Securities Litigation

Firms permitting the creation and operation of custodial accounts related to Uniform Transfers to Minors Act (UTMA) or Uniform Gifts to Minors Act (UGMA) transactions must take special notice of Financial Industry Regulatory Authority's (FINRA) recent Regulatory Notice 11-02.  This notice requires firms to take steps to establish the identity and age of the custodians and beneficiaries of custodial accounts.  Such custodial accounts are tied to UTMA and UGMA transactions allowing individuals to transfer property to a minor without the need for a formal trust.

While some requirements of UTMA and UGMA transactions vary from state to state, all states require the donor to appoint a custodial, designate a minor beneficiary, and deposit assets into the account.  Under both uniform acts, the property is the minor's property, though the custodian makes all investment decisions on the minor's behalf until the minor reaches the age of majority.

FINRA Rule 2090, the "Know Your Customer Rule," mandates that firms identify the custodian and the minor.  Firms must gather all "essential facts" about these customers.  FINRA's goal is ensuring that the custodian of a minor's account is authorized to make investment decisions. FINRA Regulatory Notice 11-02 indicates that FINRA's intent is for firms to conduct a continuing inquiry.  The inquiry should ensure that custodians are never acting on behalf of of-age beneficiaries.

FINRA's recent enforcement of this rule illustrates the importance of firms' monitoring efforts.  In December 2019, FINRA sanctioned Citigroup, JP Morgan, LPL Financial, Morgan Stanley, and Merrill Lynch for failing to reasonably supervise custodial accounts.  Together the firms paid a combined $1,400,000.  Moving forward, FINRA will continue to ensure that firms are taking the time to "establish, maintain, and enforce reasonable supervisory systems and procedures to track or monitor whether custodians timely transferred control over custodial property to UTMA and UGMA account beneficiaries."

The takeaway for FINRA firm-members is this:  After establishing the identity and age of the custodian and beneficiary, firms must ensure that there are supervisory systems and procedures in place to continue to monitor and ensure that a custodian transfers control of custodial property to an of-age beneficiary. FINRA has identified three practices as effective, namely (1) using supervisory systems and automated tools to track beneficiaries' age of majority; (2) notifying custodians to advise them that beneficiaries are approaching the age of majority and of necessary changes in the handling of accounts; and (3) maintaining systems to notify registered representatives when beneficiaries reach the age of majority and requiring communication with custodians about the transfer of custodial property.