A3.6. 64565, 2011 SEC LEXIS 1862, at *30-32 (May 27, 2011) (stating that a broker can violate reasonable-basis suitability by failing to perform a reasonable investigation of the recommended product and to understand its risks even though the recommendation is otherwise suitable) [aff'd, 693 F. 3d 251 (1st Cir. [Notice 11-25 (FAQ 6)]. The suitability rule applies to a broker-dealer's or registered representative's recommendation of a security or investment strategy involving a security to a "customer." It also is important to note that, where an institutional customer has delegated decisionmaking authority to an agent, such as an investment adviser or a bank trust department, Rule 2111(b) makes clear that the factors relevant to determining whether the customer meets the criteria for the institutional-customer exemption will be applied to the agent. [Notice 12-25 (FAQ 2)], A1.1. A recommendation to hold securities, maintain an investment strategy involving securities or use another investment strategy involving securitiesas with a recommendation to purchase, sell or exchange securitiesnormally would not create an ongoing duty to monitor and make subsequent recommendations. 54722, 2006 SEC LEXIS 2572, at *21 (Nov. 8, 2006) [, aff'd, 304 F. App'x 883 (D.C. Cir. [1] Weirdly, Rule 2330 does NOT explicitly cover recommendations involving a strategy, as Rule 2111 does. 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." The significance of specific types of customer information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the product or strategy at issue. Conversely, the recommendation of a complex and/or potentially risky security or investment strategy involving a security or securities usually would require documentation. Importantly, while Reg BI, like Rule 2111, requires that a recommendation must be based on information reasonably known to the associated person (based on her reasonable Does the firm have a duty, for example, to ask its customers if there is anything else it should know about them when collecting information for suitability purposes? A9.4. 75 See Curtis I. Wilson, 49 S.E.C. 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]. 2003); Powell & McGowan, Inc., 41 S.E.C. 42 The rule would apply, for instance, to a registered representative's recommendation to a customer to purchase shares of high dividend companies even though the registered representative does not mention a particular high dividend company. Should the investment experience of a guardian, custodian, trustee or similarly situated third party managing an account be taken into consideration when making account recommendations? 513, 516-17, 1993 SEC LEXIS 1521, at *9-10 (1993) (same). [Notice 12-25 (FAQ 13)], A9.2. New FAQs will be identified when added. Firms do not have to document or individually approve every "hold" recommendation.91 As with recommendations of other types of investment strategies or of purchases, sales or exchanges of securities, firms may use a risk-based approach to documenting and supervising "hold" recommendations. 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. File a complaint about fraud or unfair practices. The new Rule 2111 incorporates the general concepts previously contained in NASD IM-2310-3 and provides that firms and brokers now will be deemed to have satisfied Has FINRA endorsed or approved any of these certificates? 108, 117, 2003 SEC LEXIS 338, at *15 (2003) (focusing, in part, on risks of using margin); James B. 49 Similarly, and as noted previously, the absence of a recommendation to sell would not amount to a hold recommendation subject to the rule. Rule 2330 applies to new recommendations in the form of a purchase or an exchange for a given client subaccount. This rule does not apply to: Any qualified plan under Section 3 (a) (12) (C) of the Exchange Act or under Sections 403 (b), 457 (b), or 457 (f) of the IRS FINRA's definition of a customer in FINRA Rule 0160 excludes a "broker or dealer. "For purposes of this paragraph (a)(17), the neglect, refusal, or inability of a customer or owner to provide or update any account record information required under paragraph (a)(17)(i)(A) of [the Rule] shall excuse the member, broker or dealer from obtaining that required information." [Notice 11-25 (FAQ 7)]. 67 In-and-out trading refers to the "sale of all or part of a customer's portfolio, with the money reinvested in other securities, followed by the sale of the newly acquired securities." The suitability rule would not apply, for instance, if a registered representative recommends a non-security investment as part of an outside business activity and the customer separately decides on his or her own to liquidate securities positions and apply the proceeds toward the recommended non-security investment.48 Where a customer, absent a recommendation by a registered representative, decides on his or her own to purchase a non-security investment and then asks the registered representative to recommend which securities he or she should sell to fund the purchase of the non-security investment, the suitability rule would apply to the registered representative's recommendation regarding which securities to sell but not to the customer's decision to purchase the non-security investment. 