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Regulation and Compliance > Federal Regulation > FINRA

Broker Violated Reg BI With Mutual Fund Switches: FINRA

By Melanie Waddell

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What You Need to Know

  • The broker effected 25 short-term switches of Class A mutual funds, which are generally intended to be held long term.
  • The unsuitable recommendations caused two older clients to pay $40,972.50 in excessive sales fees.
  • The broker engaged in a pattern of switching between different mutual fund families.

The Financial Industry Regulatory Authority has suspended a broker, fined him $5,000 and ordered him to pay restitution for unsuitable mutual fund switches that resulted in two older clients paying excessive sales fees, which violated Regulation Best Interest.

Between July 2018 and September 2021, John Wigmore Reilly “recommended and effected 25 short-term switches of Class A mutual funds, which are generally intended to be held long-term, in two senior customers’ accounts, without having a reasonable basis to believe that his recommendations were suitable, or in his customers’ best interest,” according to FINRA’s order.

The two customers — both over 65, retired and with moderate risk tolerances — paid $40,973 in excessive sales fees.

Reilly was suspended for three months and also ordered to pay $31,675 in restitution plus interest.

With the actions, Reilly violated Reg BI’s care obligation from June 30, 2020 — the day the rule became effective — through September 2021. He violated FINRA Rule 2111 on suitability for the period July 2018 through June 29, 2020 as well as FINRA Rule 2010 on standards of business conduct.

Class A mutual fund shares typically include substantial upfront sales charges, known as front-end loads.

“They are generally suitable, or in the customer’s best interest, only as long-term investments and not for short-term trading because an investor usually must hold the Class A share for a long period of time to recoup the front-end load,” FINRA states.

Mutual fund switching occurs when a customer sells mutual fund shares and reinvests the proceeds in another mutual fund, often incurring additional charges and commissions.

Between July 2018 and June 29, 2020, Reilly recommended and effected 22 unsuitable short-term switches in Class A mutual fund shares in the seniors’ accounts, with an average holding period of 229 days, the order states.

All 22 short-term switches were part of a pattern of mutual fund switching between different mutual fund families, according to the order.

Reilly “failed to consider the customers’ investment objectives and time horizons when recommending the transactions, and further failed to consider that the customers could have reduced their transaction costs by switching within the same fund family,” the order states.

Between June 30, 2020, and September 2021, Reilly recommended and effected three short-term switches in Class A mutual fund shares that were not in the best interest of one of these customers. The average holding period of these transactions was 273 days.

The three short-term switches were also part of a pattern of mutual fund switching between different mutual fund families.

“In recommending these three switches, Reilly failed to exercise reasonable diligence, care, and skill to consider the customer’s investment objectives and time horizon, the costs associated with the recommendations, and reasonably available alternatives, including mutual funds in the same fund family as the customers’ existing holdings, or different mutual fund share classes, that may have achieved the customers’ objectives at a lower cost,” FINRA said in the order.

Melanie Waddell

@Think_MelanieW

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