FINRA Issues 529 Plan Share Class Initiative Encouraging Firms to Self-Report

Financial Institutions Law Alert

On January 28, 2019, FINRA issued Regulatory Notice 19-04 (the “Notice”), announcing the launch of its 529 Plan Share Class Initiative (the “Initiative”). The Initiative seeks to promote compliance with rules governing 529 plan recommendations and encourages firms to investigate and self-report potential violations. A 529 plan, so named after section 529 of the Internal Revenue Code (26 U.S.C. § 529), is a type of tax-advantaged savings plan designed to encourage saving for the future educational expenses of a designated beneficiary. Because 529 plans are considered municipal securities, they are subject to the Municipal Securities Rulemaking Board (MSRB) rules on suitability and supervision.

FINRA has found that, in recent years, some firms have failed to reasonably supervise the suitability of share class recommendations in 529 plans. For many 529 plans, share classes carry different costs, such as sales loads or charges at the time of investment or redemption and ongoing distribution fees, depending on the length of time the investor maintains the plan. For example, Class A shares that typically include a front-end sales charge and low annual fees may not be appropriate for 529 plans intended to benefit older beneficiaries. Conversely, Class C shares that typically have no front-end charges and higher annual fees may not be appropriate for 529 plans with a longer time horizon.

Notably, while 529 plans have traditionally been a vehicle to save only for higher education, amendments to the Internal Revenue Code that became effective in January 2018 allow 529 plan withdrawals to be used for elementary and secondary educational expenses. These changes highlight the importance of periodically assessing the customer’s needs with respect to 529 plan investments and properly supervising recommendations.

By launching this initiative, FINRA intends to encourage member firms to examine their current supervisory systems for 529 plans, identify and remedy any defects, and compensate investors who have been harmed. The Notice lists four areas of potential concern, including:

  • failure to provide training regarding different 529 plan share classes;
  • failure to assess different costs for share class transactions;
  • failure to review data regarding the 529 plan share classes sold; and
  • failure to review potential discounts when conducting suitability analyses of 529 plan recommendations.

In order to properly compensate investors, firms should assess the impact of their supervisory failures, either on a customer-specific basis or by conducting an overall statistical analysis. The Notice states that FINRA is willing to work with firms to develop statistical models to assess impacts.

Firms that self-report through the Initiative will have much more favorable outcomes than if the supervisory failures are later discovered by FINRA. In particular, the Notice states that if “a firm does not self-report under the 529 Initiative but FINRA later identifies supervisory failures by that firm, any resulting disciplinary action likely will result in the recommendation of sanctions beyond those described under the initiative.”

The deadline for firms to self-report to FINRA is 12:00 A.M Eastern Time, on April 1, 2019. Firms that already have been contacted by FINRA as of the date of the Notice regarding potential violations related to 529 plan share class sales are not required to self-report under the 529 Initiative. Firms that are subject to pending examinations by FINRA are eligible to self-report. After timely self-reporting, a firm must submit all of the Initiative’s required information for the disclosure period (January 2013 through June 2018) by May 3, 2019. The information required to be produced includes:

  • A list of the 529 plans sold by the firm, including the 529 plan name and the dates the firm offered each 529 plan,
  • The total aggregate principal amount invested in each 529 plan sold by the firm during the disclosure period,
  • A description of the firm’s supervisory systems and procedures relating to 529 plan sales during the disclosure period,
  • A description of the changes to the firm’s supervisory systems and procedures that the firm has implemented or will implement in order to strengthen compliance with its supervisory obligations. To the extent the firm identifies changes that have not yet been implemented, the firm should identify the individual supervisor at the firm who is responsible for the implementation,
  • The firm’s assessment of potential impact on customers of supervision weaknesses, including a description of the firm’s methodology for assessing impact on customers and a description of the firm’s proposal to make restitution payments to harmed customers, and
  • Any other information the firm believes would assist Enforcement in understanding the firm’s assessment of an account’s expected investment horizon, the suitability of the firm’s recommendations, or the reasonableness of the firm’s supervisory system regarding share class recommendations.

For more information regarding the Initiative and self-reporting requirements, see FINRA Regulatory Notice 19-04.