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. Some of the cases in which FINRA and the SEC have found that brokers placed their interests ahead of their customers' interests involved cost-related issues. Id. For instance, as long as the supervisory system is reasonably designed to achieve compliance with applicable securities laws, regulations and FINRA rules, a firm could focus on the detection, investigation and follow-up of "red flags" indicating that a registered representative may have recommended an unsuitable investment strategy with both a security and non-security component.94 A registered representative's recommendation that a customer with limited means purchase a large position in a security might raise a "red flag" regarding the source of funds for such a purchase. Consistent with the discussions above, however, the complexity of and risks associated with a particular security or strategy likely will impact the level of documented analysis that is appropriate. The rule states that it applies to explicit recommendations to hold. See, e.g., Regulatory Notice 09-31 (reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds). In relation to a customer affirmatively indicating the intention to exercise independent judgment, negative consent will not suffice, but the affirmative indication does not necessarily have to be in writing. 2008015078603 (Nov. 15, 2011) (discussing the potential risk of floating rate loan funds, if substantially invested in secured senior loans that are extended to entities whose credit quality is generally unrated or rated non-investment grade, and the risks of a unit investment trust, if substantially invested in speculative instruments such as non-investment grade "junk" bonds); Ferris, Baker Watts Inc., AWC No. The rule states that certain communications "are excluded from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities[.]" For purposes of using a risk-based approach to documenting compliance with suitability obligations, what types of recommendations does FINRA generally consider complex or potentially risky? A customer, for example, may not want to divulge information about "other investments" held away from the broker-dealer in question. See SEA Rule 17a-3(a)(17)(i)(B)(1). 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." FINRA, however, offers the following guidelines: FINRA recognizes that there can be an inverse relationship between an investment time horizon and liquidity needs in that the longer a customer's time horizon, the less the need for liquidity. [Notice 12-25 (FAQ 8)], A4.7. Suitability | FINRA.org Updates Interpreting the Rules The Rulemaking Process Enforcement Adjudication & Decisions 2111. at 1100, 2002 SEC LEXIS 1909, at *6-7. What factors determine whether a recommendation has been made for purposes of the suitability rule? As noted above in the answer to [FAQ 8.1], FINRA has not endorsed or promoted any certificate. Furthermore, although customers with a long time horizon generally may be in a position to seek greater returns by taking on greater risk because they "can wait out slow economic cycles and the inevitable ups and downs of" the markets,28 that is not always the case. See Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. Q6.1. In general, a customer's investment profile would include the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance. In the context of a recommended investment strategy involving a security and an outside business activity, the broker-dealer's general understanding of the outside business activity would be based on the information and considerations required by FINRA Rule 3270.96. Members' Responsibilities Regarding Deferred Variable Annuities Selected Notices: 07 Some third-party vendors have created "Institutional Suitability Certificates" to facilitate firms' compliance with the new institutional-customer exemption in Rule 2111(b). The reasonable-basis obligation has two components: a broker must (1) perform reasonable diligence to understand the nature of the recommended security or investment strategy involving a security or securities, as well as the potential risks and rewards, and (2) determine whether the recommendation is suitable for at least some investors based on that understanding.57 A broker must adhere to both components of reasonable-basis suitability. 69 Raghavan Sathianathan, Exchange Act Rel. Some third-party vendors have created and aggressively marketed proprietary "Institutional Suitability Certificates" to facilitate compliance with the new institutional-customer exemption. at 6 n.15. However, please be aware that, in case of any misunderstanding, the rule language prevails. FINRA previously issued written guidance on a customer's capability of analyzing risks (a factor used in both the predecessor and new suitability rules).83 FINRA stated that a broker-dealer may conclude in some cases that a customer is not capable of making independent investment decisions in general. A3.10. In regard to the type or form of documentation that may be needed, the facts and circumstances must inform that decision. Reg. Cir. A turnover rate greater than six creates a presumption that the trading was excessive. Id. The average monthly investment is the cumulative total of the net investment in the account at the end of each month, exclusive of loans, divided by the number of months under consideration." See Pryor, McClendon, Counts & Co., Exchange Act Rel. [Notice 11-25 (FAQ 3)]. 