsors generally offer UIT product lines in successive “series,” with the offering periods for new series usually coinciding with the maturity date of prior series. Successive UIT series frequently have the same or similar investment objectives and investment strategies as their predecessors regardless of the securities held in the portfolio.

Here’s where things got sticky. UITs impose a variety of upfront sales charges. During a typical 24-month UIT, three separate charges are imposed:

1. an initial sales charge, generally 1% of the purchase price;
2. a deferred sales charge, generally up to 2.5% of the offering price; and
3. a creation and development fee (C&D fee), generally 0.5% of the offering price.

Sponsors often waive the initial sales charge when the proceeds from a UIT’s sale are “rolled over” to fund the purchase of a new UIT, but they still apply the deferred sales charge and C&D fee. A registered representative recommending a customer sell a UIT before its maturity date causes the client to incur more significant sales charges – even if the proceeds are used to purchase a new UIT.

Early UIT rollover can nearly triple clients’ sales charges

How this plays out: A customer holds a 24-month UIT until maturity and pays a sales charge of approximately 3.95%.  However, if the customer rolls over the UIT to a new UIT after only six months, he or she will pay an additional 2.95% in sales charges. Rinse and repeat this behavior every six months and the customer will now have paid nearly 12.8% in sales charges over that two-year/24-month period.

SagePoint failed to establish and maintain a supervisory system and establish, maintain, and enforce WSPs while advising clients in matters contrary to the clients’ best interests.

1. During the time in question, the firm executed more than $895 million in UIT transactions that generated more than $17.2 million in sales charges.
2. The $895 million in UIT transactions included more than $203.7 million in proceeds from sales in which UITs were sold more than 100 days before their maturity dates. Moreover, some or all of the proceeds were used to purchase one or more new UITs (early rollovers).
3. Approximately $65.8 million of the proceeds were for transactions in which customers sold UITs more than 100 days before their maturity dates. Some or all of the proceeds were used to purchase a subsequent series of the same UIT, which had, in many cases, the same or similar investment objectives and strategies as the prior series (series-to-series early rollovers).
4. SagePoint’s WSPs did not discuss early rollovers or series-to-series early rollovers or otherwise guide firm supervisors in how to monitor for potentially unsuitable patterns of early or series-to-series early rollovers.
5. Further, the firm did not use automated reports, alerts, or similar tools to supervise for potentially unsuitable patterns.

SagePoint compliance system failed it because it could not flag representatives recommending potentially unsuitable early rollovers. This lack of oversight cost  customers $1,315,373.01 in unnecessary sales charges. And SagePoint was sanctioned, censured, and fined $300,000 along with restitution payments to clients of $1,315,373.01 plus interest.

Where was compliance?

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