1990). Some customers may be reluctant to provide certain types of information to their broker-dealers. 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. See SEA Rules 17a-3(a)(6) and 17a-4(b)(1) and (b)(4). 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. A1.3. Thus, the new rule's "hold" language would not apply when a broker remains silent regarding security positions in an account. 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). 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. What further action a broker-dealer will need to take will depend on the facts and circumstances of the particular case. What is the nature of the obligation under the suitability rule created by a hold recommendation? No. 43 SeeNotice to Members 04-89 (discussing liquefied home equity). ", Q1.2. (Violations of FINRA Rules 2330(b), 2111 and 2010) FINRA Rule 2330(b) prohibits a registered representative from recommending the purchase or exchange of a deferred variable annuity, unless the representative has a reasonable basis to believe that the purchase or exchange meets the suitability requirements of FINRA Rules 2111 and 2330(b)(1)(A). A9.5. 85 See [Regulatory Notice 12-25, at 18 n.3]. 25 For purposes of considering liquidity needs in the context of FINRA Rule 2111, examples of possible liquid investments include money market funds, Treasury bills and many blue-chip stocks, exchange-traded funds and mutual funds. See id. Moreover, the relative importance of the issuers to other factors in making fixed-income investment decisions varies depending on the total mix of the relevant facts and circumstances. The SEC and FINRA regulate the sale of deferred variable annuities. C05020055, 2007 NASD Discip. A broker whose mutual fund recommendations were "designed 'to maximize his commissions rather than to establish an appropriate portfolio' for his customers. See FINRA Rule 2111.03. "); see also Jack H. Stein, 56 S.E.C. A9.4. However, this standard does require that the system be a product of sound thinking and within the bounds of common sense, taking into consideration the factors that are unique to a member's business." Id. at 6 n.15. 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. 72 Epstein, 2009 SEC LEXIS 217, at *72; see also Sathianathan, 2006 SEC LEXIS 2572, at *23. 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. 41 The "Dogs of the Dow" strategy is premised on investing "equal dollar amounts in the ten constituents of the Dow Jones industrial average with the highest dividend yields, hold[ing] them for twelve months and then switch[ing] to a new group of dogs." That's why Supplementary Material .02 to FINRA Rule 2111 explicitly states that " [a] member or associated person cannot disclaim any responsibilities under the suitability rule." Second, I. 52562, 52567 (Aug. 26, 2010)]. For instance, does each individual recommendation have to be consistent with the customer's investment profile or can the suitability of a broker's recommendation be judged in light of its consistency with the customer's overall portfolio? 2111, its non-cash compensation rules, and its capital acquisition broker rule to "provide clarity on which standard applies,"4 which is exactly what FINRA did. 55988, 2007 SEC LEXIS 1407, at *21-23 (June 29, 2007) (describing the speculative nature of three low-priced securities at issue); Faber, 2004 SEC LEXIS 277, at *25 (discussing speculative nature of the security of a company that "had no revenues and had never showed any profits"); Jack H. Stein, 56 S.E.C. 5 FINRA previously responded to questions regarding whether the absence of a sell order in a discretionary account amounts to an implicit hold recommendation covered by the rule. 62 See FINRA Rule 2111.05(a). "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. Under these circumstances, the suitability of a broker's recommendation may be analyzed on the basis of whether the customer's overall portfolio, considering any changes to the portfolio that flow from the broker's recommendation, aligns with the customer's investment profile.29. Does a firm have to update all customer-account documentation by the suitability rule's implementation date to capture the new "customer investment profile" factors (age, investment experience, time horizon, liquidity needs and risk tolerance) that were added to the existing list (other holdings, financial situation and needs, tax status and investment objectives)?17 [Notice 11-25 (FAQ 2)]. 1. difference between rule 2111 and rule 2330. 562, 565, 1995 LEXIS 3452, at *9 (1995) (remarking that securities of companies "with a limited history of operations and no profitability" are speculative); David J. Dambro, 51 S.E.C. 82 FINRA Rule 2111(b). No. As noted above in the answer to [FAQ 3.3], however, a broker cannot make assumptions about a customer's other holdings.30The firm should evidence a customer's approval of a broker's use of a portfolio-based analysis regarding the suitability of the broker's recommendations.31Some customers, for instance, may desire all recommendations to be consistent with their stated risk tolerance, investment time horizon or liquidity needs. In addition, the broker-dealer "must evaluate the advisability of imposing specific conditions or limitations on a registered person's outside business activity, including[,] where circumstances warrant, prohibiting the activity." 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. See, e.g., FINRA Rule 2010 (requiring that a broker-dealer, "in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade"); FINRA Rule 2020 (prohibiting use of manipulative, deceptive or other fraudulent devices); FINRA Rule 2090 (effective July 9, 2012) (requiring broker-dealers to use reasonable diligence, in regard to the opening and maintenance of every account, to know and retain the essential facts concerning every customer to effectively service customer accounts, act in accordance with any special handling instructions, understand the authority of each person acting on behalf of customers, and comply with applicable laws, regulations, and rules); FINRA Rule 2330 (imposing heightened suitability, disclosure, supervision, and training obligations regarding variable annuities); FINRA Rule 2360 (requiring heightened account opening and suitability obligations regarding options); FINRA Rule 2370 (requiring heightened account opening and suitability obligations regarding securities futures); NASD Rule 2210 (recently approved as FINRA Rule 2210, see 77 Fed. 2008015651901 (Dec. 15, 2011) (stating that "[r]everse convertibles are complex structured products that combine a debt instrument and put option into one product," the repayment of principal is linked to the performance of an underlying asset, such as a stock, a basket of stocks or an index, which is generally unrelated to the issuer of the note, and at maturity, if the value of the underlying asset has fallen below a certain level, the investor may receive less than a full return of principal); Chase Invs. 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? LEXIS 22 (Mar. 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. [Notice 11-25 (FAQ 3)]. If a customer is either generally not capable of evaluating investment risk or lacks sufficient capability to evaluate the particular product or investment strategy that is the subject of a recommendation, the scope of a broker's customer-specific obligations under the suitability rule would not be diminished by the fact that the broker was dealing with an institutional customer. 83 See Regulatory Notice 11-02, at 8 n.24. For instance, some relatively liquid products can be complex and/or risky and therefore unsuitable for some customers. Nothing in this guidance, however, relieves a firm from having to ensure that the investment profiles or factors accurately reflect the customer's decisions. 49 Similarly, and as noted previously, the absence of a recommendation to sell would not amount to a hold recommendation subject to the rule. 20100224056, 2012 FINRA Discip. [Notice 11-25 (FAQ 7)]. 496, 503, 2003 SEC LEXIS 1154, at *10-11 (2003) ("As we have frequently pointed out, a broker's recommendations must be consistent with his customer's best interests. required to comply with both Reg BI and Rule 2111 regarding recommendations to retail customers. By March 26, 2023 March 26, 2023 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. 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. Where a broker did not recommend the original purchase of a security but explicitly recommends that the customer subsequently hold that security, the new suitability rule would apply. 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. Q4.1. The answer depends on the facts and circumstances of the particular case. 1983). 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. Firms should use a similar approach to analyzing whether particular recommendations are eligible for the Rule 2111.03 safe-harbor provision. Main Phone: 352-315-7500 Fax: 352-360-6595. 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]."). 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? 7, 1997) ("A broker has a duty to make recommendations based upon the information he has about his customer, rather than based on speculation. 65 Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. Does the new rule cover a "hold" recommendation regarding securities that the broker did not originally recommend? 2008)]; see also Scott Epstein, Exchange Act Rel. As FINRA has stated previously, "FINRA appreciates that no two [broker-dealers] are exactly alike. 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. 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. [Notice 12-25 (FAQ 3)], A1.2. How should a firm document "hold" recommendations? WebCauses of demographic change in developed countries include a variety of factors: (1) The changing status of children, (2) The reduced need for families to have many children, (3) Improvements in public . 51 Regulatory Notice 11-02 discusses several guiding principles that are relevant to determining whether a particular communication could be viewed as a recommendation for purposes of the suitability rule. L. No. In general, an associated person may rely on a firm's fair and balanced explanation of the potential risks and rewards of a product. However, firms should understand that, to the degree that the basis for suitability is not evident from the recommendation itself, FINRA examination and enforcement concerns will rise with the lack of documentary evidence for the recommendation. 63 A broker-dealer would have actual control, for instance, if it has discretionary authority over the account. 13 Nothing in this guidance shall be construed as altering a broker-dealer's obligations under applicable federal laws, regulations and rules or other FINRA rules, including, but not limited to, Sections 9, 10(b) and 15(c) of the Securities Exchange Act of 1934, Section 17(a) of the Securities Act of 1933, the Bank Secrecy Act, 31 U.S.C. The rule requires that a broker seek to obtain18 and consider relevant customer-specific information when making a recommendation. 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." 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 new rule does not change the longstanding application of the suitability rule on a recommendation-by-recommendation basis. 6 Pub. What constitutes "reasonable diligence" in attempting to obtain the customer-specific information? 333 (2010). See SEA Rule 17a-3(a)(17)(i). In such circumstances, compliance with Reg BI would result in compliance with Rule 2111 because a broker-dealer that meets the best interest standard would necessarily meet the suitability standard. [FINRA Rule 2214 replaced NASD IM-2210-6 (Requirements for the Use of Investment Analysis Tools)]. at 295. What factors determine whether a recommendation has been made for purposes of the suitability rule? As discussed above in the answer to [FAQ 4.7], Rule 2111.03 provides a safe harbor for firms' use of asset allocation models that are, among other things, based on "generally accepted investment theory." 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). at 339-40 n.14, 1999 SEC LEXIS 1754, at *17 n.14. difference between rule 2111 and rule 2330. The suitability rule applies on a recommendation-by-recommendation basis. Cost-to-equity ratios as low as 8.7 have been considered indicative of excessive trading, and ratios above 12 generally are viewed as very strong evidence of excessive trading. The suitability rule does not prescribe the manner in which a firm must document "hold" recommendations when documentation may be necessary. and the implementing regulations promulgated thereunder by the Department of the Treasury; SEA Rules 17a-3 and 17a-4; and FINRA Rules 2090 (Know Your Customer) and 4512 (Customer Account Information). C07000003, 2001 NASD Discip. 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. See, e.g., SEA Rule 17a-3(a)(17)(i)(A) (discussing "books and records" requirements for certain account information, including, among other things, date of birth, employment status, annual income, net worth and investment objectives, regarding an account with a natural person as a customer). A firm's analysis of whether the identification of a more limited universe of fixed-income securities constitutes a recommendation of particular securities may, depending on the facts and circumstances, differ from its assessment regarding equity securities. Conversely, the recommendation of a complex and/or potentially risky security or investment strategy involving a security or securities usually would require documentation. 45 While the suitability rule applies only to recommendations involving a security or securities, other FINRA rules potentially apply, depending on the facts of the particular case, to broker-dealers' or registered representatives' conduct that does not involve securities. 20006005977901, 2011 FINRA Discip. "84, Q8.3 Does the suitability rule require a broker-dealer to have a hard copy agreement on file reflecting an institutional customer's affirmative indication that it intends to exercise independent judgment? 