United States: FINRA Provides A Detailed Analysis Of A Broker-Dealer’s Failure To Adequately Supervise Alternative Investment Sales

Last Updated: April 1 2014
Article by Daniel Nathan and Ana-Maria Ignat

In March 2014, the Financial Industry Regulatory Authority (FINRA) fined a broker-dealer $950,000 for supervisory deficiencies related to its failure to adequately supervise the sale of "alternative investments." These investments include a laundry list of products that have been at the forefront of FINRA's priorities in recent years: nontraded real estate investment trusts (REITs), oil and gas partnerships, business development companies (BDCs), hedge funds, managed futures, and other illiquid pass-through investments.

FINRA's findings provide a useful "case study" as to the types of issues that a firm should consider in evaluating its own processes for sales of complex products.

Specifically, FINRA found that between January 2008 and July 2012, the broker-dealer did not:

  • have a reasonable supervisory system to determine whether the purchases of alternative investments caused a customer's account to be unsuitably concentrated in those investments;
  • implement a computer system or written materials that consistently identified alternative investment transactions that fell outside of the broker-dealer's internal suitability guidelines, prospectus, or state suitability standards;
  • adequately train its supervisory staff to analyze state suitability standards as part of alternative investment suitability reviews; and
  • have compliance or written supervisory procedures reasonably designed to achieve compliance with NASD and state suitability requirements. Existing procedures did not delineate the supervisory steps to be taken in connection with alternative investment product reviews, and did not offer any guidance to registered representatives or reviewing principals regarding analyzing state suitability standards for alternative investments such as REITs, BDCs, and managed futures.

FINRA addressed the broker-dealer's supervisory shortcomings using a high level of detail. FINRA's findings, which are instructive for firms evaluating the adequacy of their supervisory policies and procedures, include the following:

  • The firm's Alternative Investment Form ("AI-1 Form") did not differentiate between retirement accounts of customers below or above 59 and ½ years of age;
  • There was no indication from a review of the AI-1 Form that fees, taxes, or penalties associated with early withdrawal of retirement accounts were deducted from the liquid net worth calculation;
  • The AI-1 Form contained confusing information which did not conform to the firm's written supervisory procedures, because the Form suggested that concentration percentage limits were to be applied to each product type, rather than the entirety of a customer's alternative investment holdings;
  • The firm did not require supervisors to check for fluctuations in a customer's liquid net worth or net worth on the AI-1 Form, or by comparing it to the customer's previous AI-1 forms;
  • The firm did not require managers to verify a customer's financial information, such as liquid net worth, net worth, and income, on the AI-1 Form, to ensure that the customer was not overly concentrated in each alternative investment, and that the investment was consistent with the firm's suitability standards;
  • The firm did not look to the prospectus pertaining to the respective alternative investment for state suitability standards, and instead relied either on the subscription agreement (which often contained different information about state concentration limits than the prospectus) or email alerts from the alternative investment product sponsor regarding state suitability requirements (which were not consistently provided in a timely manner);
  • The firm lacked controls to ensure that the subscription agreement used by the financial advisor was the most recent and corresponded to the most recent prospectus issued by the sponsor of the respective alternative investment. As a result, the firm's supervisory personnel used incomplete or obsolete information regarding state concentration limits in performing the suitability review;
  • The firm did not compare or analyze its liquid net worth definition against the definitions provided by the states in which its customers resided, and did not train its managers to differentiate between the liquid net worth definitions in the various states where it sold alternative investments;
  • To track suitability standard compliance, the firm used outdated and inaccurate information regarding state suitability requirements, and misstated the suitability standards for various states;
  • The firm lacked formal training for its supervisory staff regarding appropriate methods for analyzing and applying state suitability standards to certain alternative investment transactions, including the terminology used in state suitability requirements or the differences between the applicable state standards; and
  • The firm's written supervisory procedures offered no guidance for complying with certain state concentration limits and/or understanding and applying the states' suitability standards.

These deficiencies had real-world results that attracted FINRA's attention. A significant number of customers were determined to have alternative investment holdings that exceeded the firm's concentration guidelines. For example, FINRA identified 25 instances of REIT transactions that were approved in contravention of state suitability standards or prospectus suitability standards. FINRA also identified a specific registered representative that had executed a significant number of transactions that exceeded the firm's concentration guidelines, many of which were unsuitable for the relevant customers; this representative was able to enter false customer information and to effect these transactions without detection due to the firm's insufficient supervision.

Obviously, each broker-dealer conducts and supervises its business differently. However, it is helpful to consider where FINRA found issues with a firm's policies and procedures. Firms should consider using FINRA findings in cases like this one as a checklist in its regular evaluation of its supervisory systems and procedures. It certainly is what the regulators would expect.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Daniel Nathan
In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions