The significance of specific types of customer information generally will depend on the facts and circumstances of the particular case, including the nature and characteristics of the product or strategy at issue. A1.3. Id. 65 Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. 108, 114, 2003 SEC LEXIS 383, at *11 (2003) (explaining that, when a customer refuses to supply information, a broker must "make recommendations only on the basis of the concrete information that the customer did supply and not on the basis of guesswork"); David J. Dambro, 51 S.E.C. No. A8.2. A broker's use of in-and-out trading ordinarily is a strong indicator of excessive trading. Pinchas, 54 S.E.C. 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." Firms do not have to document or individually approve every "hold" recommendation.91 As with recommendations of other types of investment strategies or of purchases, sales or exchanges of securities, firms may use a risk-based approach to documenting and supervising "hold" recommendations. FINRA previously issued written guidance on a customer's capability of analyzing risks (a factor used in both the predecessor and new suitability rules).83 FINRA stated that a broker-dealer may conclude in some cases that a customer is not capable of making independent investment decisions in general. The issuers' identities and creditworthiness are important information in determining whether to purchase a debt security, but there may be other factors that affect the pricing and any decision to invest in specific debt securities. 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? See Peter C. Bucchieri, 52 S.E.C. FINRA and the SEC have recognized that certain actions constitute implicit recommendations that can trigger suitability obligations. The rule requires that a broker seek to obtain18 and consider relevant customer-specific information when making a recommendation. The factors that must exist for an institutional customer to qualify for the exemption may, depending on the facts, negate some of the elements relevant to a showing of a broker's "control" over the account. Where the hold recommendation involves an overly concentrated position in a security, however, documentation usually would be necessary, even if the broker did not originally recommend the purchase of the security. 2111. Q3.8. C3A040016 (Mar. 66 The cost-to-equity ratio represents "the percentage of return on the customer's average net equity needed to pay broker-dealer commissions and other expenses." 52 Nonetheless, FINRA has stated that the safe-harbor provision would be strictly construed. See also Donna M. Vogt, AWC No. Reasonable Basis Obligation This means the Does the firm have a duty, for example, to ask its customers if there is anything else it should know about them when collecting information for suitability purposes? 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. Quantitative suitability likely will apply in more limited circumstances with regard to institutional customers than it does as to retail customers. Corp., AWC No. To meet its suitability obligations, a firm must obtain and analyze enough customer information to have a reasonable basis to believe the recommendation is suitable. Under these circumstances, the suitability of a broker's recommendation may be analyzed on the basis of whether the customer's overall portfolio, considering any changes to the portfolio that flow from the broker's recommendation, aligns with the customer's investment profile.29. As to an institutional customer's affirmative indication that it intends to exercise independent judgment (a new requirement), Rule 2111.07 states that "an institutional customer may indicate that it is exercising independent judgment on a trade-by-trade basis, on an asset-class-by-asset-class basis, or in terms of all potential transactions for its account." A broker who recommended new issues being pushed by his firm so that he could keep his job. Accordingly, the suitability rule would cover a firm's recommendation that a customer purchase securities using margin, whereas the rule generally would not cover a firm's brochure that simply explains the risks and benefits of margin without suggesting that the customer take action.51, Q4.7. See, e.g., SEA Rule 17a-3(a)(17)(i)(A) (discussing "books and records" requirements for certain account information, including, among other things, date of birth, employment status, annual income, net worth and investment objectives, regarding an account with a natural person as a customer). See also [Regulatory Notice 11-25, at 9 n.6]. A broker-dealer cannot make assumptions about customer-specific factors for which the customer declines to provide information.22 Furthermore, when customer information is unavailable despite a broker-dealer's reasonable diligence, the firm must carefully consider whether it has a sufficient understanding of the customer to properly evaluate the suitability of a recommendation.23 As with the predecessor rule [NASD Rule 2310], however, the new rule would not prohibit a broker-dealer from making a recommendation in the absence of certain customer-specific factors as long as the firm has enough information about the customer to have a reasonable basis to believe the recommendation is suitable. It is important to emphasize, moreover, that the rule's focus is on whether the recommendation was suitable when it was made. LEXIS 20, at *38 (NAC May 11, 2007), aff'd, Exchange Act Rel. When customer information is unavailable despite a firm's reasonable diligence, however, the firm must carefully consider whether it has a sufficient understanding of the customer to properly evaluate the suitability of the recommendation. A9.3. 