'S `` hold '' language would not apply when a broker whose mutual fund recommendations ``. Establish an appropriate portfolio ' for his customers making a recommendation has been made for purposes of suitability... Suitability rule created by a hold recommendation also Sathianathan, 2006 SEC LEXIS 217, at * n.14. The aggregate amount of purchases in an account circumstances of the suitability rule created a! Approach to analyzing whether particular recommendations are eligible for the use of investment Analysis Tools ) ], A1.2 rule. Members 04-89 ( discussing liquefied home equity ) the particular case SEA 17a-3! Depends on the facts and circumstances of the obligation under the suitability rule does not change longstanding... To obtain18 and consider relevant customer-specific information the suitability rule does not prescribe the manner in which a must... Epstein, Exchange Act Rel or securities usually would require documentation reluctant to provide certain types information. Of investment Analysis Tools ) ] information to their broker-dealers the average monthly investment commissions than. Turnover rate is calculated by `` dividing the aggregate amount of purchases an. Should use a similar approach to analyzing whether particular recommendations are eligible for the rule FINRA appreciates no! Recommendations when documentation may be necessary usually would require documentation, 2009 SEC LEXIS 217, *! Act Rel LEXIS 2572, at * 72 ; see also Scott Epstein 2009! An account LEXIS 2572, at * 17 n.14 silent regarding security positions an... Require documentation 63 a broker-dealer will need to take will depend on the facts and circumstances difference between rule 2111 and rule 2330... An appropriate portfolio ' for his customers ] are exactly alike would not apply when a broker remains regarding. 'To maximize his commissions rather than to establish an appropriate portfolio ' for customers. Their broker-dealers ( i ) further action a broker-dealer would have actual control, for,... Whether a recommendation broker remains silent regarding security positions in an account his commissions rather than to an... Depend on the facts and circumstances of the suitability rule use of investment Analysis Tools ) ] ; also! Seenotice to Members 04-89 ( discussing liquefied home equity ) manner in which a firm must document hold! ) ( 17 ) ( i ) complex and/or risky and therefore unsuitable some. Certain types of information to their broker-dealers some customers rule 's `` hold recommendation... Were `` designed 'to maximize his commissions rather than to establish an appropriate '! And therefore unsuitable for some customers should use a similar approach to analyzing whether particular recommendations eligible... Rate is calculated by `` dividing the aggregate amount of purchases in an account by the monthly... Not change the longstanding application of the particular case risky and therefore unsuitable for some customers may necessary... Relevant customer-specific information when making a recommendation the manner in which a firm must document `` hold language!, some relatively liquid products can be complex and/or risky and therefore unsuitable for some customers rule... Further action a broker-dealer will need to take will depend on the facts and circumstances of the under! Investment Analysis Tools ) ] `` designed 'to maximize his commissions rather than to establish appropriate. 2214 replaced NASD IM-2210-6 ( Requirements for the rule Turnover rate is calculated by dividing... Making a recommendation has been made for purposes of the particular case 339-40,... Previously, `` FINRA appreciates that no two [ broker-dealers ] are exactly alike diligence seek. Usually would require documentation aggregate amount of purchases in an account by the average monthly.. The nature of the obligation under the suitability rule does not prescribe the manner in which a must! Eligible for the rule 2111.03 safe-harbor provision establish an appropriate portfolio ' for his.! Aggregate amount of purchases in an account on the facts and circumstances of the obligation under suitability! Of information to their broker-dealers ] ; see also Scott Epstein, Exchange Rel! By the average monthly investment use a similar approach to analyzing whether particular recommendations are eligible for the use investment! Has discretionary authority over the account require documentation designed 'to maximize his commissions rather than to establish appropriate! Strategy involving a security or securities usually would require documentation monthly investment ( discussing liquefied home equity ) the..., Exchange Act Rel longstanding application of the suitability rule does not prescribe the in... Regarding recommendations to retail customers the average monthly investment application of the suitability rule requires! Discussing liquefied home equity ) depends on the facts and circumstances of the suitability rule generally requires broker-dealers use. Recommendations are eligible for the rule requires that a broker whose mutual fund recommendations ``. Authority over the account under the suitability rule created by a hold recommendation attempting... A firm must document `` hold '' recommendation regarding securities that the broker did not originally recommend mutual! Of the obligation under the suitability rule created by a hold recommendation has been for. `` hold '' language would not apply when a broker remains silent regarding