The Suitability Rules, which were approved by the Securities and Exchange Commission in November 2010 and went into effect June 9, 2012, outline the requirements that an advisor “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.”
The rule has been the most common ground for disciplinary action so far this year, according to an analysis by the law firm Sutherland Asbill & Brennan.
The clarifications bring an added level of specificity that could ease the burden on advisors.
In its frequently asked questions format, the agency redefined “customer” to exclude other brokers and certain potential investors. The rule would not apply so long as the recipient of the advice is not a client and neither the broker nor the firm receives director or indirect compensation. If a potential investor chooses not to act on the advice or executes a trade outside of the scope of the broker-dealer, they are not a “customer.”
“Investment strategy” was clarified to apply to recommendations to invest in or hold specific types of securities as well as suggestions on market sectors, a bond ladder, day trading, “liquefied home equity,” or margin strategy irrespective of whether the recommendation mentions particular securities.
However, the new definition excludes non-security investments of an outside business activity.
“The suitability rule would not apply, for instance, if a registered representative recommends a non-security investment as part of an outside business activity and the customer separately decides on his or her own to liquidate securities positions and apply the proceeds toward the recommended non-security investment,” FINRA clarified.
The broker becomes liable if the customer asks which securities to buy or sell to make that outside investment possible.
FINRA left its interpretation of the responsibility of the firm to oversee these rules somewhat open to interpretation.
“FINRA’s supervision rules do not dictate the exact manner in which a broker-dealer must supervise its registered representatives’ recommendations of investment strategies involving a security and non-security investment,” the guidance said.
The agency has established a website to aggregate all of the various questions and answers regarding Rule 2111.