January 22, 2018
In today's BrokeAndBroker.com Blog, our publisher Bill Singer, Esq. analyzes an excellent FINRA AWC involving the promotion of a charitable remainder trust by a registered rep. Bill applauds FINRA's well-written settlement and finds the self-regulator's rationale compelling. On top of that, the imposed fine and suspension seem balanced and fair. The regulator did a superb job in presenting its case. The Respondent's lawyer did a superb job in negotiating a reasonable package of sanctions. Unfortunately, there's a voluntary Corrective Action Statement appended to the published AWC and as BrokeAndBroker.com readers know, Bill doesn't like these after-thoughts -- not one bit.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Sandeep Varma submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Sandeep Varma, Respondent (AWC 2014040164801, January 19, 2018).
The AWC asserts that Varma was first registered in 1990 and from 1995 through October 2015, he was registered with FINRA member firm LPL Financial LLC. The AWC asserts that he has "no relevant disciplinary history."
CRT Tax Strategy
As set forth in part in the AWC, starting in the early 1990s, Varma purportedly employed a tax-strategy using a charitable remainder trust ("CRT") with certain customers as follows:
[C]ustomers would typically sell appreciated real estate through a CRT, without immediately paying capital gains tax on the sale, and the proceeds from the sale could then be invested in various investment instruments held within the CRT. Typically, Varma recommended that the proceeds from the sale be invested in variable annuities held within the CRT. At the time the CRT was created, Varma's customers would also typically purchase some form of life insurance policy through an irrevocable children's trust to replace the value of the appreciated asset for the customers' heirs. Varma's customers would then take periodic, required income from the CRT and use the income from the CRT to pay, in whole or in part, premiums associated with the life insurance policy Varma recommended to replace the value of the sold appreciated asset.
As set forth in part in the AWC, from September 2013 through February 2014, Varma allegedly conducted four seminars promoting the use of CRTs. The AWC alleges that about 70 prospective customers attended these seminars, during which. Varma delivered a written presentation in the form of a slide deck that he had created.
Oversimplified and Misleading
The AWC deemed Varma's presentation as oversimplified and misleading in violation of FINRA Rule 2210(d)(1)(A) and (B), and cited the following in support of that allegation:
Varma's presentation repeatedly referenced the elimination of capital gains tax on the sale of appreciated assets by using the CRT strategy. The presentation failed to disclose, however, that the strategy only avoided capital gains tax at the time of the sale of the appreciated asset. Specifically, if the investments held in the CRT purchased with the proceeds of the sale performed poorly, then the principal of the proceeds would be invaded to pay the CRT's required, periodic income and, in that case, the customer may have to pay some portion of the capital gains taxes from the sale of the appreciated asset. . .
Unfair and Unbalanced
Also, the AWC deemed Varma's presentation as having failed to provide a fair and balanced discussion of the risks associated with the strategy in violation of FINRA Rule 2210(d)(1)(A). and cited the following in support of that allegation:
By illustration, Varma's presentation depicted the purchase of a significant life insurance policy to replace for the prospective customers' heirs the value of the appreciated asset sold to fund the CRT. The presentation, however, failed to disclose that the customers' ability to pay the life insurance premiums using income from the CRT was dependent on the performance of the investments held by the CRT. The seminar presentation further failed to disclose the potential risk that the life insurance policy could lapse should customers be unable to afford to pay premiums associated with maintaining it or that the life insurance policy payout was dependent on the claims-paying ability of the insurance provider. . .
Unsound Basis for Evaluation
Finally, the AWC deemed Varma's presentation as having failed to provide a sound basis for evaluating the CRT investment strategy and violated FINRA Rule 2210(d)(1)(A) and (B), and cited the following in support of that allegation:
The presentation depicted increased income and improved cash flow from employing the CRT strategy, as well as the increased amounts left to the customers' heirs due to securing the substantial life insurance policy. In doing so, the presentation projected performance of assets held in the CRT in an exaggerated and promissory manner by projecting only positive performance and not clearly disclosing how negative investment performance could affect the strategy. . .
