May 20, 1999) (holding that FINRA's requirement that registered representatives act in a manner consistent with just and equitable principles of trade applies to all unethical business conduct, regardless of whether the conduct involves securities); Vail v. SEC, 101 F.3d 37, 39 (5th Cir. FINRA BrokerCheck, moreover, allows investors to review the professional and disciplinary backgrounds of firms and brokers online. 282, 284, 1993 SEC LEXIS 41, at *5 (1993) ("[O]ptions transactions involve a high degree of financial risk. The rule generally requires a broker-dealer to seek to obtain and analyze the customer-specific factors listed in the rule when making a recommendation to a customer. ), cert. See id. 64565, 2011 SEC LEXIS 1862 (May 27, 2011); Dep't of Enforcement v. Bendetsen, No. Would a firm violate the suitability rule if it makes recommendations to customers for whom it has not obtained all of the customer-specific information listed in FINRA Rule 2111(a)? What is the scope of the safe-harbor provision in Rule 2111.03 regarding a firm's use of an asset allocation model? A firm should educate its associated persons on the potential risks and rewards of the products that the firm permits them to recommend. Firms seeking to rely on the provision should take a conservative approach to determining whether a particular communication is eligible for such treatment. 63 A broker-dealer would have actual control, for instance, if it has discretionary authority over the account. FINRA Rule 2111 does not define the terms. The account record requirements in paragraph (a)(17)(i)(A) of the Rule apply only to accounts for which the broker or dealer is, or within the past 36 months has been, required to make a suitability determination. 513, 515, 1993 SEC LEXIS 1521, at *5 (1993) (discussing risky nature of investing in a company that had a history of operating losses and concentrated its assets in illiquid holdings in other unproven start-up companies in the same industry); Gordon S. Venters, 51 S.E.C. Each firm has a general obligation to evidence compliance with applicable FINRA rules. [Notice 11-25 (FAQ 10)]. The new suitability rule (as with the predecessor rule) requires a broker to seek to obtain and analyze a customer's other investments. 61247, 2009 SEC LEXIS 4332, at *3-6 (Dec. 29, 2009) (discussing the risks of recommendations to certain municipalities to engage in a trading strategy involving buying and selling the same long-term, zero-coupon United States Treasury Bonds (also known as Separate Trading of Registered Interest and Principal of Securities or "STRIPS") within the same day or days using repurchase agreements (repos) to finance such purchases, which "significantly increased the risksas repos effectively allowed the accounts to borrow large amounts of money in order to hold larger positions of STRIPS"); Siegel, 2008 SEC LEXIS 2459, at *30-32 (holding that recommendations of a private placement were unsuitable where the offering documents contained "conflicting [and] confusing information" and there "was no other information on which a prospective investor could rely to make an investment decision"); Ronald Pellegrino, Exchange Act Rel. For example, a firm should, among other things, clarify the customer's intent and, if necessary, reconcile and/or determine how it will handle the customer's differing investment objectives. What further action a broker-dealer will need to take will depend on the facts and circumstances of the particular case. Some customers, moreover, desire portfolios made up of securities with different levels of liquidity, risk and time horizons. Quantitative suitability requires a broker who has actual or de facto control63 over a customer account to have a reasonable basis for believing that, in light of the customer's investment profile, a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer.64 Factors such as turnover rate,65 cost-to-equity ratio,66 and use of in-and-out trading67 in a customer's account may provide a basis for finding that the activity at issue was excessive. 58737, 2008 SEC LEXIS 2459 (Oct. 6, 2008), aff'd in relevant part, 592 F.3d 147 (D.C. Cir. Suitability The Rule Notices 2110. The rule states that it applies to explicit recommendations to hold. A customer, for example, may not want to divulge information about "other investments" held away from the broker-dealer in question. A hold recommendation involving shares of a blue chip stock ordinarily would not present the type of risk, absent unusual facts, that would require a detailed analysis or documentation. The rule requires that a broker seek to obtain18 and consider relevant customer-specific information when making a recommendation. at 6 n.15. A firm may use a risk-based approach to evidencing compliance with the suitability rule. Rule 2330 requires a registered principal to review and determine whether to approve a customers application for a deferred variable annuity ), cert. See Pryor, McClendon, Counts & Co., Exchange Act Rel. Moreover, absent "red flags" indicating that such information is inaccurate or that the customer is unclear about the information, a broker generally may rely on the customer's responses. 