This segment of our trends in disciplinary actions series focuses on
suitability rules. While this topic is far too vast to cover exhaustively in a
blog post, let’s look at the highlights.
FINRA’s suitability rules require that registered representatives have a
reasonable basis to believe that a recommended transaction or investment
strategy involving a security or securities is suitable for the customer, based
on the information obtained through the reasonable diligence of your firm or
any associated person to establish a customer's investment profile. A
customer’s investment profile consists of the customer’s:
- age
- other investments
- financial situation and needs
- tax status
- investment objectives
- investment experience
- investment time horizon
- liquidity needs
- risk tolerance
- any other pertinent information that the customer may disclose
Taking it a step further, FINRA imposes three specific suitability
obligations when making a recommendation.
- Reasonable basis suitability obligation—This means that your
recommendations must be suitable for at least some investors. Additionally,
reasonable diligence takes into consideration things such as the complexity
of an investment, the risks associated with the security or investment, and a
firm’s or associated person's familiarity with the security or investment
strategy.
- Customer-specific suitability obligation—This means your recommendations
must be suitable for the specific customer you are assisting or others with a
like profile.
- Quantitative suitability obligation—This means that any series of
recommendations you make (even if they seem suitable when isolated) must be
suitable when taken together, considering a customer’s investment
profile.
Moving forward with a transaction or making a recommendation to a customer
you know is financially unable or unsuitable for an investment is a direct
violation of these rules.
Let’s look at an example. For one registered representative, recommending and
executing hundreds of unsuitable purchases of non-traditional ETFs in his
customers’ accounts got him a permanent bar from association with any FINRA
member in all capacities. Specifically, the registered representative:
- failed to use reasonable diligence to obtain an adequate knowledge base
regarding these highly sophisticated products before recommending them to his
customers
- failed to consider or understand the extraordinary risks associated with
non-traditional ETFs, the features of such investments, and the compounding
of risks associate with holding non-traditional ETFs
In total, the registered representative recommended that his clients
purchase more than $22 million in non-traditional ETFs, and routinely failed to
sell these products on the same day he purchased them. He also failed to
conduct a daily analysis to ascertain whether it was appropriate to hold the
products for an extended period.
Among other things, the registered representative did not have a reasonable
basis to believe that his long-term buy-and-hold recommendations were suitable
and failed to conduct a customer-specific suitability analysis for many of the
customers for whom he either made recommendations or exercised discretion to
purchase non-traditional ETFs. All of this resulted in big losses for his
customers. Finally, after all of that, the registered representative failed to
disclose any of this to his firm.
Ensure that your registered representatives are knowledgeable of the FINRA
suitability requirements through training and firm policies. Take some time to
review and modify your policies if necessary, to keep your representatives and
your firm out of hot water!
Firm Element Solutions