In accordance with the terms of the AWC, FINRA imposed upon Varma a $15,000 fine and a 10-business-suspension from associating with any FINRA member firm in any capacity.
Bill Singer's Comment
The Varma AWC includes a provision under "III. OTHER MATTERS" that states:
D. I may attach a Corrective Action Statement to this AWC that is a statement of demonstrable corrective steps taken to prevent future misconduct. I understand that I may not deny the charges or make any statement that is inconsistent with the AWC in this Statement. This Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
Respondents in a settled disciplinary action may submit a Corrective Action Statement and/or a Mitigation Statement to NASD Regulation. This article clarifies the NASD policies regarding such Statements.
A Letter of Acceptance, Waiver and Consent (AWC) permits a respondent in an NASD Regulation disciplinary action to settle the matter prior to the filing of a formal complaint. A Corrective Action Statement may be attached to the AWC, which is filed with the SEC and available to the public, provided such statement is: (1) limited to demonstrable steps taken to correct a problem associated with the disciplinary action; (2) generally no longer than 2-3 pages; and (3) contains the following legend:
This Corrective Action Statement is submitted by the Respondent. It does not constitute factual or legal findings by NASD Regulation, Inc., nor does it reflect the views of NASD Regulation, Inc., or its staff.
Separately, respondents may submit a Mitigation Statement for consideration by NASD Regulation and the National Adjudicatory Council. Generally, such Statements are used to describe mitigating circumstances surrounding the violation for the decision maker to consider in its review of the terms of a settlement. Unlike Corrective Action Statements, Mitigation Statements are not attached to the AWC or public order.
Respondents may also settle a matter after the complaint is filed by submitting an Offer of Settlement. While both Corrective Action and Mitigation Statements may be submitted to NASD Regulation in connection with Offers of Settlements, these Statements are not attached to the final Order Accepting the Offer of Settlement, which is filed with the SEC and available to the public.
NASD Regulation will not accept Corrective Action or Mitigation Statements that deny the allegations or are inconsistent with the findings in the settlement. . .
FINRA AWCs permit the attachment of a Corrective Action Statement to demonstrate the steps taken by a respondent to prevent future misconduct subject to the understanding that such an attachment may not deny the charges or make any statement that is inconsistent with the AWC. Further the Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
I am no fan of Corrective Action Statement and rarely, if ever, advocate their use. Given that the premise of an AWC is a settlement made without admitting or denying the findings, I don't understand why anyone would voluntarily submit a statement that typically make admissions of facts and findings; promises to correct situations that have not necessarily been acknowledged or admitted to; and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal. If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it.
Some think that a Corrective Action Statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. As with any post-game analysis, it's just not going to change the score. Moreover, if during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in your statement, or, it is alleged that you failed to implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission.
I notice that some settling Respondents submit a Corrective Action Statement that details a proposed or in-place supervisory scheme at a current FINRA member firm -- which takes on the trappings of a proposed scheme of enhanced supervision of a statutorily disqualified individual attendant to the filing of a FINRA Membership Continuance Application (the "Form MC-400") http://brokeandbroker.com/PDF/MC400.pdf. I find this written proposal an ill-advised practice because most AWC Respondents are merely suspended and fined and are not subjected to any further regulatory constraints after their time is served and the dollars paid. If FINRA wants to impose specific supervisory conditions upon a settling Respondent or require the submission of an undertaking by the registered rep or member firm, then so be it. On the other hand, why any member firm would draft an extensive list of compliance Do's and Don'ts to which a suspended rep would be subjected upon his or her return to production baffles me. Frankly, I'm old school: Don't volunteer anything and don't answer questions that weren't asked.