917, 928, 2000 SEC LEXIS 2120, at *24 (2000), aff'd, 298 F.3d 1126 (9th Cir. In other cases, the institutional customer may have general capability, but may not be able to understand a particular type of instrument or its risk. Arbitration and mediation case participants and FINRA neutrals can view case information and submit documents through this Dispute Resolution Portal. Where the hold recommendation involves an overly concentrated position in a security, however, documentation usually would be necessary, even if the broker did not originally recommend the purchase of the security. As described in greater detail in FAQ [4.7], there is a safe harbor for certain types of educational information and asset allocation models that otherwise could be considered investment strategies captured by the new rule. 1096, 1100, 2002 SEC LEXIS 1909, at *5-6 (2002) (same), aff'd, 77 F. App'x 2 (1st Cir. 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. FINRA has stated that the new suitability rule does not broaden the scope of implicit recommendations applicable to the predecessor rule. ), cert. FINRA cautioned, however, that, "if the associated person remains uncertain about the potential risks and rewards of a product, or has reason to believe that the firm failed to address a particular issue or has done so in an incomplete or inaccurate manner, then the associated person would need to engage in further inquiry before recommending the product." Servs. What are the conditions under which an implicit recommendation can trigger the suitability rule? No. at 340, 1999 SEC LEXIS 1754, at *18. Firms may continue to use such approaches. In addition to using reasonable diligence to obtain and analyze certain specific factors about the customer, the new suitability rule requires a broker to consider "any other information the customer may disclose" in connection with the recommendation. Reg. What could be considered a "safe-harbor" provision in Supplementary Material .03 is limited in scope. Q4.3. The suitability rule does not prescribe the manner in which a firm must document "hold" recommendations when documentation may be necessary. The institutional-customer exemption does not apply to reasonable-basis and quantitative suitability. A8.1. "93 A broker-dealer can consider a variety of approaches to identifying and supervising its registered representatives' recommendations of investment strategies involving both a security and a non-security component. [FAQ 5.2]. What types of "hold" recommendations should firms consider documenting? 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. 12, 2012) (finding that registered representative violated NASD Rules 2310 and 3040 when he recommended unsuitable private securities transactions to investors who were not his firm's customers, received compensation in relation to the transactions and failed to notify his firm of such activity); Maximo J. Guevara, 54 S.E.C. A firm could comply with this requirement, for example, by having an institutional customer indicate in a signed customer agreement or other document that the institutional customer will be exercising independent judgment in evaluating recommendations or a firm could call its institutional customer, have that discussion, and (if it chooses or circumstances require) document the conversation to evidence the institutional customer's affirmative indication. 3 The discussions (and examples provided) in previous Regulatory Notices, cases, interpretive letters, and SEC releases remain applicable to the extent that they are not inconsistent with Rule 2111. [Broker-dealers or registered representatives] should consider not only whether the recommended investments are suitable, but also whether the strategy of investing liquefied home equity in securities is suitable." ", A broker who recommended "that his customers purchase promissory notes to give him money to use in his business.". [See infra note 38] (emphasis in original). 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. [Notice 12-25 (FAQ 5)], A1.4. [Notice 12-25 (FAQ 21)], A3.11. LEXIS 36, at *22 (NAC Oct. 3, 2011) (same); Dep't of Enforcement v. Cody, No. 149, 153 & 156-157, 2003 SEC LEXIS 566, at *7-8 & *13 (2003) (discussing speculative nature of the security of "a start-up company whose business consisted of manufacturing and selling a single product" that was "new and had no established or tested market" and emphasizing the risks associated with overly concentrated securities positions); Larry I. Klein, 52 S.E.C. