There are a number of important regulatory issues concerning sales practices associated with municipal fund securities and, therefore, 529 plans. The cornerstone of the securities industry is the principle that brokers, dealers, and municipal securities dealers conduct their business fairly with all persons and not engage in a deceptive, dishonest, or unfair practice. (The MSRB’s Rule G-17 is at the core of its customer protection rule.) This simple statement contains the underlying premise that sales activities may not mislead the public and that errors of omission or misstatements of fact are contrary to fair and equitable trade practices. Therefore, if a customer purchasing a Section 529 plan can benefit from an unlimited state tax benefit, then not informing the client of this fact violates MSRB and FINRA rules.
In fact, the MSRB stated in 2006 that dealers have an affirmative obligation to make the following disclosures to any client purchasing an out-of-state 529 plan.
• Depending on the state in which either the client or the plan’s beneficiary resides, favorable state tax treatment may only be available only if the client invests in his home state’s 529 plan.
• Potential state tax benefits are one of many factors that the client should consider in making a decision.
• The client should consult with his financial or tax adviser about his particular situation to determine the advantages and limitations of investing in his home state’s 529 plan. He may also want to contact his home state and other states to learn more about their plans.
One of the ways of fulfilling this “out-of-state disclosure obligation” is to include these disclosures in the plan’s official statement (program disclosure document). If this is the case, however, they may not be buried in the fine print—they must be included in a way that they are “reasonably likely to be noted by the investor.” The client must also receive the official statement no later than the time the sale takes place.
If these disclosures are not included in the official statement, then the dealer must provide them separately either before or at the time of the transaction.
In its guidelines concerning communications with the public, FINRA states that member communications must be clear and not overly complex or technical in order to avoid confusion. In such cases, a lengthy, highly technical explanation may be more confusing than shorter, less technical information. Sales material and advertising should also take into account the audience who receives the information. Different levels of explanation may be necessary for varied categories of clients, and it may be difficult to limit the audience to a particular piece of information. When using promotional material, it is important to state the potential tax implications associated with a particular product. General references to tax-exempt or tax-free may not be sufficient unless the product is in fact both federal and state tax-free. An indication should be made as to which taxes apply, if any, or which taxes do not apply. A registered representative should act prudently when recommending a particular 529 savings plan to an investor. Consideration should be given as to why the investor is purchasing the plan, when the funds will be needed, the risk of loss of principal, and market performance failing to meet expectations. A determination should be made as to the ultimate goal, i.e., how much money needs to be invested in order to achieve the desired result and whether the individual can sustain the program over the necessary time frame. The commissions that the registered representative expects to earn from the sale should not be part of this analysis.
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