Three years ago, the Financial Industry Regulatory Authority Inc. fined a mid-sized independent broker-dealer, Berthel Fisher & Co. Financial Services Inc. and an affiliate firm, a whopping $775,000 for a variety of failures to supervise sales of nontraded real estate investment trusts and leveraged exchange-traded funds that took place from 2008 to 2012.
Now, Berthel Fisher, with 350 reps operating in 230 branch offices, is in hot water again over failing to supervise the sale of an investment product. This time, sales of unit investment trusts are the issue, and Finra last month sued Berthel Fisher and its former broker, Jeffrey Dragon, for structuring sales from 2013 to 2014 of UITs to clients in order to allegedly avoid reaching levels at which breakpoint discounts would kick in, harming clients, but boosting the broker's commission.
Berthel Fischer fired Mr. Dragon in September, because it "believed he did not adhere to a term of his heightened supervision agreement, which required him to run all business, including fixed indexed annuities, through the firm's commission grid," according to Mr. Dragon's BrokerCheck profile. The Finra complaint alleges he generated more than $421,000 in commissions for himself and Berthel, by recommending short-term trading of the UITs, inconsistent with the buy and hold design of the products and also requiring clients to pay "substantial" sales charges.
Specifically, he recommended to 12 clients, many of whom were seniors and unsophisticated investors, that they liquidate UIT positions that they had held for only a few months, and which they had purchased on Mr. Dragon's advice, and then use the proceeds to purchase other UITs, according to the Finra complaint. Nearly all of the UITs at issue carried sales charges totaling 3.95% before available discounts.
"Berthel allowed this activity to occur — and in fact, profited from it — as a direct result of the inadequate system for supervising UIT trading," the complaint says. "Throughout the UIT period, Berthel's only regular supervisory review of UIT recommendations and customer activity consisted of manual reviews of daily trade blotters that did not indicate either how long UIT positions had been held before liquidation or the source of funds used to purchase UITs."
What's more, the firm lagged on its oversight of flipping of mutual funds, a perennial issue with regulators, the complaint alleges. "Berthel's supervisory system was also inadequate because it was not reasonably designed to prevent short-term and potentially excessive trading in mutual funds," according to the complaint.
A UIT is a type of fund that is a mix between an actively managed fund and a fixed portfolio of income-producing securities that is purchased and held to maturity. UITs typically issue redeemable securities, or units, like a mutual fund, which means that the UIT will buy back an investor's units, at the investor's request, at their approximate net asset value, according to the Securities and Exchange Commission.
For the past couple of years, Finra has been cracking down on firms for missing discounts on UIT sales, after conducting a sweep of broker-dealers. So, Berthel Fisher is not alone for drawing Finra's attention on UIT sales.
What stands out with Berthel Fisher is that the alleged failure to supervise the short-term trading of UITs by Mr. Dragon is that it occurred right after the firm was whacked for failing to supervise sales of nontraded REITs, if Finra's complaint is to be believed. It would stand to reason that, after having its feet held to the fire by Finra over nontraded REIT sales, it would button up its compliance and review of sales of esoteric products like UITs.
"Berthel Fisher has a very aggressive culture when it comes to sales practices," said Andrew Stoltmann, a plaintiff's attorney who said he has sued the firm on behalf of clients about ten times in Finra arbitration. "My opinion is that culture is ingrained at the firm even though they get whacked. The leopard doesn't really change its spots. It's just the latest in a long series of issues that Berthel Fisher has had."
Unlike nontraded REITs, UITs are "liquid" products and make up only 1% of Berthel Fisher's business, firm spokeswoman Shelli Brady wrote in an email, who stressed that the firm has always taken compliance obligations seriously.
"The reality is UITs have been the source of compliance problems industry-wide," Ms. Brady wrote. "In fact, as reported by your publication, Finra has fined at least 25 independent broker dealers over UIT transactions. While we cannot comment on ongoing proceedings, we can say that the firm has cooperated fully with Finra and has made refunds to clients. We look forward to presenting the firm's side of the case at the appropriate time."
Wouldn't it make more sense for Berthel Fisher and other firms to fix a problem like failing to supervise product sales by brokers before they get fined by Finra? A firm saying it takes compliance seriously is one thing; acting on those words is another.