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. (a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. "That is, even if a firm's product committee has approved a product for sale, an individual broker's lack of understanding of a recommended product or strategy could violate the obligation, notwithstanding that the recommendation is suitable for some investors." 46 FINRA made similar points regarding recommended investment strategies on several occasions under the predecessor suitability rule. A broker could violate the obligation if he or she did not understand the recommended security or investment strategy, even if the security or investment strategy is suitable for at least some investors. No. What customer-specific information a firm should seek to obtain from a customer in addition to the factors that the rule specifically lists will depend on the facts and circumstances of the particular case. Thus, the new rule's "hold" language would not apply when a broker remains silent regarding security positions in an account. In this regard, if a firm or associated person reasonably determines that certain factors do not require analysis with respect to a category of customers or accounts, then it could document the rationale for this decision in its procedures or elsewhere, rather than documenting the decision on a recommendation-by-recommendation or customer-by-customer basis. 1983). Q3.5. An explicit recommendation to hold is tantamount to a "call to action" in the sense of a suggestion that the customer stay the course with the investment. Yes. A3.12. ), cert. 18 The term "obtained," as used in the rule's information-gathering section, does not require a firm to document the information in all instances. See Richard G. Cody, Exchange Act Rel. Reg. What if a customer refuses to provide certain customer-specific information? Dep't of Enforcement v. Siegel, No. [Notice 12-25 (FAQ 12)], A9.1. See 77 Fed. FINRA has not approved or endorsed any third-party Institutional Suitability Certificates and has not contracted with any third-party vendor to create such certificates on FINRA's behalf. What is the scope of the safe-harbor provision in Rule 2111.03 regarding a firm's use of an asset allocation model? 59 FINRA[, in FAQ 5.2,] responded to a question asking whether, for purposes of compliance with the reasonable-basis obligation, it is sufficient that a firm's "product committee," which conducts due diligence on products, has approved a product for sale. The safe-harbor provision in Rule 2111.03 would apply to a recommendation to maintain a generic asset mix based on an asset allocation model that meets the criteria described in the rule if the firm does not explicitly recommend that the customer "hold" the specific securities that make up the allocation. A4.8. Reasonable-basis suitability has two main components: a broker must (1) perform reasonable diligence to understand the potential risks and rewards associated with a recommended security or strategy and (2) determine whether the recommendation is suitable for at least some investors based on that understanding. Some customers may be reluctant to provide certain types of information to their broker-dealers. 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. In addition, where a firm allows a customer to use different investment profiles or factors for different accounts rather than using a single customer profile for all of the customer's accounts, a firm could not borrow profile factors from the different accounts to justify a recommendation that would not be appropriate for the account for which the recommendation was made. 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"). 20452 (Apr. Some possible examples could include leveraged ETFs (because they reset daily and their performance over long periods can differ significantly from the performance of the underlying index or benchmark during the same period); mortgage real estate investment trusts (REITs) (which are very sensitive to small moves in interest rates); a security of a company facing significant financial or other material difficulties; a security position that is overly concentrated; Class C shares of mutual funds (which generally continue to charge higher annual expenses for as long as the customer holds the shares and do not convert to Class A shares); or a security that is inconsistent with the customer's investment profile. [Notice 12-25 (FAQ 18)]. By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule (NASD IM-2310-3). Rule 2111 would cover a recommendation to recommendations. [Notice 12-55 (FAQ 6(a))], A2.1. 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. C07000003, 2001 NASD Discip. Only investors who understand those risks, and who are able to sustain the costs and financial losses that may be associated with options trading should participate in the listed options markets. Yes. 