Wells Fargo: Why Were They Fined over a Million Dollars for “Failure to Supervise”?

The Financial Industry Regulatory Authority (FINRA) has hit Wells Fargo with some hefty fines this year, due in part to their alleged failure to supervise some of their brokers. For example, Wells Fargo was fined $550,000 for two of their brokers’ allegedly unsuitable recommendations. Even more recently, the firm was required to pay $2 million in light of their alleged failure to supervise their investment adviser’s recommendations to purchase and sell costly variable annuities in order to generate fees and commissions.

What Does “Failure to Supervise” Mean?

“Failure to supervise” is an allegation that is often made against brokerage firms. Under FINRA and SEC rules, the firms are required to monitor their brokers’ activities to ensure that they’re furthering their clients’ financial interests.

FINRA Rule 3110 requires each firm to have “reasonably designed” written supervisory procedures in place. For instance, making high-risk investments might flag a certain broker’s conduct for review. Rule 3110 also requires firms to monitor their broker’s communications with clients. This is partly so that the firm can catch any investor complaints, and in an ideal world, this would allow them to address the issue before it ended up on their public record.

But as a few Wells Fargo investors found out, policies and firm supervision don’t always work how they’re supposed to. Even with appropriate protocols in place, FINRA alleges that Wells Fargo failed to enforce their policies, and allegedly allowed broker misconduct to take place right under their noses.

Barred Brokers Charles Frieda and Charles Lynch

On August 28, 2020, Wells Fargo agreed to pay $550,000 in fines and restitution (plus interest) to customers after they failed to supervise two of its brokers, Charles Frieda and Charles Lynch Jr. Frieda and Lynch made highly risky recommendations, concentrating their clients’ investment portfolios in the notoriously volatile energy sector, according to their Acceptance, Waiver & Consent (AWC) agreement. (An AWC allows brokers and firms to consent to findings without technically admitting to any wrongdoing.)

Lynch and Frieda were able to make these investment recommendations in spite of the fact that Wells Fargo limits how many energy securities financial advisers can have in one client’s portfolio. In order to circumvent Wells Fargo’s rules, Lynch and Frieda moved their client’s money from advisory accounts into brokerage accounts. FINRA alleges that Wells Fargo knew Lynch and Frieda were moving the money in order to get around the firm’s policies, but their management did not perform a reasonable investigation into their broker’s actions. When energy prices took a hit in 2014 and 2015, 70 of Frieda’s and Lynch’s clients lost a total of $10 million.

As of 2017, both Charles Frieda and Charles Lynch Jr. have been barred by FINRA.

Fines for Variable Annuities

On September 2, 2020, FINRA announced that Wells Fargo Advisors Financial Network and Wells Fargo Clearing Services would have to pay $1.35 million in restitution to clients, in addition to $675,000 in fines. In this AWC, Wells Fargo consented to the findings that they had failed to establish and maintain an adequate supervisory system. As a result, investment advisers incurred steep charges for their clients when they switched from one type of investment to another. This AWC does not specify the names of the brokers who engaged in this strategy.

The findings also state there should have been some kind of alert that brokers were moving money from variable annuities to investment company products. If there had been, Wells Fargo could have reviewed the purchases to make sure they were suitable for their customers. According to FINRA rules, both firms and investment advisers are required to only recommend investments that are suitable for their clients’ financial situations and goals. FINRA alleged that these switches not only incurred steep charges, but in at least one case, caused the client to earn less from her investment than she would have had she not made the switch.

How Can Brokers with Bad Records Keep Their Jobs?

It’s not clear from the AWC what Frieda and Lynch got out of their client’s risky investments, but many high-risk investments come with a high commission for the broker. Unfortunately, that can be more important to unscrupulous advisers than their client’s financial well-being.

Brokerage firms and brokers are required to disclose customer complaints and regulatory events. These complaints and regulatory events are listed on their public BrokerCheck records, which is maintained by FINRA. Before FINRA barred Frieda and Lynch, they had amassed a huge number of disclosures — as of today, BrokerCheck lists 60 for Frieda and 62 for Lynch, dating back to 2012. For context, that number of disclosures is unusual. According to a study from 2016, only 7.8% of brokers have any BrokerCheck disclosures.

This raises the question: In 2012, once Wells Fargo started receiving complaints about Frieda and Lynch, why didn’t they terminate their positions as brokers?

In the securities industry, professional success should not be confused with money management skills. Data shows that a high percentage of the most successful brokers in the US have some of the worst records. It seems that a lot of firms hire brokers based on criteria outside of their ability to make good choices with their clients’ money.

Experts familiar with the securities industry speculate that seemingly reckless brokers must be good for business, in spite of the possibility of fines and sanctions from FINRA. Brokers with misconduct tend to cluster in certain firms. According to this report from Reuters, there are 48 firms that employ 30% of brokers who have disclosures on their records. Another study reported that only half of brokers lose their jobs after an instance of misconduct.

Most brokers and financial advisers make money by carefully managing their client’s investments and developing solid reputations. But a dangerous minority make it possible for clients to lose huge amounts of money — losses that in some cases, the firm could have stopped. While there are rules in place meant to prevent these losses, it’s ultimately up to investors (and their attorneys) to supervise and protect their investments.