LexisNexis Corporate & Securities Law Community 2011 Top 50 Blogs

Bon mots

"You can observe a lot just by watching." Yogi Berra

"We do not distain to borrow wit or wisdom from any man who is capable of lending us either." Henry Fielding, Tom Jones

"In our complex society the accountant's certificate and the lawyer's opinion can be instruments for inflicting pecuniary loss more potent than the chisel or the crowbar." United States v. Benjamin, 328 F.2d 854, 862 (2d Cir. 1964)

Finra Bar For Unsuitable Mutual Fund Switch Recommendations Sustained

Scott Epstein, Exchange Act Rel. 59328, January 30, 2009

Time since appeal – 1 year 13 days
Time since last brief – 6 months 23 days
Pages – 34
Footnotes – 79


Epstein was a rep at Merrill Lynch. Finra found he made unsuitable mutual fund switch recommendations to customers and barred him. The Commission upheld the bar. The charges were based on Epstein's switching of twelve elderly, retired, unsophisticated customers who did not clearly understand the fee structure associated with various mutual fund share classes. He generally had customers sell shares of one fund and moved them into shares of funds in another fund family causing the customers to pay fees and earn himself a bonus. Had he switched the customer to a fund in the original fund family the transaction would have been cost free to the customer, but he would have earned no bonus.


Epstein worked at a Merrill call center that serviced accounts with assets of less than $100,000. Calls were assigned randomly to reps. The reps also made cold calls to accounts that had been transferred to the call center from branch offices. Conversations with customers were recorded.

Reps at the call center were allowed to make recommendations to customers about mutual funds and were allowed to recommend individual stocks and bonds only if a customer requested such advice.

According to Epstein's counsel, due to computer crashes information about a customer's age, marital status, income, assets, and investment experience was often unavailable to the reps at the call center.

Reps at the call center were on teams that were required to meet certain production levels. They were paid salaries but also received bonuses based on production. Epstein's salary was $35,000 and he earned a bonus during the relevant time of $26,000.

Reps were instructed to make recommendations as to which classes of mutual fund shares were appropriate for customers based on the amounts to be invested and the anticipated holding period of the shares.

Epstein's conduct was clearly egregious. He never told customers that they could switch funds within a fund family without incurring any fees. Some of his customers incurred substantial capital gains tax liability due to his recommendations that he never explained. The funds he switched investors into often had much higher expense ratios and similar or lower historic rates of return. Some elderly customers were switched out of B class shares that were due to convert to lower cost D class shares and placed into B class shares that had a new multiyear holding period to avoid liquidation fees. He made cold calls and immediately discussed fund switches without inquiring into the investment objectives of his customers.

Epstein did not challenge Finra's finding that he made unsuitable recommendations in violation of Finra Rule 2310. Finra rules specifically prohibit recommending mutual fund switches based on the compensation the rep will receive as a result of the switch. He also failed to obtain current information about his customer's investment objectives before recommending the fund switches.

Epstein based his defense on complaints about Finra procedures. He complained that Finra relied on tape recordings of his sales pitches and did not call any customer witnesses. Unfortunately, the Commission has long held that Finra may base its cases on hearsay. Here the recordings were reliable and probative. Live customer testimony would not have afforded Epstein any meaningful defense as he did not claim the customers were biased or that the tapes were not accurate and complete.

Epstein claims he was targeted for selective prosecution because he had made complaints about the operation of Merrill's call centers. Selective prosecution is improper only if it is based on race, religion, or a desire to prevent exercise of a constitutionally protected right. Epstein made no such showing here. The evidence does not support Epstein's retaliation claim as Finra's investigation was based on a customer complaint letter that predated his "whistle blowing."

Epstein also argued that the sanction was excessive as he was young and inexperienced and therefore merely demonstrated bad judgment. The Commission ruled this does not excuse his conduct as "[t]hose who hold themselves out as professionals with specialized knowledge and skill to furnish guidance cannot be heard to claim youth or inexperience...." Nor is lack of disciplinary history a mitigating factor as there should be no reward for acting in accordance with one's duties as a professional.


This is a textbook case of unsuitable recommendations – switching them out of one mutual fund into another fund with higher fees. The only one who benefited was the rep. Epstein did not contest the finding of making unsuitable recommendations and based his defense solely on procedural claims and arguments about the severity of the sanction. Under these circumstances the case raised no complex issues of law or fact yet the opinion took almost 7 months.

There is substantial precedent undiscussed in this opinion that requires a rep to fully disclose to the customer all facts, (including an enhanced commission to himself) that bear on the validity of his recommendation. The Commission could have used this case as an opportunity to stress this duty but it chose not to. Important issues such as this are often raised by Finra enforcement matters and it is distressing that Finra cases will be heard by only three commissioners.