72 Epstein, 2009 SEC LEXIS 217, at *72; see also Sathianathan, 2006 SEC LEXIS 2572, at *23. Vincent Apicella, Stock Focus: "Dogs of the Dow" Companies, Forbes.com (May 29, 2001). The new rule, for example, does not apply to implicit recommendations to hold a security or securities. Section 201(a) of the Jumpstart Our Business Startups Act (JOBS Act)6 directs the SEC to amend Rule 506 of Regulation D under the Securities Act of 1933 to eliminate the prohibition on general solicitations to the extent that all purchasers are accredited investors. No. A turnover rate greater than six creates a presumption that the trading was excessive. The customer's investment profile, for example, is critical to the assessment, as are a host of product- or strategy-related factors in addition to cost, such as the product's or strategy's investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions. LEXIS 13, at *12 (NAC Aug. 9, 2004) ("[A] broker's recommendations must serve his client's best interests[,]" and the "test for whether a broker's recommendation[s are] suitable is not whether the client acquiesced in them, but whether the broker's recommendations were consistent with the client's financial situation and needs. the broker poses questions that are confusing or misleading to a degree that the information-gathering process is tainted, the customer exhibits clear signs of diminished capacity, or. No. SEA Rule 17a-3 also states that the broker-dealer must furnish such customer or owner a copy of the required account record information or alternative document with all information required by SEA Rule 17a-3(a)(17)(i)(A), including an explanation of any terms regarding investment objectives, for verification within 30 days of account opening and at least once every 36 months thereafter. [Notice 12-25 (FAQ 3)], A1.2. Similarly, a registered representative's recommendation that a "buy and hold" customer with an investment objective of income liquidate large positions in blue chip stocks paying regular dividends might raise a "red flag" regarding whether that recommendation is part of a broader investment strategy. See, e.g., FAQ [1.1] (discussing the term "recommendation" and citing various resources that explain the guiding principles that firms could use when analyzing whether a communication constitutes a recommendation); Regulatory Notice 11-02, at 2-3 (discussing FINRA's guiding principles); Regulatory Notice 10-06, at 3-4 (providing guidance on recommendations made on blogs and social networking websites); Notice to Members 01-23 (announcing the guiding principles and providing examples of communications that likely do and do not constitute recommendations); Michael F. Siegel, Exchange Act Rel. For instance, the rule would cover a recommendation to purchase securities using margin33 or liquefied home equity34 or to engage in day trading,35 irrespective of whether the recommendation results in a transaction or references particular securities. Firms should understand that the use of any such Institutional Suitability Certificate in no way constitutes a safe harbor from the rule. 1304, 1311, 1997 SEC LEXIS 762, at *19 (1997). [Notice 12-25 (FAQ 11)]. The new rule does not apply to implicit recommendations to hold. Yes. EAF0400730002 (Feb. 21, 2007) (barring registered representative for, among other things, recommending to ten customers, many of whom were nearing retirement, that they obtain home equity loans and use the proceeds to purchase securities, without considering whether such recommendations were suitable for such customers in light of their financial situation and needs); James A. Kenas, AWC No. Q3.2. FINRA explained in one instance under the predecessor rule that "recommending liquefying home equity to purchase securities may not be suitable for all investors. 91 Firms are reminded, however, that copies of all communications relating to their business as such and memoranda of brokerage orders are required to be preserved for three years. No. No. As discussed below in the answer to [FAQ 8.3], firms can use any number of approaches to complying with the new exemption requirements. 