New FINRA Suitability Rule Goes Into Effect
As of July 9, 2012, FINRA’s new suitability Rule (Rule 2111) takes effect to replace the old NASD/FINRA Rule 2310. The new Rule can be found here.
The new suitability Rule, and its supplemental material, contains several clarifications which are important for investor protection. First, the Rule clearly states that recommendations of investment strategies as well as transactions fall under the rule. The supplemental material further states that “investment strategy” is to be interpreted broadly, including recommendations to hold securities.
The new Rule also sets out more specifically investor financial information that a registered representative must consider when making recommendations. Specific information includes: “customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.” The Rule also sets out a standard to be applied in regard to the representative’s efforts to discover customer suitability information: “reasonable diligence” is required to discover the customer’s investment profile.
The supplemental material to the Rule further clarifies FINRA standards regarding three kinds of suitability: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. Reasonable basis suitability is required due diligence on a security before it can be recommended to customers - this issue can arise in private placement or TIC situations where the security is not on a national exchange. Customer specific suitability is, as described above, recommending a security only if it is suitable for a customer’s specific situation. Quantitative suitability is in essence a ban on churning - representatives cannot recommend (or trade with discretion) if the number of trades is excessive in light of the customer’s financial situation and investment profile. Turnover rates and cost-equity ratios are often used to demonstrate the lack of suitability of churned accounts.
Next entry: SEC Releases Financial Literacy Study
Previous entry: GUILTY PLEA IN FRAUDULENT INVESTMENT SCHEME