On September 25, 2017, the Financial Industry Regulatory Authority (“FINRA”) issued a fine of $3.25 million against Morgan Stanley Smith Barney LLC (“Morgan Stanley”) in connection with the brokerage firm’s alleged failure to supervise its brokers’ short-term trades of unit investment trusts. Unit investment trusts (“UITs”) are a specific type of Investment Company, as defined by the Investment Company Act of 1940 (the ’40 Act), and subject to regulation by the SEC. Unlike mutual funds, closed-end funds, or ETFs, UITs are unique in that they are created for a specific, limited time period (e.g., 24 months). Furthermore, UITs consist of a static investment portfolio as part of a pre-selected pooled investment vehicle.
Typically, UITs impose a number of charges. Some of these charges include a deferred sales charge, a creation and development fee, as well as annual operating expenses charged as an annual fee to account for portfolio administration and bookkeeping. In aggregates, these various fees might total approximately 4% for a typical 24-month UIT. Thus, any investor in a UIT will experience a “drag” on the performance of their UIT portfolio in the form of various fees.
Because UITs carry a substantial fee structure and are subject to termination after a given time period, there exists the potential for some financial advisors to recommend to their clients that they roll-over, or switch, from one UIT to another. In its worst form, this sales practice amounts to a stock broker seeking enhanced income through switching clients out of one product to another on a short-term basis in order to earn commissions and fees, at the expense of the client.