Broker-dealers are still allowing illegal transactions and withdrawals from minors’ accounts and even ignoring red flags including customer complaints about the activity, the Financial Industry Regulatory Authority (Finra) warned today.

The legal warning to the industry comes just two months after Finra sanctioned Citigroup Global Markets Inc.; J.P. Morgan Securities LLC; LPL Financial LLC; Morgan Stanley Smith Barney LLC; and Merrill Lynch, Pierce, Fenner & Smith Inc. for widespread violations relating to their failure to supervise illegal transactions in Uniform Transfers to Minors Act (UTMA) and Uniform Gifts to Minors Act (UGMA) accounts. The five firms paid combined fines totaling $1.4 million to settle the charges.

UTMA and UGMA accounts are custodial accounts that provide a way to transfer property to a minor beneficiary without the need for a formal trust. The named custodian makes all investment decisions on the beneficiary’s behalf until the beneficiary reaches the age of majority (usually age 21), at which point the custodian is required by state law to transfer control over the account to the beneficiary.  

Broker-dealers’ failure to transfer control and supervise the accounts, which are set up to protect the financial interests of minors, have allowed terminated custodians to make withdrawals and transfers in minors’ accounts months or years after their custodial authority is terminated, Finra said in the new notice.

Investor losses that arise when terminated custodians are essentially allowed to raid accounts they no longer legally should be allowed to touch has put the issue squarely on securities attorneys’ radar. “We are watching this closely and anticipate bringing cases of unauthorized trading and transactions against broker-dealers as a result of this continued type of failed supervision,” said Adam Gana, a securities fraud attorney at New York City-based Gana Weinstein LLP, in an interview with Financial Advisor.

If unauthorized transactions occur in UTMA and UGMA accounts, the broker-dealer is “irrevocably responsible” for failing to supervise and prevent the violation, Gana added.

In December, as part of the original announcement, Finra said the five sanctioned firms permitted customers to open UTMA and UGMA accounts, “yet failed to establish, maintain and enforce reasonable supervisory systems and procedures to track or monitor whether custodians timely transferred control over custodial property to account beneficiaries. As a result, UTMA account custodians authorized transactions in UTMA accounts months, or even years, after the beneficiaries reached the age of majority and after the custodians had become obligated to transfer the custodial property.”

Finra rules “require firms to verify the authority of any person purporting to act on behalf of a customer,” said Jessica Hopper, an executive vice president of Finra and its head of enforcement.

“This is essential to safeguarding customer assets,” Hopper added, “particularly in the case of UTMA and UGMA accounts, where it is essential for firms to implement supervisory systems reasonably designed to verify custodians’ authority to make investment decisions after the account beneficiaries reach the age of majority.”

Specifically, the firms were found to be in violation of “know your customer” rules, which require broker-dealers to verify essential facts about a customer at intervals reasonably calculated to prevent and detect any mishandling of the customer’s account that might result from the customer’s change in circumstances.

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