True to the financial services industry, the regulations keep on coming.
Starting July 9, 2012, new FINRA rule 2111 will replace rule 2310, creating suitability requirements for broker/dealers designed to ensure financial professionals serve clients to the best of their ability. Whether recommending a security, a hold or an investment strategy, the broker/dealer will now have to prove they have taken into consideration the following items (new details are in bold):
- The customer’s age
- Other investments
- Financial situation and needs
- Tax status
- Investment objectives
- Investment experience
- Investment time horizon
- Liquidity needs
- Risk tolerance
- Other information the customer may disclose
And Rule 2111 includes not one but THREE separate suitability obligations:
1. Reasonable Basis Suitability focuses on the security or strategy.
A broker/dealer must have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. This requirement ensures financial professionals are familiar with every security or strategy they recommend.
2. Customer-Specific Suitability focuses on the particular customer.
A broker/dealer must have a reasonable basis to believe their recommendation is suitable for a particular customer based on that individual’s investment profile. [Note: there is an exception to customer-specific suitability for institutional customers in certain circumstances. Call me if you have additional questions.]
3. Quantitative Suitability focuses on the customer’s entire portfolio.
A broker-dealer must have a reasonable basis for believing that a series of recommended transactions are not excessive and unsuitable for the customer in light of their investment profile. This requirement looks at the customer’s entire portfolio, as well as at turnover rate, cost-equity ratio and in-and-out trading. The rule is violated if the rep does not have a clear understanding of both the product and the customer.
Thankfully, my colleague, Hank Sanchez, has been closely following Rule 2111 so Oyster can help broker/dealers comply by following these steps:
- Update procedures to comply with the rule.
- Update account documentation to cover the new required items.
- Train reps, supervisors and compliance staff.
- Review and update surveillance reports to capture the new requirements.
- Document whether and how the institutional clients meet the customer specific obligation.
- Update documentation with institutional investors to specify whether they affirmatively acknowledge that they are exercising independent judgment and document who controls the account (rep or client).
- Document suitability of strategies.
FINRA says the new rule isn’t about documentation, but did you notice how many of these steps require documentation? From my perspective, the requirements express the sentiment, “If it’s not in writing, it doesn’t exist.” In other words, if you’re making a recommendation, including a “hold”, you’d better document the reasons why.
July 2012 may seem far away, but Rule 2111 has the potential to fundamentally change the way you document — or make — recommendations. To learn more about the Oyster Consulting approach to Rule 2111, call me at 804.965.5403. I might not always be by my phone, but I will always call you back.