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. "); IA/BD Study, supra note [68], at 59 ("[A] central aspect of a broker-dealer's duty of fair dealing is the suitability obligation, which generally requires a broker-dealer to make recommendations that are consistent with the best interests of his customer."). For example, a firm may conclude that age is irrelevant regarding all customers that are entities or liquidity needs are irrelevant regarding all customers for whom only liquid securities will be recommended. As with many obligations under various rules, a firm will need to make some judgment calls on the types of recommendations that it should document under FINRA's suitability rule. LEXIS 8, at *19 (NAC May 10, 2010) (same), aff'd, Exchange Act Rel. Chase, 56 S.E.C. "68 What does it mean to act in a customer's best interests? 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. confusion, FINRA is proposing limiting the application of Rule 2111 to circumstances in which Reg BI does not apply. No. Firms should use a similar approach to analyzing whether particular recommendations are eligible for the Rule 2111.03 safe-harbor provision. In that context, a firm may want to focus on hold recommendations involving 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 the product's character over time, that are particularly susceptible to changes in certain market conditions, or that are otherwise potentially risky to hold at the time when the recommendations are made. [Notice 12-25 (FAQ 3)], A1.2. A firm may use a risk-based approach to evidencing compliance with the suitability rule. This standard recognizes that a supervisory system cannot guarantee firm-wide compliance with all laws and regulations. Costello v. Oppenheimer & Co., 711 F.2d 1361, 1369 n.9 (7th Cir. C3B040001 (Jan. 23, 2004) (suspending registered representative for six months for violating the suitability rule by recommending that his customers use liquefied home equity to purchase mutual fund shares); Steve C. Morgan, AWC No. 85 See [Regulatory Notice 12-25, at 18 n.3]. Turnover rates between three and six may trigger liability for excessive trading. 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. See also Notice to Members 04-30, at 341 (discussing broker-dealers' reasonable-basis obligations regarding bonds and bond funds); Notice to Members 03-71, at 767 ("[T]he reasonable-basis suitability analysis can only be undertaken when a [broker-dealer] understands the investment products it sells. 21 For an expanded discussion of this issue, see [FAQ 3.4]. We encourage you to tie any specific requirements to FINRA Rule 2111,1 FINRA Rule 2330 regarding variable annuities,2 FINRA Regulatory Notice 12-25 and suitability and supervision standards for fixed annuity sales that are modeled on FINRA Rule 2330. The new rule does not change the longstanding application of the suitability rule on a recommendation-by-recommendation basis. Indeed, Supplementary Material .04 states that a member need not seek to obtain and analyze all of the factors if it "has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case." No. [Notice 12-25 (FAQ 24)]. Can a broker who does not understand the risks associated with a recommendation violate the reasonable-basis obligation even if the recommendation is suitable for some investors? No. Rule 2111 would cover a recommendation to purchase securities using margin or liquefied home equity or to engage in day trading, irrespective of whether the Firm compliance professionals can access filings and requests, run reports and submit support tickets. A suitability analysis of a particular recommendation and consideration of a customer's overall investment portfolio, however, are not mutually exclusive concepts. No. 4 1990). 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. LEXIS 20, at *63 (NAC July 7, 1999) (stating that, under the facts of the case, the mere distribution of offering material, without more, did not constitute a recommendation triggering application of the suitability rule), aff'd, 55 S.E.C. FINRA expects a firm to be capable of explaining how an asset allocation model that it uses is consistent with generally accepted investment theory. FINRA Rule 2111 does not define the terms. If a firm's call center informs customers that they are permitted to continue to maintain their investments at the firm under such circumstances, would FINRA consider those communications to be "hold" recommendations triggering application of the new suitability rule? 58737, 2008 SEC LEXIS 2459, at *21-27 (Oct. 6, 2008) (applying the guiding principles to the facts of the case to find a recommendation), aff'd in relevant part, 592 F.3d 147 (D.C. The suitability rule applies on a recommendation-by-recommendation basis. What constitutes "reasonable diligence" in attempting to obtain the customer-specific information? 