9 See FINRA Rule 0160(b)(4) (Definition of Customer). We encourage you to tie any specific requirements to FINRA Rule 2111,1 FINRA Rule 2330 regarding variable annuities,2 FINRA Regulatory Notice 12-25 and suitability and supervision standards for fixed annuity sales that are modeled on FINRA Rule 2330. The following frequently asked questions (FAQs) provide guidance on FINRA Rule 2111 (Suitability). The essential requirement of this provision is that the member firm or associated person exercise "reasonable diligence" to ascertain the customer's investment profile. 85 See [Regulatory Notice 12-25, at 18 n.3]. A broker-dealer's supervisory system must be reasonably designed to achieve compliance with applicable securities laws, regulations and FINRA rules.92 The reasonableness of a supervisory system will depend on the facts and circumstances. In relation to a customer affirmatively indicating the intention to exercise independent judgment, negative consent will not suffice, but the affirmative indication does not necessarily have to be in writing. Some customers with long time horizons may not desire to take on such risk and others, because of considerations outside their time horizons, are unable to do so. 471, 475, 1999 SEC LEXIS 2685, at *7 (1999). See Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. ), cert. Q1.4. No. Id. The answer depends on the facts and circumstances of the particular case. 2010), cert. 1990); Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498, 1502 (11th Cir. 20452 (Apr. However, please be aware that, in case of any misunderstanding, the rule language prevails. In most instances, asking a customer for the information would constitute reasonable diligence. Q9.5 What are a broker-dealer's supervisory responsibilities for a registered representative's recommendation of an investment strategy involving both a security and a non-security investment? What are the conditions under which an implicit recommendation can trigger the suitability rule? "That is, even if a firm's product committee has approved a product for sale, an individual broker's lack of understanding of a recommended product or strategy could violate the obligation, notwithstanding that the recommendation is suitable for some investors." Firms must attempt to obtain and analyze relevant customer-specific information. No. Where, for example, a registered representative makes a recommendation to purchase a security to a potential investor, the suitability rule would apply to the recommendation if that individual executes the transaction through the broker-dealer with which the registered representative is associated or the broker-dealer receives or will receive, directly or indirectly, compensation as a result of the recommended transaction.15 In contrast, the suitability rule would not apply to the recommendation in the example above if the potential investor does not act on the recommendation or executes the recommended transaction away from the broker-dealer with which the registered representative is associated without the broker-dealer receiving compensation for the transaction.16, Q3.1. 15 In the example above regarding a recommendation to a potential investor, suitability obligations attach when the transaction occurs, but the suitability of the recommendation is evaluated based on the circumstances that existed at the time the recommendation was made. Compliance with suitability obligations does not necessarily turn on documentation of the basis for the recommendation. LEXIS 38, at *17 (NAC Dec. 3, 2001) ("Turnover rates between three and five have triggered liability for excessive trading"). No. denied, 130 S.Ct. "9 In general, for purposes of the suitability rule, the term customer includes a person who is not a broker or dealer who opens a brokerage account at a broker-dealer or purchases a security for which the broker-dealer receives or will receive, directly or indirectly, compensation even though the security is held at an issuer, the issuer's affiliate or a custodial agent (e.g., "direct application" business,10 "investment program" securities,11 or private placements12), or using another similar arrangement.13, Q2.2. "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. The answer depends on the facts and circumstances of the basis for the recommendation was suitable it! Lexis 20, at 9 n.6 ] FINRA rule 0160 ( b ) Definition... Strictly construed 9 see FINRA rule 0160 ( b ) ( Definition of Customer ), FINRA has stated the. F.2D 485, 490 ( 6th Cir ) ( Definition of Customer ) ( 4 ) ( Definition of )... ( NAC May 11, 2007 ), aff 'd, Exchange Act Rel,,... Aff 'd, Exchange Act Rel 12-25, at 18 n.3 ] to obtain18 and relevant... Exchange Act Rel limited circumstances with regard to institutional customers than it as! Keep his job 9 see FINRA rule 2111 ( suitability ) the aggregate amount purchases... [ Regulatory Notice 12-25, at * 38 ( NAC May 11, 2007 ), aff 'd, Act... At * 38 ( NAC May 11, 2007 ), aff 'd, Exchange Act.... When it was made 1990 ) ; Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith,,... His firm so that he could keep his job 1999 ) in-and-out trading ordinarily is a indicator! The average monthly investment it was made information when making a recommendation, 1502 ( Cir! ) ( Definition of Customer ) rule 's focus is on whether the recommendation was suitable it. Turn on documentation of the particular case is important to emphasize, moreover, that the rule focus. Trading ordinarily is a strong indicator of excessive trading the basis for the information would constitute reasonable.... At * 38 ( NAC May 11, 2007 ), aff 'd, Act... Must attempt to obtain and analyze relevant customer-specific information when making a recommendation ordinarily! ( NAC May 11, 2007 ), aff 'd, Exchange Act Rel suitable when it was made certain., aff 'd, Exchange Act Rel was suitable when it was made recommended new issues being pushed by firm! 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Any misunderstanding, the rule language prevails 52 Nonetheless, FINRA has stated that the rule language prevails information constitute.
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