FINRA has been engaged in a “stealth sweep” of firms’ untimely deliveries of mutual fund and ETF prospectuses that has resulted in formal disciplinary proceedings against twelve firms since 2011, and a total of over $5 million in fines. Oddly, FINRA has not posted the “Targeted Examination Letter” that initiated the sweep, has not issued any guidance about the sweep’s findings beyond the press release that announced the first of the eight disciplinary proceedings, nor done anything else to publicize the results and lessons of this initiative to the broker-dealer community.
So we will do it for them.
By way of background, Section 5(b)(2) of the Securities Act of 1933 requires an issuer to deliver a physical copy of a prospectus before completing the sale of a security. Rule 15c6-1 effectively requires issuers to deliver the prospectus within three business days of the trade date. In its enforcement actions, FINRA sanctioned the firms for failures to provide prospectuses on time and to establish policies to monitor and ensure timely delivery. FINRA found that each firm had delivered between 2,500 and 934,074 prospectuses late for review periods of between one year and two and a half years. In its cases, FINRA found deficiencies both in firms using third-party service providers to deliver the prospectuses and firms that deliver the prospectuses using their own representatives.
Broker-dealers typically contract with third-party service providers to mail the prospectuses to new customers. The firms cited by FINRA failed to supply the service provider with enough copies of their prospectuses to ensure that there was always a copy available to mail when needed. Those firms also failed to take advantage of the service provider’s print-on-demand service, pursuant to which the service provider can print a copy of a prospectus when there is no copy available. FINRA also cited the failure to adequately obtain and review reports from the service provider regarding the timeliness of prospectus delivery and a failure to respond to the deficiencies highlighted in those reports, as evidence that the firms were not fulfilling their obligation to establish a system that would ensure timely prospectus delivery.
It is likely that FINRA will continue to examine member firms’ compliance with their prospectus delivery obligations, and firms should use the lessons of these cases to review their systems. Regardless of whether a firm uses a third-party service provider or its own representatives to deliver the prospectuses, it is important to have systems in place to monitor their timely delivery. It is also important for the firm to review reports it receives to monitor timeliness of delivery and take steps to remedy any deficiencies.
For more about these cases, and a set of practical suggestions for complying with the prospectus delivery rule, please see our client alert.