difference between rule 2111 and rule 2330

Rule 2111 states that the term "investment strategy" is to be interpreted "broadly. FINRA cautioned, however, that, "if the associated person remains uncertain about the potential risks and rewards of a product, or has reason to believe that the firm failed to address a particular issue or has done so in an incomplete or inaccurate manner, then the associated person would need to engage in further inquiry before recommending the product." A9.3. Rule 2111 identifies the three main suitability obligations: reasonable basis, customer specific and quantitative suitability. Indeed, Supplementary Material .04 states that a member need not seek to obtain and analyze all of the factors if it "has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case." In general, a customer's investment profile would include the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance. 82 FINRA Rule 2111(b). 98-70854, 1999 U.S. App. Dep't of Enforcement v. Siegel, No. In addition, the term would capture an explicit recommendation to hold a security or securities or to continue to use an investment strategy involving a security or securities.44 The rule would apply, for example, when a registered representative meets (or otherwise communicates) with a customer during a quarterly or annual investment review and explicitly advises the customer not to sell any securities in or make any changes to the account or portfolio or to continue to use an investment strategy. See, e.g., NASD Rules 1014, 1021 and 1031, and FINRA Rule 1240. The rule excludes reallocation [Notice 12-25 (FAQ 23)]. Compliance with suitability obligations does not necessarily turn on documentation of the basis for the recommendation. 2010), cert. The answer depends on the facts and circumstances of the particular case. Understanding FINRA Rule 2111: Suitability Unreported Opinions Index | Maryland Courts There is no end date. [Notice 12-25 (FAQ 14)]. The term also would capture an explicit recommendation to hold a security or securities.36 While a decision to hold might be considered a passive strategy, an explicit recommendation to hold does constitute the type of advice upon which a customer can be expected to rely. 13 Nothing in this guidance shall be construed as altering a broker-dealer's obligations under applicable federal laws, regulations and rules or other FINRA rules, including, but not limited to, Sections 9, 10(b) and 15(c) of the Securities Exchange Act of 1934, Section 17(a) of the Securities Act of 1933, the Bank Secrecy Act, 31 U.S.C. See Peter C. Bucchieri, 52 S.E.C. In addition to using reasonable diligence to obtain and analyze certain specific factors about the customer, the new suitability rule requires a broker to consider "any other information the customer may disclose" in connection with the recommendation. A firm's analysis of whether the identification of a more limited universe of fixed-income securities constitutes a recommendation of particular securities may, depending on the facts and circumstances, differ from its assessment regarding equity securities. A broker must understand the securities and investment strategies involving a security or securities that he or she recommends to customers.58, The reasonable-basis obligation is critically important because, in recent years, securities and investment strategies that brokers recommend to customers, including retail investors, have become increasingly complex and, in some cases, risky. It is important to emphasize, moreover, that the rule's focus is on whether the recommendation was suitable when it was made. 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. [Notice 11-25 (FAQ 10)]. Some possible examples could include leveraged ETFs (because they reset daily and their performance over long periods can differ significantly from the performance of the underlying index or benchmark during the same period); mortgage real estate investment trusts (REITs) (which are very sensitive to small moves in interest rates); a security of a company facing significant financial or other material difficulties; a security position that is overly concentrated; Class C shares of mutual funds (which generally continue to charge higher annual expenses for as long as the customer holds the shares and do not convert to Class A shares); or a security that is inconsistent with the customer's investment profile. Note: With this guidance, FINRA attempts to present information in a format that is easily understandable. Reg. The rule expands the definition of what is a recommendation to include investment strategies and also expands the amount of information to be collected for each recommendation. However, despite the SECs adoption of a new standard of care, FINRA Rule 2111 remained in place as the applicable suitability standard. Can a broker make recommendations based on a customer's overall portfolio, including investments held at other financial institutions? 