Trends in Disciplinary Actions – Suitability Rules

by Julie Mendel | Jan 24, 2019
FINRA Trends in Disciplinary Action

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!

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