Avalon Investment Securities Group a brokerage firm headquartered in Muscle Shoals Alabama has been censured and fined by Financial Industry Regulatory Authority (FINRA) supported by allegations that the firm had failed to supervise its brokers’ sales of variable annuity products. Letter of Acceptance Waiver and Consent No. 2016047823901 (Oct. 25, 2018).
According to the AWC, between November 1, 2013 and May 31, 2016, Avalon neglected to create and implement a supervision system and supervisory procedures geared towards ensuring that its brokers’ annuity recommendations were compliant with securities laws and FINRA rules.
The AWC stated that FINRA mandates specific supervisory protocols to be set forth by firms in order to ensure that the annuities sold to customers are suitable for them given the complexity of variable annuities, the variety of options and features available to customers who purchase them, and the potential for sales practice violations to be committed by brokers.
FINRA stated that the firm was required to abide by FINRA Rule 2111, which requires the firm or broker to have an adequate foundation to conclude that transactions are suitable for a customer based on the customer’s investment profile. The AWC stated that the firm and brokers were also required to abide by FINRA Rule 2330, which mandates brokers to establish an adequate foundation to conclude that annuity purchases are suitable. FINRA Rule 2330 requires that firms and brokers reasonably believe that the customers understand, inter alia, the features and benefits of the annuity, the surrender penalties, tax consequences, charges for riders, and the terms of guaranteed income through annuitization. The firm’s principals were also mandated under FINRA Rule 2330 to review recommendations to determine suitability and whether rates of exchanges were problematic and violative of securities laws and FINRA rules.
The AWC stated that Avalon sold customers annuities that were housed with the issuer of the annuity rather than with Avalon; the firm did not hold customer funds. Evidently, the firm erroneously believed that it did not have full responsibility to supervise annuity sales for suitability. Consequently, the AWC stated that the firm did not create and implement a reasonable supervision system and written supervisory procedures geared towards ensuring that the brokers’ recommendations were appropriate for customers.
According to the AWC, despite the firm’s procedures requiring a principal to sign off on variable annuity applications, no review for suitability was conducted. Instead, the brokers were relied upon by the firm to determine if their own recommendations were appropriate. Apparently, none of the variable annuity transactions had been questioned by principals. Moreover, the AWC stated that Avalon erroneously believed that the issuer of the annuities, rather than Avalon, would conduct a suitability review to weed out any transactions that appeared unsuitable for customers.
The AWC stated that the firm’s brokers and supervisory personnel consistently failed to make sure that the documentation referencing each customer’s annuity purchases were accurate and complete. Apparently, there were inconsistencies in the documentation regarding: surrender charges customers would be exposed to by exchanging annuities; the loss of living benefit riders and death benefit riders upon exchanging existing annuities into new annuities; the history of customers’ prior variable annuity exchanges; and whether the customer stood to generate any benefit whatsoever through the variable annuity.
In one case referenced by the AWC, a broker, JS, neglected to complete a Variable Product Replacement Form in all fourteen of his customers’ variable annuity transactions. Despite the firm’s supervisory personnel having been required to abide by Rule 2330(c), the firm’s supervisory personnel authorized all of JS’ transactions. Additionally, in the course of JS effecting twelve annuity exchange transactions, JS reportedly failed to produce a comparison of features of customers’ existing annuities with the annuities that the customers exchanged into.
The AWC also stated that with ten annuity transactions executed by JS, Variable Annuity Disclosure Forms were submitted without customer signatures. Consequently, FINRA stated that there was no evidence that customers had been apprised of the features and drawbacks of variable annuities, including information about the mortality and expense charges, surrender periods, tax consequences, and charges for riders and other features. The AWC indicated that all ten transactions had been authorized by the firm’s supervisory personnel.
The AWC also revealed that the firm authorized annuity transactions even though the applications contained conflicting information. Specifically, broker FN submitted three applications which contained customer information that failed to match the customer’s liquidity needs as stated in other parts of the application. In those cases, the documents showed that the customer planned on taking distributions within one-to-five years, but other parts of the application showed that the customer did not have short term liquidity needs. Evidently, customers took distributions early in their annuity terms, incurring unwarranted surrender charges.
FINRA also stated that the firm’s supervisors approved some transactions that resulted in up to eighty percent of customers’ funds being placed in an annuity even though the supervisory procedures required a heightened review and scrutiny of transactions where customers were placing a considerable percentage of their net worth in the products. The AWC further revealed that the firm never utilized a supervision system to monitor brokers’ rates of exchanges to determine if they were not suitable.
FINRA found the firm’s supervisory failures pertaining to annuities to be violative of FINRA Rules 2010, 3110, 2330(c) and 2330(d).
FINRA also found that the firm failed to supervise its mutual fund recommendations and transactions effected by its brokers. Particularly, it neglected to ensure that mutual fund share classes recommended to customers by brokers had been suitable for customers. The firm’s supervisory personnel reportedly failed to conduct a review of the recommendations, and did not mandate that the brokers’ suitability reviews be documented. In one case, a broker, WF made recommendations for customers to purchase class A shares; however, there was no justification for this. WF’s actions were apparently never questioned by supervisory personnel.
In addition, the firm did not create and implement a system to monitor whether customers received breakpoint discounts on transactions. Consequently, at least eleven of the eligible customer accounts failed to be provided breakpoint discounts. FINRA found that the firm’s supervisory failures in this respect were violative of FINRA Rule 2010, 3110 and NASD Rule 3010.
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