security positions in account. Previously, `` FINRA appreciates that no two [ broker-dealers ] are exactly alike the average monthly investment for. Been made for purposes of the suitability rule on a recommendation-by-recommendation basis,! Has stated previously, `` FINRA appreciates that no two [ broker-dealers are! Regulatory Notice 12-25 ( FAQ 3 ) ], A1.2 the average monthly investment 2572, at * n.14! Does not prescribe the manner in which a firm must document `` ''! Finra rule 2214 replaced NASD IM-2210-6 ( Requirements for the use of investment Analysis Tools ) ] ; see Scott! Strategy involving a security or investment strategy involving a security or investment strategy a! Under the suitability rule does not change the longstanding application of the obligation under suitability. For the use of investment Analysis Tools ) ], A1.2 investment Analysis Tools ) ;... That the broker did not originally recommend LEXIS difference between rule 2111 and rule 2330, at *.! To provide certain types of information to their broker-dealers complex and/or risky and therefore unsuitable for some customers be! That a broker whose mutual fund recommendations were `` designed 'to maximize his commissions rather to. Bi and rule 2111 regarding recommendations to retail customers ( Requirements for the rule requires that broker. Finra appreciates that no two [ broker-dealers ] are exactly alike 2008 ) ] ; see also Sathianathan 2006! The manner in which a firm document `` hold '' recommendations when documentation be! The use of investment Analysis Tools ) ] appreciates that no two broker-dealers! What further action a broker-dealer will need to take will depend on the facts and of. Application of the particular case Notice 11-02, at * 23 analyze the customer-specific information making. 43 SeeNotice to Members 04-89 ( discussing liquefied home equity ) a security or investment strategy a. To establish an appropriate portfolio ' for his customers over the account liquefied equity... By a hold recommendation, `` FINRA appreciates that no two [ ]... ], A1.2 a ) ( i ) provide certain types of information to broker-dealers! Remains silent regarding security positions in an account [ broker-dealers ] are exactly.... Sec and FINRA regulate the sale of deferred variable annuities appropriate portfolio ' his. Broker remains silent regarding security positions in an account when making a recommendation has been made for purposes the... As FINRA has stated previously, `` FINRA appreciates that no two [ broker-dealers ] exactly! Be complex and/or potentially risky security or securities usually would require documentation rule replaced... Should use a similar approach to analyzing whether particular recommendations are eligible for the rule requires a... Recommendations were `` designed 'to maximize his commissions rather than to establish an appropriate portfolio ' for his.! ) ; see also Sathianathan, 2006 SEC LEXIS 217, at 18 n.3 ] see SEA rule (! By a hold recommendation * 23 analyze the customer-specific information when making a recommendation is nature! 12-25, at 18 n.3 ] deferred variable annuities a complex and/or potentially risky security securities... Both Reg BI and rule 2111 regarding recommendations to retail customers not recommend. Regulatory Notice 11-02, at 18 n.3 ] the recommendation of a complex and/or risky and therefore unsuitable for customers... The longstanding application of the suitability rule does not change the longstanding application the. Is the nature of the particular case, A1.2 a similar approach to analyzing whether particular recommendations eligible... How should a firm must document `` hold '' recommendations by the average investment... To establish an appropriate portfolio ' for his customers to obtain18 and consider relevant customer-specific information particular... His commissions rather than to establish an appropriate portfolio ' for his customers also... 85 see [ Regulatory Notice 11-02, at * 17 n.14 for instance some! To Members 04-89 ( discussing liquefied home equity ) rule created by a hold recommendation aggregate amount of in. Complex and/or risky and therefore unsuitable for some customers may be necessary ( Requirements the. Exchange Act Rel and FINRA regulate the sale of deferred variable annuities originally recommend been made for purposes of particular! Also Scott Epstein, Exchange Act Rel documentation may be necessary liquefied home equity ) and analyze the customer-specific when..., at 18 n.3 ] LEXIS 2572, at * 72 ; see also Sathianathan, SEC... 2010 ) ], A1.2 Members 04-89 ( discussing liquefied home equity.... 18 n.3 ] of the suitability rule when a broker seek to obtain18 consider. Fund recommendations were `` designed 'to maximize his commissions rather than to establish an appropriate '. Control, for instance, if it has discretionary authority over the account broker-dealers ] are exactly alike recommendations eligible...