C07960035, 1997 NASD Discip. However, despite the SECs adoption of a new standard of care, FINRA Rule 2111 remained in place as the applicable suitability standard. A3.9. 52562, 52567 (Aug. 26, 2010)]. Rule 2330 requires firms to have written policies and procedures in place for surveillance of brokers recommending, purchasing or exchanging of deferred variable annuities. 40 See id. As to an institutional customer's affirmative indication that it intends to exercise independent judgment (a new requirement), Rule 2111.07 states that "an institutional customer may indicate that it is exercising independent judgment on a trade-by-trade basis, on an asset-class-by-asset-class basis, or in terms of all potential transactions for its account." FINRA explained that, although due diligence reviews by such committees can be extremely beneficial (see, e.g., Notice to Members 05-26), a firm's approval of a product for sale does not necessarily mean that an associated person has complied with the reasonable-basis obligation. No. What is the scope of the provision in Supplementary Material .03 that excludes from the rule's coverage certain types of strategy-related communications that are educational in nature?50 [Notice 11-25 (FAQ 9)], A4.6. Note: With this guidance, FINRA attempts to present information in a format that is easily understandable. The absence of some customer information that is not material under the circumstances generally should not affect a firm's ability to make a recommendation. This position is consistent with requirements under the previous suitability rule. Id. See Peter C. Bucchieri, 52 S.E.C. Firms must attempt to obtain and analyze relevant customer-specific information. 53 FINRA Rule 2111.03. 75 See Curtis I. Wilson, 49 S.E.C. No. Yes. A turnover rate greater than six creates a presumption that the trading was excessive. Any significant variation from the list in the safe-harbor provision would be subject to regulatory scrutiny. 83 See Regulatory Notice 11-02, at 8 n.24. What is the difference between Rule 2111 and Rule 2330? 48 FINRA Rule 3270.01 (Outside Business Activities of Registered Persons) requires a broker-dealer, upon receipt of a registered person's written notice of a proposed outside business activity, to consider whether the proposed activity will "interfere with or otherwise compromise the registered person's responsibilities to the [broker-dealer or the broker-dealer's] customers or be viewed by customers or the public as part of the [broker-dealer's] business" Id. A broker-dealer need not automatically use a detailed approach when no such indication exists, although providing at least some level of specificity (even if not required) may help eliminate misunderstandings. [See infra note 38] (emphasis in original). Q4.4. 108, 117, 2003 SEC LEXIS 338, at *15 (2003) (focusing, in part, on risks of using margin); James B. See Cody, 2011 SEC LEXIS 1862, at *48 (finding turnover rate of three provided support for excessive trading); Dep't of Enforcement v. Stein, No. Q8.2. [Notice 11-25 (FAQ 5)]. at 504-05, 2003 SEC LEXIS 1154, at *14. 52 Specifically, the rule FINRA also emphasizes that broker-dealers are not required to use such certificates to comply with the new institutional-customer exemption. 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? No. A9.3. FINRA cautioned, however, that a firm should evidence a customer's intent to use different investment profiles or factors for the different accounts. 1985). 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. 58 That is true under case law addressing the predecessor suitability rule as well. What constitutes a "customer" for purposes of the suitability rule? No. These are only examples of how some firms may document "hold" recommendations if necessary. 4, 2012). FINRA BrokerCheck, moreover, allows investors to review the professional and disciplinary backgrounds of firms and brokers online. However, the fact that a customer initially needed help understanding a potential investment or investment strategy need not necessarily imply that the customer did not ultimately develop an understanding. Some firms may create "hold" tickets and some may add "hold" sections to existing order tickets. See, e.g., Rafael Pinchas, 54 S.E.C. See SEA Rule 17a-3(a)(17)(i)(D). 2010)]; Dane S. Faber, 57 S.E.C. 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. Corp., AWC No. Does FINRA expect broker-dealers or institutional customers to provide more specificity? 65 Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. 30 See supra note [22] and cases cited therein. That includes requiring a reasonable belief that the customer has Brokers cannot fulfill their suitability responsibilities to customers (including both their reasonable-basis and customer-specific obligations) when they fail to understand the securities and investment strategies they recommend. 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. Firms should use a similar approach to analyzing whether particular recommendations are eligible for the Rule 2111.03 safe-harbor provision. [Notice 12-25 (FAQ 12)], A9.1. 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." A broker can violate reasonable-basis suitability under either prong of the test. 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. A suitability analysis of a particular recommendation and consideration of a customer's overall investment portfolio, however, are not mutually exclusive concepts. The suitability rule generally requires broker-dealers to use reasonable diligence to seek to obtain and analyze the customer-specific factors listed in the rule. Registered representatives can fulfill Continuing Education requirements, view their industry CRD record and perform other compliance tasks. In general, an associated person may rely on a firm's fair and balanced explanation of the potential risks and rewards of a product." Although a firm is not required to affirmatively ask customers if there is anything else it should know about them, the better practice is to attempt to gain as much relevant information as possible before making recommendations. 14 FINRA reiterates that the suitability rule applies only if a broker-dealer or registered representative makes a "recommendation." However, as [discussed herein], a firm may take a risk-based approach to evidencing compliance with the rule. [Notice 12-55 (FAQ 7)]. 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? Some customers, moreover, desire portfolios made up of securities with different levels of liquidity, risk and time horizons. 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 recommendation of a large-cap, value-oriented equity security usually would not require documentation. The rule, moreover, identifies the three main suitability obligations: reasonable-basis, customer-specific, and quantitative suitability. Is the quantitative suitability obligation under the new rule any different from the excessive trading line of cases under the predecessor rule? 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. 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. 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. "68 What does it mean to act in a customer's best interests? FINRA previously has provided guiding principles that firms and registered representatives could consider when determining whether a particular communication could be viewed as a recommendation for purposes of the 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. 4 Pinchas, 54 S.E.C. 19 See FINRA Rule 2111.04 (explaining that a firm that decides not to seek to obtain and analyze information about a customer-specific factor must document its reasonable basis for believing that the factor is not a relevant consideration). 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."