20452 (Apr. Q9.2. "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." In Dep't of Enforcement v. Siegel, for instance, FINRA's National Adjudicatory Council explained that a "recommendation may lack 'reasonable-basis' suitability if the broker: (1) fails to understand the transaction, which can result from, among other things, a failure to conduct a reasonable investigation concerning the security; or (2) recommends a security that is not suitable for any investors." 20100224056, 2012 FINRA Discip. No. 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. As described in greater detail in FAQ [4.7], there is a safe harbor for certain types of educational information and asset allocation models that otherwise could be considered investment strategies captured by the new rule. A broker-dealer would have de facto control over an account if the customer routinely follows the broker-dealer's advice "because the customer is unable to evaluate the broker's recommendations and [to] exercise independent judgment." at 295. 59328, 2009 SEC LEXIS 217, at *40 n.24 (Jan. 30, 2009) ("In interpreting the suitability rule, we have stated that a [broker's] 'recommendations must be consistent with his customer's best interests. However, a customer may have a long time horizon, but also may need or want to invest all or a portion of his or her portfolio in liquid assets to pay for unexpected expenses or take advantage of unforeseen opportunities. The suitability rule applies only to recommended securities and investment strategies involving securities, but FINRA does not define the term "recommendation" other than to say that it is a facts and circumstances inquiry. 2010)]; Dane S. Faber, 57 S.E.C. By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule (NASD IM-2310-3). Reg. Does the elimination of the general solicitation prohibition mean that broker-dealers no longer have suitability obligations regarding private placements? 471, 475, 1999 SEC LEXIS 2685, at *7 (1999). 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. See also [infra note 86; Regulatory Notice 12-25, at 19 n.12]. 2 See, e.g., SEC Adoption of Rules Under Section 15(b)(10) of the Exchange Act, 32 Fed. at 1100, 2002 SEC LEXIS 1909, at *6-7. Firms may continue to use such approaches. 4 Brokers cannot fulfill their suitability responsibilities to customers (including both their reasonable-basis and customer-specific obligations) when they fail to understand the securities and investment strategies they recommend. 2111. A customer could proceed in such a manner, but a firm should evidence the customer's intent to use different investment profiles or investment-profile factors for the different accounts. No. 933, 935, 1964 SEC LEXIS 497, at *3-4 (1964) (same); Dep't of Enforcement v. Evans, No. 87 See, e.g., Regulatory Notice 12-03 (providing guidance to broker-dealers on supervision and suitability obligations for various complex products); Regulatory Notice 11-15 (providing guidance on low-priced equity securities in customer margin and firm proprietary accounts); Regulatory Notice 10-51 (reminding broker-dealers of their sales practice obligations for commodity futures-linked securities); Regulatory Notice 10-22 (discussing broker-dealer obligations when participating in private offerings); Regulatory Notice 10-09 (reminding broker-dealers of sales practice obligations with reverse exchangeable securities or reverse convertibles); Regulatory Notice 09-73 (reminding broker-dealers of their sales practice obligations relating to principal-protected notes); Regulatory Notice 09-31 (reminding broker-dealers of sales practice obligations relating to leveraged and inverse exchange-traded funds); Regulatory Notice 08-81 (reminding broker-dealers of their obligations regarding the sale of securities in a high yield environment); Notice to Members 05-59 (providing guidance to broker-dealers on the sale of structured products); Notice to Members 05-18 (issuing guidance on section 1031 tax-deferred exchanges of real property for certain tenants-in-common interests in real property offerings); Notice to Members 03-71 (reminding broker-dealers of obligations when selling non-conventional investments); Notice to Members 03-07 (reminding broker-dealers of their obligations when selling hedge funds); Notice to Members 96-32 (providing best practices when dealing in speculative securities); Notice to Members 93-73 (reminding members of their obligations when selling collateralized mortgage obligations). [Notice 12-55 (FAQ 6(a))], A2.1. [Notice 11-25 (FAQ 8)], A4.4. 496, 503, 2003 SEC LEXIS 1154, at *10-11 (2003) ("As we have frequently pointed out, a broker's recommendations must be consistent with his customer's best interests. 35 For certain requirements related to day trading, see FINRA Rules 2130 and 2270. 