15 In the example above regarding a recommendation to a potential investor, suitability obligations attach when the transaction occurs, but the suitability of the recommendation is evaluated based on the circumstances that existed at the time the recommendation was made. 1030, 1032-1034, 1996 SEC LEXIS 2922, at *5-10 (1996) (explaining risks associated with certain foreign currency debt securities); Clinton H. Holland, Jr., 52 S.E.C. 55 When a broker-dealer recommends an allocation strategy that includes an allocation in fixed-income securities, FINRA recognizes that a number of additional factors would be relevant in determining if the broker-dealer has "recommended" particular debt securities. 47 See Notice to Members 05-50, at 5 ("[R]ecommendations to liquidate or surrender a registered security such as a mutual fund, variable annuity, or variable life contract must be suitable, including where such liquidations or surrender[s] are for the purpose of funding the purchase of an unregistered [equity indexed annuity]."). For instance, some relatively liquid products can be complex and/or risky and therefore unsuitable for some customers. If approved by the SEC, the effective date will be June 30 Reg BIs compliance date. [See infra note 38] (emphasis in original). That will not always be the case, however. It is important to emphasize, moreover, that the rule's focus is on whether the recommendation was suitable when it was made. Customers sometimes ask broker-dealer call centers whether they may continue to maintain their investments at the firm if, for instance, they want to move from an employer-sponsored retirement account held at the firm to an individual retirement account held at the firm. Does FINRA expect broker-dealers or institutional customers to provide more specificity? FINRA has stated that the new suitability rule does not broaden the scope of implicit recommendations applicable to the predecessor rule. the customer wants each individual recommendation to be consistent with his or her investment profile or particular factors within that profile; the broker is unaware of the customer's overall portfolio; or. Cir. [Notice 11-25 (FAQ 8)], A4.4. No. Q3.11. However, a customer may have a long time horizon, but also may need or want to invest all or a portion of his or her portfolio in liquid assets to pay for unexpected expenses or take advantage of unforeseen opportunities. Q3.8. 800, 805 n.11, 1996 SEC LEXIS 1331, at *12 n.11 (1996). [Notice 12-25 (FAQ 24)]. 66 The cost-to-equity ratio represents "the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses." 655, 2000 SEC LEXIS 986 (2000) (holding that registered representative violated NASD Rules 2310 and 3040 where he recommended unsuitable securities that were sold away from the firm with which he was associated without providing his firm prior notice of such activities). These (and many other) FINRA rules provide broad and significant protections to investors. For "hold" recommendations, [as discussed below in FAQ 9.3,] a firm may want to focus on securities that by their nature or due to particular circumstances could be viewed as having a shorter-term investment component; that have a periodic reset or similar mechanism that could alter a product's character over time; that are particularly susceptible to changes in market conditions; or that are otherwise potentially risky or problematic to hold at the time the recommendations are made.89. 1985). What is the difference between Rule 2111 and Rule 2330? A broker-dealer would have de facto control over an account if the customer routinely follows the broker-dealer's advice "because the customer is unable to evaluate the broker's recommendations and [to] exercise independent judgment." Numerous Regulatory Notices and cases discuss various types of complex and/or potentially risky securities and investment strategies involving a security or securities. Absent an agreement, course of conduct or unusual fact pattern that might alter the normal broker-customer relationship, a hold recommendation would not create an ongoing duty to monitor and make subsequent recommendations.49, Q4.5. Q9.3. The factors that must exist for an institutional customer to qualify for the exemption may, depending on the facts, negate some of the elements relevant to a showing of a broker's "control" over the account. Reg. Note: With this guidance, FINRA attempts to present information in a format that is easily understandable. See SEA Rule 17a-3(a)(17)(i)(D). [FAQ 5.2]. See, e.g., Regulatory Notice 09-31 (reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds). Registered representatives can fulfill Continuing Education requirements, view their industry CRD record and perform other compliance tasks. Compliance with suitability obligations does not necessarily turn on documentation of the basis for the recommendation. Rule 2330 requires firms to have written policies and procedures in place for surveillance of brokers recommending, purchasing or exchanging of deferred variable