See [FAQ 4.6]. Unless the facts indicate that an associated person's failure to sell securities in a discretionary account was intended as or tantamount to an explicit recommendation to hold, FINRA would not view the associated person's inaction or silence in such circumstances as a recommendation to hold the securities for purposes of the suitability rule. 95 For example, in supervising an identified recommended investment strategy involving a security and a non-security component, a broker-dealer may need to consider, in addition to the customer's investment profile, whether a recommended securities liquidation causes an overconcentration in particular securities or types of securities remaining in the account, changes the composition of the customer's remaining securities investments to an extent that the customer's portfolio no longer matches his or her investment profile, subjects the customer to early withdrawal fees or penalties, exposes the customer to losses because of the lack of a ready market for the securities at the time of the liquidation, or results in potential adverse tax treatment. The suitability rule also would not apply to a firm's allocation recommendation regarding broad-based market sectors (e.g., agriculture, construction, finance, manufacturing, mining, retail, services, transportation and public utilities, and wholesale trade).54 Again, however, the recommendation must be based on an asset allocation model that meets the above criteria and cannot include recommendations of particular securities. [Notice 11-25 (FAQ 10)]. 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). No. "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. 26 See www.sec.gov/investor/pubs/assetallocation.htm. Yes. 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. 1 See, e.g., Regulatory Notice 11-02, at 2-3 (discussing FINRA's guiding principles that firms and brokers should consider when determining whether a particular communication could be considered a "recommendation" for purposes of the suitability rule); Regulatory Notice 10-06, at 3-4 (providing guidance on recommendations made on blogs and social networking websites); Notice to Members 01-23 (announcing the guiding principles and providing examples of communications that likely do and do not constitute recommendations); Michael F. Siegel, Exchange Act Rel. Although due diligence reviews by such committees can be extremely beneficial,61 a firm's approval of a product for sale does not necessarily mean that an associated person has complied with the reasonable-basis obligation. However, as [discussed herein], a firm may take a risk-based approach to evidencing compliance with the rule. 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. By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule (NASD IM-2310-3). The institutional-customer exemption does not apply to reasonable-basis and quantitative suitability. [Broker-dealers] have different business models; offer divergent services, products and investment strategies; and employ distinct approaches to complying with applicable regulatory requirements. A broker who recommended new issues being pushed by his firm so that he could keep his job. A broker can violate reasonable-basis suitability under either prong of the test. [Notice 12-25 (FAQ 16)]. 67 In-and-out trading refers to the "sale of all or part of a customer's portfolio, with the money reinvested in other securities, followed by the sale of the newly acquired securities." The rule states that certain communications "are excluded from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities[.]" 5311, et seq. It also is important to note that, where an institutional customer has delegated decisionmaking authority to an agent, such as an investment adviser or a bank trust department, Rule 2111(b) makes clear that the factors relevant to determining whether the customer meets the criteria for the institutional-customer exemption will be applied to the agent. No. See Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. C3A040016 (Mar. "); Paul C. Kettler, 51 S.E.C. "); Daniel R. Howard, 55 S.E.C. FINRA expects a firm to be capable of explaining how an asset allocation model that it uses is consistent with generally accepted investment theory. Does a firm have to use the exact rule terminology when seeking to obtain customer-specific information? Rule 2111 requires that the suitability assessment be "based on the information obtained through the reasonable diligence of the member or associated person to ascertain the [Notice 12-25 (FAQ 15)], A3.2. 91 Firms are reminded, however, that copies of all communications relating to their business as such and memoranda of brokerage orders are required to be preserved for three years. 282, 284, 1993 SEC LEXIS 41, at *5 (1993) ("[O]ptions transactions involve a high degree of financial risk. See SEA Rule 17a-3(a)(17)(i)(D). 4, 2012). [Notice 12-25 (FAQ 14)]. 