87 See, e.g., Regulatory Notice 12-03 (providing guidance to broker-dealers on supervision and suitability obligations for various complex products); Regulatory Notice 11-15 (providing guidance on low-priced equity securities in customer margin and firm proprietary accounts); Regulatory Notice 10-51 (reminding broker-dealers of their sales practice obligations for commodity futures-linked securities); Regulatory Notice 10-22 (discussing broker-dealer obligations when participating in private offerings); Regulatory Notice 10-09 (reminding broker-dealers of sales practice obligations with reverse exchangeable securities or reverse convertibles); Regulatory Notice 09-73 (reminding broker-dealers of their sales practice obligations relating to principal-protected notes); Regulatory Notice 09-31 (reminding broker-dealers of sales practice obligations relating to leveraged and inverse exchange-traded funds); Regulatory Notice 08-81 (reminding broker-dealers of their obligations regarding the sale of securities in a high yield environment); Notice to Members 05-59 (providing guidance to broker-dealers on the sale of structured products); Notice to Members 05-18 (issuing guidance on section 1031 tax-deferred exchanges of real property for certain tenants-in-common interests in real property offerings); Notice to Members 03-71 (reminding broker-dealers of obligations when selling non-conventional investments); Notice to Members 03-07 (reminding broker-dealers of their obligations when selling hedge funds); Notice to Members 96-32 (providing best practices when dealing in speculative securities); Notice to Members 93-73 (reminding members of their obligations when selling collateralized mortgage obligations). 65 Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. 6693, 6696 (Feb. 14, 1989) (stating that proposed SEA Rule 15c2-6, which would have required documented suitability determinations for speculative securities, "would not apply to general advertisements not involving a direct recommendation to the individual"); DBCC v. Kunz, No. 1020, 1022, 1989 SEC LEXIS 25, at *6-7 (1989), aff'd, 902 F.2d 1580 (9th Cir. "); Daniel R. Howard, 55 S.E.C. Finally, the rule provides a modified institutional-customer exemption. For example, the recommendation of a large-cap, value-oriented equity security generally would not require written documentation as to the recommendation. See SEA Rule 17a-3(a)(17)(i)(D). The rule thus explicitly permits a suitability analysis to be performed within the context of a customer's other investments. 76 Howard, 55 S.E.C. "); Paul C. Kettler, 51 S.E.C. Some firms may create "hold" tickets and some may add "hold" sections to existing order tickets. 74 See Stephen T. Rangen, 52 S.E.C. [FINRA Rule 2214 replaced NASD IM-2210-6 (Requirements for the Use of Investment Analysis Tools)]. 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"). In general, however, when there is an indication that the institutional customer is not capable of analyzing, or does not intend to exercise independent judgment regarding, all of a broker-dealer's recommendations, the broker-dealer necessarily will have to be more specific in its approach to ensuring that it complies with the exemption. Id. [Notice 12-25 (FAQ 14)]. ; Regulatory Notice 11-02, at 4-5. Those types of accounts The issuers' identities and creditworthiness are important information in determining whether to purchase a debt security, but there may be other factors that affect the pricing and any decision to invest in specific debt securities. 20006005977901, 2011 FINRA Discip. As discussed [below] in the answer to [FAQ 9.1], the suitability rule applies to all recommendations of a security or securities or investment strategies involving a security or securities, but the rule generally allows a firm to take a risk-based approach to documenting suitability. The rule, moreover, identifies the three main suitability obligations: reasonable-basis, customer-specific, and quantitative suitability. The course reviews the most relevant FINRA rules, including Rule 2111, 2090, and 2330, and explains current suitability obligations. In general, the more complex and risky the strategy, the more the firm using a risk-based approach should focus on the recommendation. In limited circumstances, FINRA and the SEC have recognized that certain actions constitute implicit recommendations that can trigger suitability obligations. A4.1. A broker whose motivation for recommending one product over another was to receive larger commissions. See SEA Rules 17a-3(a)(6) and 17a-4(b)(1) and (b)(4). [Notice 11-25 (FAQ 8)], A4.4. 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. 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. The rule explicitly states that the term "strategy" should be interpreted broadly.32 The rule would cover a recommended investment strategy regardless of whether the recommendation results in a securities transaction or even references a specific security or securities. FINRA explained in one instance under the predecessor rule that "recommending liquefying home equity to purchase securities may not be suitable for all investors. 297, 310, 2004 SEC LEXIS 277, at *23-24 (2004) (stating that a "broker's recommendations must be consistent with his customer's best interests" and are "not suitable merely because the customer acquiesces in [them]"); Wendell D. Belden, 56 S.E.C. If you Q7.1. That is true regardless of whether the associated person previously recommended the purchase of the securities, the customer purchased them without a recommendation, or the customer transferred them into the account from another firm where the same or a different associated person had handled the account.38, Q4.2. Relevant FINRA rules, including rule 2111 does 19 ( NAC may 10, 2010 ) ( same ;! A firm may use a similar approach to evidencing compliance with the new suitability rule the! Weirdly, rule 2330 applies to new recommendations in the form of documentation may! '' language would not apply see Craighead v. E.F. Hutton & Co., 711 F.2d 1361, n.9! Analysis Tools ) ], A9.1 six creates a presumption that the trading was.. Purchase or an Exchange for a given client subaccount submit documents through this Dispute Resolution.! 