FINRA Sanctions Essex Securities for Failing to Supervise Mutual Fund Switching

shutterstock_184429547The Financial Industry Regulatory Authority (FINRA), in an acceptance, waiver, and consent action (AWC), sanctioned brokerage firm Essex Securities, LLC (Essex Securities) alleging that from February 2010, through March 2011, Essex Securities through one of its brokers violated industry rules by engaging in a pattern of unsuitable mutual fund switching, a form of churning, in the accounts of seven customers. Further, FINRA found that Essex Securities violated FINRA’ supervisory rules by failing to establish and maintain a supervisory system reasonably designed to prevent unsuitable mutual fund switching.

Essex has been a FINRA member broker-dealer since 1998, is headquartered in Topsfield, MA, and conducts a general securities business with approximately 50 brokers out of 26 branch offices.

FINRA alleged that an Essex Securities broker engaged in a pattern of unsuitable mutual fund switching in seven customer accounts by not having reasonable grounds for believing that such transactions were suitable for those customers due to the frequency of the transactions and the transaction costs incurred. Part of the suitability rule requires brokers to take into consideration the cost consequences of the transactions and ensure that there is a reasonable basis for the incurring of such costs. In this case, FINRA found that on at least 29 occasions, the broker recommended that customers sell mutual funds within only one to thirteen months after purchasing them. Essex Securities was found to have earned commissions of approximately $60,000 on these switch transactions and broker himself was paid approximately $54,000.

On average, FINRA determined that the customers held Class A mutual funds for less than 6 months. FINRA then found that the broker used the proceeds of those sales to purchase mutual funds offered by other fund families for those customers, causing the customers to pay additional commissions. This pattern of mutual fund switching was found to be unsuitable because it incurred additional costs on the customers without any corresponding benefit.

In addition, FINRA found that Essex Securities failed to establish and maintain a supervisory system reasonably designed to prevent the unsuitable mutual fund switching. According to FINRA, the Firm’s written procedures stated that “mutual funds are to be sold as long-term investments with a minimum holding period of three to four years.” However, FINRA found that the firm lacked adequate systems and procedures to monitor for unsuitable mutual fund switching in customer accounts.

For instance, the firm had no exception reports or procedures to monitor for trends or patterns involving representatives who effected multiple mutual fund switch transactions for a customer within a short time period. Furher, FINRA found that the firm did not provide guidance to supervisors regarding the appropriate steps to determine such issues as whether a registered representative may have engaged in unsuitable short term and/or unsuitable mutual fund switching; whether a registered representative recommended the appropriate share class in a mutual fund switch transaction; or what action was necessary once a pattern of mutual fund switching was detected.

Investors who have suffered losses through excessive trading and churning may be able recover their losses through arbitration. The attorneys at Gana LLP are experienced in representing investors in cases where brokerage firms fail to supervise their representatives trading in client accounts. Our consultations are free of charge and the firm is only compensated if you recover.