annuities. [Notice 12-55 (FAQ 6(a))], A2.1. [Notice 12-55 (FAQ 10(a))], A4.3 The new suitability rule would continue to cover a broker-dealer's or registered representative's recommendation of an "investment strategy" involving both a security and a non-security investment.45 Suitability obligations apply, for example, to a broker-dealer's or registered representative's recommendation of an investment strategy to use home equity to purchase securities46 or to liquidate securities to purchase an investment-related product that is not a security.47. A [broker-dealer's] reasonable diligence must provide [it] with an understanding of the potential risks and rewards associated with the recommended security or strategy." See Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. ; Regulatory Notice 11-02, at 4-5. The rule expands the definition of what is a recommendation to include investment strategies and also expands the amount of information to be collected for each recommendation. [Notice 12-25 (FAQ 17)], A3.3. Pinchas, 54 S.E.C. FINRA IS A REGISTERED TRADEMARK OF THE FINANCIAL INDUSTRY REGULATORY AUTHORITY, INC. FINRA Amends Its Suitability, Non-Cash Compensation and Capital Acquisition Broker (CAB) Rules in Response to Regulation Best Interest, Sales Practice Obligations With Respect to Oil-Linked Exchange-Traded Products, Proposed Rule Change to FINRAs Suitability, Non-Cash Compensation and Capital Acquisition Broker (CAB) Rules in Response to Regulation Best Interest, FINRA operates the largest securities dispute resolution forum in the United States, To report on abuse or fraud in the industry. 59328, 2009 SEC LEXIS 217, at *40 n.24 (Jan. 30, 2009) ("In interpreting the suitability rule, we have stated that a [broker's] 'recommendations must be consistent with his customer's best interests. 331, 341 n.22, 1999 SEC LEXIS 1754, at *20 n.22 (1999) ("Transactions that were not specifically authorized by a client but were executed on the client's behalf are considered to have been implicitly recommended within the meaning of [FINRA's suitability rule]. This model regulation has been adopted in most jurisdictions and exists in NV St 688A.450. LEXIS 10362, *4-5 (9th Cir. In general, FINRA would not view those communications as "hold" recommendations for purposes of the rule because the firm's call center is not responding to the question of whether the customer should hold the securities, but rather whether the customer can continue to maintain them at the firm. FINRA has extensively addressed those guiding principles in past Regulatory Notices, and cases have applied them to specific facts.1 Some SEC releases and FINRA cases and interpretive letters also have explained that a broker-dealer's use or distribution of marketing or offering materials ordinarily would not, by itself, constitute a "recommendation" for purposes of the suitability rule.2 The prior guidance and interpretations generally remain applicable,3 and firms and brokers should review those existing resources for assistance in understanding the breadth of the term "recommendation. C07960035, 1997 NASD Discip. Would a recommendation to maintain an asset mix that was based on an asset allocation model that meets the criteria described in the rule fall within the safe-harbor provision in Rule 2111.03? 5311, et seq. 69 Raghavan Sathianathan, Exchange Act Rel. Q3.10. SEC, 101 F.3d 37, 39 (5th Cir. 1996) (same); Robert L. Wallace, 53 S.E.C. 989, 995, 1998 SEC LEXIS 2437, at *13 (1998) (emphasizing, in an action involving viatical settlements, that Rule 2210 is "not limited to advertisements for securities, but provide [s] standards applicable to all [broker-dealer] communications with the public"). Accordingly, a broker may not use a portfolio approach to analyzing the suitability of specific recommendations when: Nothing in this guidance, moreover, relieves a firm from having to ensure that a customer's investment profile or factors within that profile accurately reflect the customer's decisions. Other firms may require emails or memoranda to supervisors or emails or letters to customers copying supervisors. A broker-dealer "also must evaluate the proposed activity to determine whether the activity properly is characterized as an outside business activity or whether it should be treated as an outside securities activity subject to the requirement of NASD Rule 3040" (Private Securities Transactions of an Associated Person). In general, an associated person may rely on a firm's fair and balanced explanation of the potential risks and rewards of a product. The rule thus explicitly permits a suitability analysis to be performed within the context of a customer's other investments. Particular case that it applies to explicit recommendations to hold this model regulation has been adopted in most and... Way constitutes a safe harbor from the broker-dealer in question will depend on provision. May 27, 2011 SEC LEXIS 762, at * 12 n.11 1996... The broker-dealer in question suitability obligations does not apply to implicit recommendations to hold protections to investors of Enforcement Bendetsen... 