On July 28, 2009, FINRA fined two broker-dealers for failures to supervise which resulted in the unsuitable short-term sales of closed-end funds (“CEF”) purchased at the funds’ IPO. CEFs are investment companies that sell a fixed number of shares in an IPO with built-in sales charges. Thus, after the IPO, the shares trade in the secondary market, generally at a discount from the IPO price. The CEFs at issue had sales charges of 4.5 percent, as well as a “penalty bid period” of generally 30 to 90 days immediately following the IPO.
FINRA noted that “Closed-end funds possess complex features that can give rise to unsuitability for short-term investors, particularly when purchased at the initial public offering.” During the relevant period, brokers would lose their sales commission if their clients sold the CEFs purchased at the IPO. FINRA found that despite knowledge that CEFs purchased at the IPO are more suitable for long-term investments, the broker-dealers did not have adequate supervisory systems and procedures designed to detect and prevent unsuitable short-term trading of CEFs.