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]."). The customer's investment profile, for example, is critical to the assessment, as are a host of product- or strategy-related factors in addition to cost, such as the product's or strategy's investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility and likely performance in a variety of market and economic conditions. 35 For certain requirements related to day trading, see FINRA Rules 2130 and 2270. What could be considered a "safe-harbor" provision in Supplementary Material .03 is limited in scope. 98-70854, 1999 U.S. App. Id. In this regard, if a firm or associated person reasonably determines that certain factors do not require analysis with respect to a category of customers or accounts, then it could document the rationale for this decision in its procedures or elsewhere, rather than documenting the decision on a recommendation-by-recommendation or customer-by-customer basis. Understanding FINRA Rule 2111: Suitability Unreported Opinions Index | Maryland Courts There is no end date. 31 Firms should note, however, that SEA Rule 17a-3 requires that, for each account with a natural person as a customer or owner, a broker-dealer generally must create a record that includes, among other things, the account's investment objectives. 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. See Pryor, McClendon, Counts & Co., Exchange Act Rel. Cir. '")[, aff'd, 416 F. App'x 142 (3d Cir. 2111. FINRA and the SEC have recognized that certain actions constitute implicit recommendations that can trigger suitability obligations. Can a customer with multiple accounts at a single firm have different investment profiles or investment-profile factors (e.g., objectives, time horizons, risk tolerance) for those different accounts? For instance, as long as the supervisory system is reasonably designed to achieve compliance with applicable securities laws, regulations and FINRA rules, a firm could focus on the detection, investigation and follow-up of "red flags" indicating that a registered representative may have recommended an unsuitable investment strategy with both a security and non-security component.94 A registered representative's recommendation that a customer with limited means purchase a large position in a security might raise a "red flag" regarding the source of funds for such a purchase. 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. FINRA Rule 2111 does not define the terms. Does FINRA expect broker-dealers or institutional customers to provide more specificity? [Notice 12-25 (FAQ 13)], A9.2. Thus, the new rule's "hold" language would not apply when a broker remains silent regarding security positions in an account. The rule excludes reallocation ]"52 Specifically, the rule provides a safe harbor for firms' use of "[a]sset allocation models that are (i) based on generally accepted investment theory, (ii) accompanied by disclosures of all material facts and assumptions that may affect a reasonable investor's assessment of the asset allocation model or any report generated by such model, and (iii) in compliance with [FINRA Rule 2214] (Requirements for the Use of Investment Analysis Tools), if the asset allocation model is an 'investment analysis tool' covered by [FINRA Rule 2214]."53. 471, 475, 1999 SEC LEXIS 2685, at *7 (1999). In general, FINRA would not view those communications as "hold" recommendations for purposes of the rule because the firm's call center is not responding to the question of whether the customer should hold the securities, but rather whether the customer can continue to maintain them at the firm. 48 FINRA Rule 3270.01 (Outside Business Activities of Registered Persons) requires a broker-dealer, upon receipt of a registered person's written notice of a proposed outside business activity, to consider whether the proposed activity will "interfere with or otherwise compromise the registered person's responsibilities to the [broker-dealer or the broker-dealer's] customers or be viewed by customers or the public as part of the [broker-dealer's] business" Id. The suitability rule applies on a recommendation-by-recommendation basis. Recently FINRA Rule 2111 went into effect regarding Suitability. Dep't of Enforcement v. Siegel, No. The quantitative suitability obligation under the new rule simply codifies excessive trading cases. 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." No. The recommendation of a large-cap, value-oriented equity security usually would not require documentation. 77 It is important to keep in mind that, in addition to the suitability rule, FINRA has numerous other investor-protection rules. Some of the "Institutional Suitability Certificates" that are being marketed do not identify an institutional customer's experience with particular asset classes or types of securities or investment strategies involving a security or securities. Can a broker make recommendations based on a customer's overall portfolio, including investments held at other financial institutions? [Notice 11-25 (FAQ 4)]. 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