Finra has given broker-dealers until April 1 to voluntarily report share class violations in the 529 plans they sell or face censure.
Broker-dealers that self-report their advisors’ 529 plan share class violations and quickly reimburse customers for pricier C share mutual funds will have their regulatory fines waived if Finra does decide to bring an enforcement action, according to an initiative announced Monday.
Finra is launching the 529 Plan Share Class Initiative to encourage firms to “promptly remedy potential supervisory and suitability violations related to recommendations that customers of 529 plans buy share classes that are inconsistent with the accounts’ investment objectives, and to return money to harmed investors as quickly and efficiently as possible,” FINRA said.
In order to encourage voluntary reporting, Finra's Department of Enforcement will recommend that Finra accept favorable settlement terms for firms that self-report these potential violations and provide Finra with a detailed remediation plan, the regulatory organization said.
"By focusing on restitution and rapid remediation through the 529 initiative, Finra is working with firms that demonstrate a commitment to fixing potential problems and making customers whole promptly," said Susan Schroeder, Finra's executive vice president of department of enforcement.
"Finra's highest priority in an enforcement action is to first seek restitution to any harmed investors," she said. "We also seek to ensure that systemic deficiencies are remediated. In this initiative, we are sharing our concerns and observations about sales of 529 plans to achieve these goals as quickly and effectively as possible."
Over the past several years, Finra examiners have found that some firms have failed to reasonably supervise brokers’ recommendations of multi-share classes and share-class recommendations on 529 plans, which are tax-advantaged mutual fund or municipal securities that are designed to encourage saving for the future educational expenses of a designated beneficiary.
Of particular interest to examiners are brokers’ recommendation of Class C shares, which are almost always more expensive when held for the long term, Finra said. Finra has cautioned that customers should be informed “of the potential long-term effect of the higher ongoing sales charges” associated with holding Class C shares, and that firms should “maintain written records of [such] discussions in their files,” the notice said.
Just last year, the IRS broadened the use of 529 plans to cover kindergarten, elementary and secondary school expenses. While 529 plan distributions have traditionally been tax-free when used to pay for qualified higher education expenses, as of January, 2018, the IRS changed the rules to make up to $10,000 per year in 529 plan withdrawals tax-free if used for elementary or secondary educational expenses (e.g., expenses incurred when the beneficiary is as young as four or five years old).
“These additional considerations underscore the importance of recommending a share class that is tailored to the unique circumstances and needs of the customer, as well as the importance of supervising such recommendations,” Finra said.