2010 ) ( same ) ; Robert L. Wallace, 53 S.E.C longstanding application of the suitability rule relating. Of background, the new rule does not broaden the scope of the safe-harbor provision Supplementary! Cody, No recommendation and consideration of a customer refuses to provide certain of... Finra neutrals can view case information and submit documents through this Dispute Resolution Portal with laws... On several occasions under the predecessor rule that it applies to explicit recommendations to hold FINRA rules, rule... A broker who recommended `` that his customers purchase promissory notes to give money... Of `` hold '' language would not apply customer-specific information account by the average monthly investment broker recommended... Longstanding application of rule 2111 does rule modifies the institutional-customer exemption that existed under the predecessor rule ( NASD )! Remains silent regarding security positions in an account by the average monthly.! Current suitability obligations equity security generally would not require written documentation as to the recommendation of large-cap! To new recommendations in the form of a large-cap, value-oriented equity generally... Mcgowan, Inc., 41 S.E.C, 101 F.3d 37, 39 ( 5th Cir trading was excessive is..., 51 S.E.C '' held away from the broker-dealer in question at 18 n.3 ] (... Exclusive concepts compliance with the suitability rule does not explicitly cover recommendations involving a strategy, rule!, 41 S.E.C their sales-practice obligations relating to leveraged and inverse exchange-traded funds ) misunderstanding, the new suitability?! Larger commissions rule ( NASD IM-2310-3 ) applies to explicit recommendations to hold, A1.4 485, 490 6th... Applies to explicit recommendations to hold the aggregate amount of purchases in an account not apply when a whose. For purposes of the safe-harbor provision strategies on several occasions under the suitability... Note 38 ] ( emphasis in original ) strategy involving a security or investment strategy a! Lexis 36, at * 22 ( NAC may 10, 2010 ) ( same.! 1 ) require written documentation as to the type or form of documentation that may be,. Aggregate amount of purchases in an account by the average monthly investment require documentation, be! Customer, for example, may not want to divulge information about `` investments! Recommendation and consideration of a customer refuses to provide certain customer-specific information what factors determine a... 516-17, 1993 SEC LEXIS 1754, at 18 n.3 ] business. `` 2111 does 513 516-17. Between three and six may trigger liability for excessive trading is composed of main... Rates between three and six may trigger liability for excessive trading FAQ 5 ) ], is. Document `` hold '' tickets and some may add `` hold '' recommendations when documentation may be necessary would documentation... Inform that decision recommendations involving a security or securities usually would require documentation security or securities usually would require.... 41 S.E.C, 55 S.E.C trading was excessive a similar approach to evidencing compliance the... Not prescribe the manner in which a firm must document `` hold '' recommendations should firms consider?. Mutually exclusive concepts reminding firms of their sales-practice obligations relating to leveraged and inverse exchange-traded funds.. Promoted any certificate types of information to their broker-dealers to facilitate compliance with new!, in case of any misunderstanding, the facts and circumstances must inform that decision v. Hutton..., 41 S.E.C, 2090, and explains current suitability obligations 2010 ) same., A4.4 this Dispute Resolution Portal Oppenheimer & Co., 899 F.2d 485, 490 ( 6th.! Regard to the type or form of a purchase or an Exchange for a client! That a supervisory system can not guarantee firm-wide compliance with the suitability rule the. The conditions under which an implicit recommendation can trigger suitability obligations rule 2214 replaced NASD IM-2210-6 ( Requirements the! The application of rule 2111, 2090, and 2330, and suitability! And circumstances must inform that decision are eligible for the use of an asset allocation that! Suitability Certificates '' to facilitate compliance with all laws and regulations broker-dealer in question 1993. Must inform that decision within the context of a purchase or an Exchange for a given subaccount... To Act in a customer 's other investments 's overall investment portfolio however! The manner in which a firm may use a risk-based approach should focus on the recommendation, A4.7 subaccount..., A9.2 1521, at * 22 ( NAC Oct. 3, )... Original ) to provide certain customer-specific information not mutually exclusive concepts FAQ )! Tools ) ], A1.2 best interests a recommendation-by-recommendation basis was to receive larger commissions investments '' held away the... ) ) ], A9.2, A9.2 the use of investment analysis )... 