In the Matter of the Financial Industry Regulatory Authority (FINRA) Department of Enforcement v. Paul Zenke (FINRA Office of Hearing Officers Disciplinary Proceeding #20060043777, May 2, 2008)
http://www.finra.org/web/groups/enforcement/documents/oho_disciplinary_decisions/p038594.pdf , presents a case involving Respondent Zenke, who after practicing law for over 13 years, in December 2000, registered as a general securities representative with FINRA member Investment Centers of America ("ICA"). Zenke remained with ICA until December 2006, when he resigned due to his disagreement with the firm over the circumstances alleged in FINRA's one-count Complaint: that he violated NASD Conduct Rule 2110 by charging impermissible commissions in connection with the sale of six no-load mutual funds to seven customers in nine transactions.
NASD Business Conduct Rule 2110: Standards of Commercial Honor and Principles of Trade
A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.
Zenke filed an Answer requesting a hearing, admitting that he charged commissions on the mutual fund sales as alleged, and denying that the charges were prohibited by the mutual fund prospectuses, or otherwise improper.
The Under-$50,000 Crowd
ICA did not permit fee-based accounts for customers with assets under $50,000. Zenke told his customers with accounts under $50,000 that they could either
· buy no-load mutual fund shares directly from the distributor without receiving any specific recommendation from Zenke and without paying Zenke any fee; or,
· rely upon Zenke to recommend and purchase no-load mutual fund shares for them. For this service, he told them, he would charge a commission.
Although ICA customers with fee-based accounts had executed an advisory agreement that spelled out quarterly fees based on account assets, Zenke's agreement with his under-$50,000 clients was less formal and oral-and his transaction charges ranged from .5% to 3% of the principal invested (or in some cases zero). Zenke apparently believed that his proposal fairly addressed a conflict of interest that he saw as inherent in the system; namely, that in order for him to earn compensation from sub-$50,000 clients seeking his advice, he would need to sell such clients load funds. Consequently, Zenke sold shares of six no-load mutual funds to seven customers who had agreed to his proposal in nine transactions, charging total commissions of $2,790.
Zenke did not tell ICA what he was doing or receive ICA's permission to take this approach, and added the charges without ICA's knowledge by manually inputting the commissions into a field entitled "commission override" in ICA's clearing broker's system. For mutual fund transactions, ICA intended this field to be used to recoup ticket charges imposed by ICA's clearing broker, although ICA did not have a written procedure explaining this, and Zenke was unaware of it.
Not Leaving Well Enough Alone
Zenke's charges for no-load mutual funds came to light in February 2006, when Zenke noted that a commission he had input was not charged, and he requested that the trade be re-booked to include it. ICA's Trading Department attempted to accommodate Zenke's request; however, the Mutual Fund Department at ICA's clearing firm rejected the commission charge as impermissible. Zenke inquired further by electronic mail, noting that he had been able to charge commissions on many other no-load fund transactions. ICA's Director of Products and Services responded, advising Zenke that he was not permitted to charge a commission on a no-load fund. Zenke argued that it would be better for his customers to pay a commission for a no-load fund, than to buy a load fund with a higher sales charge. ICA Management did not agree, and reimbursed the commissions charged. Zenke resigned over this issue.
FINRA Panel Ruling
Following a hearing, a FINRA Hearing Panel found that Zenke had violated Rule 2110 by charging commission for no-load mutual funds with seeking and receiving his firm's approval. The Panel suspended Zenke for 20 business days, fined him $5,000, and required him to re-qualify in all capacities. Among other considerations, the Panel specifically noted that Respondent was an attorney, who should have appreciated the issues that his conduct raised.
Was the Charge Prohibited?
FINRA's Department of Enforcement's (DOE) argued that mutual fund prospectuses specifically prohibit a brokerage firm from charging fees or commissions on the sale of no-load funds. However, the Panel was not persuaded by this argument as additional charges are at times contemplated in fund prospectuses. Nonetheless, the Panel distinguished between whether it would have been permissible for ICA to charge the commissions at issue, and whether it was improper for Zenke to have imposed those charges on his own.
In pointed and well-reasoned language, the Panel framed the issues as such:
[A] registered representative is the agent for the firm with which he or she is associated; and, like any agent, has only such authority as the firm delegates. Thus, Respondent could impose commissions or other charges on the sale of no-load funds (or any other investment), only insofar as ICA had authorized him to do so. In this case, Respondent neither sought nor obtained authority to impose the commissions he charged.
Moreover, Respondent had no reasonable basis for believing that he had authority to impose those charges. On the contrary, of ICA's 650 registered representatives, Respondent was the only one who imposed any charges on sales of no-load mutual funds in excess of the ticket charge imposed by ICA's clearing broker. FINRA's Staff examiner testified that in his review of thousands of no-load mutual fund transactions in twenty firms, he had never seen such charges. Because this approach deviated so dramatically from industry practice, Respondent knew or should have known that the arrangement was, at the least, unconventional; nevertheless, he did not tell his firm what he was doing or seek its permission to impose the charges. Nor did he document these arrangements, despite his knowledge of his firm's practice of documenting its charges with respect to fee-based accounts. Moreover, the fees Respondent charged varied widely; in some cases he charged 3% of the cost of a no-load fund, and in other cases he charged less, or nothing. As a result, it was likely that customers received unjustifiably disparate treatment as to the commissions Respondent imposed.