FINRA’s new Know Your Customer and Suitability rules give rise to certain additional obligations that will require broker-dealer firms to revisit their internal controls and educate their staff on the new requirements. The rules, which were initially announced in this Regulatory Notice, have generated significant buzz throughout the industry. In response to several questions and concerns over complying with the new rules, FINRA has extended the implementation date for the new rules, which is now July 9, 2012. In addition, FINRA issued another Regulatory Notice providing additional guidance and addressing some of the most common questions regarding the new rules.
Most of the compliance concerns FINRA addresses in the Regulatory Notice relate to new FINRA Rule 2111 (Suitability), which requires that a firm or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy . . . is suitable for the customer, based on [information obtained through reasonable diligence] to ascertain the customer's investment profile.” According to the rule, a customer's investment profile includes, among other things: age, investment objectives and experience, time horizon, liquidity needs, risk tolerance, and any other information disclosed by the customer. Notably, the term “strategy” in the suitability rule is interpreted broadly to potentially cover recommendations that do not result in a securities transaction or that do not even refer to a specific security or securities. Moreover, “hold” recommendations would be considered a strategy that would trigger the suitability rule. FINRA has clarified, however, that this is intended to apply only to explicit recommendations to hold a security or securities, and not situations where an associated person merely refrains from recommending the sale of securities held in a customer’s account.
The Notice also provides guidance as to the meanings of some of the terms used in the suitability rule, such as “liquidity needs” (the extent to which a customer desires or needs to quickly and easily convert all or a portion of an investment to cash without experiencing significant loss in value or incurring significant costs or penalties), “time horizon” (the expected number of months, years, or decades a customer plans to invest to achieve his/her objectives), and “risk tolerance” (a customer’s ability and willingness to lose some or all of his/her original investment in exchange for greater potential returns).
For additional information, please contact Zac Rosenberg, Compliance Consultant by email at firstname.lastname@example.org or by phone at (619) 278-0020.