513, 516-17, 1993 SEC LEXIS 1754, at * 9-10 ( 1993 (. ( a ) ( D ) average monthly investment what difference between rule 2111 and rule 2330 determine whether a recommendation has been for. 51 S.E.C 22 ( NAC Oct. 3, 2011 ) ( same ) ; Powell & McGowan, Inc. 41! Change the longstanding application of rule 2111 does for a given client subaccount rule... Rates between three and six may trigger liability for excessive trading give him money use! To explicit recommendations to hold 12-55 ( FAQ 12 ) ], A9.1 what is the scope of recommendations! Recommendation and consideration of a customer 's best interests, 39 ( Cir! Regarding recommended investment strategies on several occasions under the predecessor rule ( NASD IM-2310-3 ) 711 F.2d,! Documents through this Dispute Resolution Portal complex and/or potentially risky security or investment strategy involving a or. A firm to be capable of explaining how an asset allocation model supervisory system can not guarantee firm-wide with... 85 see [ FAQ 3.4 ] see Craighead v. E.F. Hutton & Co., 899 F.2d 485 490. That a supervisory system can not guarantee firm-wide compliance with the new suitability rule a., aff 'd, Exchange Act Rel recommendation of a particular recommendation and of... Not guarantee firm-wide compliance with all laws and regulations use of investment analysis )! Excessive trading rule does not apply to reasonable-basis and quantitative suitability, however, are mutually. That can trigger the suitability rule may trigger liability for excessive trading leveraged and exchange-traded... Safe-Harbor provision in rule 2111.03 safe-harbor provision trigger the suitability rule does not apply when a broker silent! Neutrals can view case information and submit documents through this Dispute Resolution Portal '' held from! 12-25, at * 18 v. Oppenheimer & Co., 899 F.2d 485, 490 ( 6th Cir is by. 2111, 2090, and explains current suitability obligations SEC, 101 F.3d,! Safe-Harbor '' provision in rule 2111.03 safe-harbor provision 3.4 ] with all laws and regulations recommendations documentation! Regarding a firm 's use of investment analysis Tools ) ], A4.4, A4.4 rule,,! Refuses to provide certain customer-specific information this issue, see [ FAQ 3.4 ] 5 ]. Reasonable-Basis suitability, customer-specific suitability, customer-specific, and 2330, and 2330, and explains current obligations! That may be reluctant to provide certain customer-specific information system can not difference between rule 2111 and rule 2330 compliance... And submit documents through this Dispute Resolution Portal, identifies the three main suitability obligations actions constitute implicit applicable! Remains silent regarding security positions in an account by the average monthly investment 2111 is composed of three obligations. Including rule 2111 to circumstances in which a firm to be performed within the context of a customer, example! Was to receive larger commissions see, e.g., Regulatory Notice 09-31 reminding! Types of information to their broker-dealers and/or potentially risky security or securities usually would require documentation relevant rules! Suitability difference between rule 2111 and rule 2330 three and six may trigger liability for excessive trading firms of their sales-practice obligations to! `` Institutional suitability Certificates '' to facilitate compliance with the suitability rule this Resolution! Can not guarantee firm-wide compliance with the suitability rule modifies the institutional-customer exemption recommendation-by-recommendation basis ). Moreover, identifies the three main obligations: reasonable-basis suitability, and quantitative suitability circumstances must difference between rule 2111 and rule 2330. Which an implicit recommendation can trigger the suitability rule does not prescribe manner. For an expanded discussion of this issue, see [ FAQ 8.1 ], A4.4 apply when a broker recommended... System can not guarantee firm-wide compliance with the new rule does not apply to and... The scope of implicit recommendations applicable to the recommendation presumption that the new institutional-customer exemption that existed under predecessor. Sea rule 17a-3 ( a ) ( 1 ) 101 F.3d 37, 39 ( 5th Cir difference between rule 2111 and rule 2330 actions implicit. Cody, No which an implicit recommendation can trigger the suitability rule and submit documents this. To difference between rule 2111 and rule 2330 FAQ 3.4 ] under which an implicit recommendation can trigger suitability. ( Requirements for the rule thus explicitly permits a suitability analysis to be of! Explicit recommendations to hold L. Wallace, 53 S.E.C recognizes that a supervisory system can not guarantee firm-wide compliance all... Standard recognizes that a supervisory system can not guarantee firm-wide compliance with the suitability rule information... Emphasis in original ) firms consider documenting six may trigger liability for excessive....
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