I appreciate that some employer members think that memorializing an enhanced scheme of oversight for a settling registered person gives the firm a hedge against future misconduct but I don't agree with that premise. If a firm harbors such concerns about a particular associated person that the member feels compelled to memorialize in a FINRA settlement agreement an extensive, proposed supervisory protocol, then maybe that firm should terminate the individual. You think that's harsh? Just imagine what some customer's lawyer will do with that published list of proposed corrective actions if the stockbroker engages in disputed conduct. A savvy claimant's lawyer will cite all that voluntary language attached to an AWC about strict supervision as proof that the employer brokerage firm knew that the stockbroker was a compliance nightmare requiring enhanced oversight, which, it will be argued, did not occur in violation of the specific representations to a self-regulatory-organization as part of a disciplinary settlement. Yeah, I know, when I put it like that, it doesn't sound so good. Trust me, it will be put like just like that. Notwithstanding my opinions, Varma apparently determined that it was advisable to submit this Corrective Action Statement:
CORRECTIVE ACTION STATEMENT
RE: FINANCIAL INDUSTRY REGULATORY AUTHORITY LETTER OF ACCEPTANCE, WAIVER AND CONSENT NO. 2014040164801
TO: Department of Enforcement
Financial Industry Regulatory Authority ("FINRA")
RE: Sandeep Varma, Respondent
CRD No. 1926613
This Corrective Action Statement is submitted by the Respondent. Ii does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff.
To address the conduct within the above-referenced AWC. the following corrective actions have been taken by Mr. Varma:
Mr. Varma will work closely with his broker-dealer's Compliance and Advertising Review Departments to ensure that any presentations created or used by Mr. Varma regarding Charitable Remainder Trusts ("CRTs") meet all FINRA disclosure requirements and that they specifically address the following:
- Any future seminar presentation created and used by Mr. Varma regarding CRTs will include a statement which relays that while capital gains tax is avoided at the point of sale of an appreciated asset within a CRT, income from the trust is taxable, and, depending on the performance of the assets in the trust and the nature of the returns of the assets held in the trust, some of that income may be taxed at capital gains tax rates.
- Any future seminar presentation created and used by Mr. Varma regarding CRTs will disclose that any illustrations or examples provided are for illustrative purposes only and are not intended as projections of possible performance; poor or negative performance of assets held within the CRT will negatively affect income from the trust, which in turn can affect the ability to pay insurance premiums on any insurance put in place to replace the value of assets gifted to a CRT; insurance policy death benefits are subject to the claims paying ability of the insurance company and such insurance policies may lapse if not properly funded or can lapse due to poor performance of sub-accounts within variable policies or lower interest rates in fixed insurance products . . .
So . . . lemme see if I got this. Varma's voluntary Corrective Action Statement asserts (now as a matter of written record) that his future CRT presentations will "meet all FINRA disclosure requirements." As if, what? Varma wasn't already obligated to comply with all FINRA disclosure requirements? Why re-state the obvious?
On top of agreeing in writing not to do what he already is required not to do, Varma now promises that his future CRT presentations will state that "while capital gains tax is avoided at the point of sale of an appreciated asset within a CRT, income from the trust is taxable." Since Varma was charged with not having made that exact statement and agreed to a fine and suspension in order to settle the charges, what's the point of voluntarily adding this tidbit? Similarly, what does he gain by volunteering in writing that any future CRT presentations will explain that illustrations or examples are only for illustrative purposes? Again, such an undertaking is already a compliance/regulatory requirement.
In nit-picking this and other Corrective Action Statements, I am merely trying to raise consciousness about what strikes me as a dubious undertaking to put in a voluntary writing what amounts to a promise to not commit murder -- as if you could commit murder but for your promising not to so in a Corrective Action Statement appended to an AWC?
If the addition of Corrective Action Statement moved the sanctions needle and achieved a lesser fine or fewer days of suspension, okay, that would be a worthwhile reason for putting your corrective actions in writing. In reality. the voluntary statement provided to FINRA does not accomplish that goal. All of which returns me to the lessons learned during some 36 years on the Street. Don't volunteer nuthin'. Don't put nuthin' in writing that may come back and bite you in the ass. Pay your fine. Do your time. Keep your mouth shut and take yer lumps.