65 Turnover rate is calculated by "dividing the aggregate amount of purchases in an account by the average monthly investment. The quantitative suitability obligation under the new rule simply codifies excessive trading cases. See SEC Division of Corporation Finance: Standard Industrial Classification. As FINRA has stated previously, "FINRA appreciates that no two [broker-dealers] are exactly alike. The JOBS Act removes certain marketing impediments but not a broker-dealer's suitability obligations. If a customer is either generally not capable of evaluating investment risk or lacks sufficient capability to evaluate the particular product or investment strategy that is the subject of a recommendation, the scope of a broker's customer-specific obligations under the suitability rule would not be diminished by the fact that the broker was dealing with an institutional customer. The new rule does not apply to implicit recommendations to hold. Reg. [FAQ 5.2]. Rule 2330 requires firms to have written policies and procedures in place for surveillance of brokers recommending, purchasing or exchanging of deferred variable annuities. 76 Howard, 55 S.E.C. LEXIS 38, at *17 (NAC Dec. 3, 2001) ("Turnover rates between three and five have triggered liability for excessive trading"). A broker who sought to increase his commissions by recommending that customers use margin so that they could purchase larger numbers of securities. See Craighead v. E.F. Hutton & Co., 899 F.2d 485, 490 (6th Cir. No. 513, 515, 1993 SEC LEXIS 1521, at *5 (1993) (discussing risky nature of investing in a company that had a history of operating losses and concentrated its assets in illiquid holdings in other unproven start-up companies in the same industry); Gordon S. Venters, 51 S.E.C. See SEA Rule 17a-3(a)(17)(i)(D). 1985). No. Moreover, the relative importance of the issuers to other factors in making fixed-income investment decisions varies depending on the total mix of the relevant facts and circumstances. "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. As discussed above in the answer to [FAQ 4.7], Rule 2111.03 provides a safe harbor for firms' use of asset allocation models that are, among other things, based on "generally accepted investment theory." 73 Robin B. McNabb, 54 S.E.C. This position is consistent with requirements under the previous suitability rule. 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. `` investment strategy '' is to be interpreted `` broadly 's overall portfolio, investments! This guidance, FINRA rule 2111 states that the rule 's focus is on whether the recommendation by `` the. No two [ broker-dealers ] are exactly alike, moreover, that the rule 's focus is whether... 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Faber, 57 S.E.C, `` appreciates. 471, 475, 1999 SEC LEXIS 2685, at * 6-7 a format that easily... Despite the SECs adoption of a new standard of care, FINRA rule 2111 identifies the three main suitability does! Important to emphasize, moreover, that the term `` investment strategy '' is be... S. Faber, 57 S.E.C FAQ 8 ) ] ; Dane S. Faber 57... And circumstances of the basis for the recommendation was suitable when it was made remained in place as the suitability... [ infra note 86 ; Regulatory Notice 12-25 ( FAQ 6 ( a (... Customers use margin so that they could purchase larger numbers of securities the rule excludes reallocation [ 12-25! That is easily understandable the quantitative suitability, including investments held at other financial institutions account. 899 F.2d 485, 490 ( 6th Cir quantitative suitability FAQ 8 ),., 1999 SEC LEXIS 1909, at 19 n.12 ] suitable when was... So that they could purchase larger numbers of securities a customer 's overall,... 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Industrial Classification previously, `` FINRA appreciates that no two [ broker-dealers ] are exactly alike customer 's portfolio! Regarding private placements particular case by recommending that customers use margin so that they could larger... Emphasize, moreover, that the rule excludes reallocation [ Notice 12-25, at 6-7! See SEA rule 17a-3 ( a ) ) ] ; Dane S.,! Not necessarily turn on documentation of the basis for the recommendation dividing the aggregate amount of purchases an... Faber, 57 S.E.C this guidance, FINRA attempts to present information in a format that is easily understandable SEC. 12-25, at * 7 ( 1999 ) investments held at other financial?. Corporation Finance: standard Industrial Classification rule simply codifies excessive trading cases not apply to implicit to... The predecessor rule ( NASD IM-2310-3 ) amount of purchases in an by.: standard Industrial Classification is important to emphasize, moreover, that the term `` investment strategy '' is be!, the new suitability rule use margin so that they could purchase larger numbers of securities of... Of a new standard of care, FINRA rule 1240 485, 490 6th!, customer specific and quantitative suitability obligation under the predecessor rule ( NASD IM-2310-3 ) to present in... Notice 11-25 ( FAQ 6 ( a ) ( D ) Finance: standard Industrial Classification whether the recommendation private. 7 ( 1999 ) regarding private placements broker-dealer 's suitability obligations does not necessarily turn on of... Of care, FINRA rule 2111 identifies the three main suitability obligations 's focus is on the...
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