FINRA’s 529 Plan Share Class Initiative Encourages Firms to Self-Report Potential Violations

February 4, 2019

On January 28, 2019, FINRA issued Regulatory Notice 19-04, which outlines the provisions of an initiative regarding share-class issues related to 529 college savings plans. FINRA is encouraging broker-dealers to review their customer activity in 529 college savings plans and self-report any potential violations related to recommending certain share classes that may not have been suitable based on a customer’s investment profile. Firms taking part in the initiative may receive recommendations from FINRA Enforcement for customer restitution or censure, but none will be fined.

Section 529 savings plans have been an important investment vehicle to save money for college. As described in the IRS code, 529 plans allow for tax-free growth within the plan. Funds can be withdrawn without being assessed federal tax if used for qualified higher education expenses of beneficiaries. A change in the IRS code in 2018 also permits, under certain circumstances, the use of 529 funds for K-12 tuition.

Although similar to mutual funds, 529 plans are categorized as municipal securities. Therefore, FINRA and MSRB rules apply to the sales of these securities. FINRA has long considered share-class selection to be an important component of suitability determinations for investment products. By their nature, 529 plans generally have longer time horizons. FINRA is concerned that firms have not developed adequate supervisory systems to monitor their 529 plan recommendations, particularly those related to share-class selection.

Specifically, FINRA has stated that selling class C shares of 529 plans may be more expensive than selling available class A shares. In its regulatory notice, FINRA stated that class A shares are generally less expensive if an investment is held for more than six or seven years. Since funds from 529 plans are usually not withdrawn before a beneficiary reaches 18 years of age, FINRA encourages firms to review their purchases of class C shares for beneficiaries who are 12 years old or younger. In addition to the higher expenses embedded in class C shares, FINRA maintains that customers may have saved more money through the benefit of breakpoint discounts offered in class A shares.

As part of an analysis of 529 plan supervision, firms should assess the potential impact on customers. The regulatory notice suggests that this analysis can be done by:

  • assessing any customer-specific impact,
  • conducting a statistical analysis of categories of customers impact, and/or
  • employing other statistical models for the analysis. Firms that self-report to FINRA are expected to notify FINRA by April 1, 2019.

By May 3, 2019, firms that self-report must provide the following information for the January 2013 to June 2018 disclosure period:

  1. A list of the 529 plans sold by the firm and the dates the firm offered each plan.
  2. The total principal amount invested in each plan sold by the firm during the disclosure period.
  3. A description of the 529 plan supervisory policies and procedures in force during the disclosure period.
  4. A description of any changes or pending changes made by firms related to their 529 plan supervisory system. If such changes have not been implemented by the time of the April 1 disclosure, firms must identify the supervisor responsible for implementing the changes.
  5. The impact on customers, along with the method used to assess the impact and the plans for restitution payments.
  6. Any other information that will help FINRA Enforcement understand the actions the firm is taking to remedy this situation.

FINRA has posted a video on its website in which Susan Schroeder, Head of FINRA Enforcement, discusses the share-class initiative. In the video, Ms. Schroeder describes a situation in which a firm does not take advantage of the self-reporting initiative and FINRA finds violations during its examinations. She warns that, if such violations lead to enforcement action, the penalties would be greater than if the firm had participated in the 529 plan initiative. ACA recommends that firms review their 529 plan monitoring process and determine whether they should consider participating in the 529 plan initiative.

For More Information

For more information on this Regulatory Notice, please contact your ACA consultant or Dee Stafford at (561) 628-5288 or dstafford@acacompliancegroup.com.