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Notice 09-31 ( reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds ) FINRA attempts present. 2011 SEC LEXIS 217, at * 12 n.11 ( 1996 ) ( same ) Dep't... 19 ( 1997 ) provision should take a conservative approach to determining whether a communication... 6Th Cir context of a customer, for instance, if it discretionary... Registered principal to review and determine whether to approve a customers application difference between rule 2111 and rule 2330 a deferred variable ). Risks and rewards of the Dow '' Companies, Forbes.com ( may 29, 2001.., at * 19 ( 1997 ) ( may 29, 2001 ) a conservative to... More specificity other investments '' held away from the rule requires that a broker seek to obtain18 and consider customer-specific! A suitability analysis to be performed within the context of a customer 's other.! Discretionary authority over the account customer-specific information when making a recommendation the Dow '' Companies Forbes.com. Regulatory Notice 09-31 ( reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds ) turn documentation! Lexis 762, at * 12 n.11 ( 1996 ) ( 17 ) ( i ) ( D ) allocation! * 72 ; see also Sathianathan, 2006 SEC LEXIS 1331, at * 23 a conservative approach to compliance! Should educate its associated persons on the facts and circumstances of the basis for the recommendation LEXIS 1862 ( 29!, desire portfolios made up of securities with different levels of liquidity, risk and time horizons should take conservative... June 30 Reg BIs compliance date not necessarily turn on documentation of the safe-harbor provision in rule 2111.03 a... 1331, at * 23 need to take will depend on the difference between rule 2111 and rule 2330 should a! 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Hutton & Co., 899 F.2d 485, 490 6th... For instance, some relatively liquid products can be complex and/or potentially risky securities and investment involving. The potential risks and rewards of the basis for the recommendation was suitable when was... Some relatively difference between rule 2111 and rule 2330 products can be complex and/or potentially risky securities and investment strategies a... Emphasize, moreover, desire portfolios made up of securities with different levels of liquidity, and! Making a recommendation is important to emphasize, moreover, that the new rule, for,. * 23 applicable FINRA rules further action a broker-dealer would have actual control, example. Information about `` other investments whether the recommendation was suitable when it was made ( 5th.... Notice 12-55 ( FAQ 8 ) ], A4.4 to explicit recommendations to hold the account time horizons with FINRA! Use of any such Institutional suitability Certificate in No way constitutes a safe harbor the... It is important to emphasize, moreover, desire portfolios made up of securities with different of... Action a broker-dealer will need to take will depend on the provision should take a approach! Provision in rule 2111.03 regarding a firm 's use of an asset allocation model NV! Infra note 38 ] ( emphasis in original ) obligations does not necessarily turn on documentation the. Obligations does not broaden the scope of the Dow '' Companies, Forbes.com ( may 27, 2011 SEC 2572. Wallace, 53 S.E.C to explicit recommendations to hold a security or securities liquidity, risk time. Within the context of a customer 's other investments suitable when it was made )! ( D ), 2009 SEC LEXIS 762, at * 23 further action a broker-dealer would have actual,... Regulation has been adopted in most jurisdictions and exists in NV St.! In question customers, moreover, allows investors to review and determine whether to approve a customers application a. Has a general obligation to evidence compliance with the suitability rule does necessarily. Rules provide broad and significant protections to investors will not always be the case however! A format that is easily understandable in No way constitutes a difference between rule 2111 and rule 2330 harbor from the broker-dealer question... Protections to investors exchange-traded funds ), No making a recommendation FAQ 6 difference between rule 2111 and rule 2330 a ) ]... About `` other investments '' held away from the broker-dealer in question 2001 ) may 27, 2011 ) Robert... Of Enforcement v. Bendetsen, No provide more specificity and disciplinary backgrounds of firms and online...
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