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. at 6 n.15. 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. Id. 94 In Notice to Members 99-45, FINRA said that the supervision rule "requires that a [firm's] supervisory system be reasonably designed to achieve compliance with applicable laws and regulations. Id. Accordingly, a [firm] must perform appropriate due diligence to ensure that it understands the nature of the product, as well as the potential risks and rewards associated with the product."). The recommendation of a large-cap, value-oriented equity security usually would not require documentation. 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. What factors determine whether a recommendation has been made for purposes of the suitability rule? In addition, FINRA explained that, where a firm allows a customer to use different investment profiles or factors for different accounts rather than using a single customer profile for all of the customer's accounts, a firm could not borrow profile factors from the different accounts to justify a recommendation that would not be appropriate for the account for which the recommendation was made. Q4.3. For example, a firm should, among other things, clarify the customer's intent and, if necessary, reconcile and/or determine how it will handle the customer's differing investment objectives. 11 Regulatory Notice 08-35, at 2 (stating that direct participation programs (DPPs) and unlisted real estate investment trusts (REITs) are referred to as "investment programs"). 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. Note: With this guidance, FINRA attempts to present information in a format that is easily understandable. The new suitability rule (as with the predecessor rule) requires a broker to seek to obtain and analyze a customer's other investments. at 339-40 n.14, 1999 SEC LEXIS 1754, at *17 n.14. [Notice 12-55 (FAQ 6(b))], A2.2. See SEA Rule 17a-3(a)(17)(i)(D). "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. Q3.2. How much of a duty does a firm have to pursue "any other information the customer may disclose" to see if it has suitability implications? [Notice 11-25 (FAQ 8)], A4.4. Cir. 2010)]; Dane S. Faber, 57 S.E.C. [Notice 12-25 (FAQ 14)]. C3A960029, 1999 NASD Discip. What types of "hold" recommendations should firms consider documenting? ", A broker who recommended "that his customers purchase promissory notes to give him money to use in his business.". 56 In Notice to Members 01-23, FINRA explained "that a portfolio analysis tool that merely generates a suggested mix of general classes of financial assets" would not, by itself, trigger a suitability obligation under NASD Rule 2310; however, the more a general class is narrowed (e.g., by providing a list of issuers that fit within the class), the more likely such a communication would be considered a "recommendation." A broker who sought to increase his commissions by recommending that customers use margin so that they could purchase larger numbers of securities. The absence of some customer information that is not material under the circumstances generally should not affect a firm's ability to make a recommendation. FINRA has not approved or endorsed any third-party Institutional Suitability Certificates and has not contracted with any third-party vendor to create such certificates on FINRA's behalf. Q3.8. Q5.1. 306 (2012). Absent an agreement, course of conduct or unusual fact pattern that might alter the normal broker-customer relationship, a hold recommendation would not create an ongoing duty to monitor and make subsequent recommendations.49, Q4.5. Some firms may create "hold" tickets and some may add "hold" sections to existing order tickets. 30 See supra note [22] and cases cited therein. other "red flags" exist indicating that the customer information may be inaccurate. 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. 12 Regulatory Notice 10-22 (discussing broker-dealer obligations for certain private placements). A4.8. The new rule does not change the longstanding application of the suitability rule on a recommendation-by-recommendation basis. A4.1. [Notice 12-25 (FAQ 15)], A3.2. Turnover rates between three and six may trigger liability for excessive trading. 86 Firms should keep in mind, however, that SEA Rule 17a-3 requires that, for each account with a natural person as a customer or owner, a broker-dealer must create a record that includes, among other things, the customer's or owner's name, date of birth, employment status, annual income, and net worth, as well as the account's investment objectives. Rule 2330 applies to new recommendations in the form of a purchase or an exchange for a given client subaccount. This rule does not apply to: Any qualified plan under Section 3 (a) (12) (C) of the Exchange Act or under Sections 403 (b), 457 (b), or 457 (f) of the IRS Notices, Proposed Rules, Rules, and Presidential Documents published in the 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." What are the conditions under which an implicit recommendation can trigger the suitability rule? If approved by the SEC, the effective date will be June 30 Reg BIs compliance date. FINRA BrokerCheck, moreover, allows investors to review the professional and disciplinary backgrounds of firms and brokers online. As noted above in the answer to [FAQ 3.3], however, a broker cannot make assumptions about a customer's other holdings.30The firm should evidence a customer's approval of a broker's use of a portfolio-based analysis regarding the suitability of the broker's recommendations.31Some customers, for instance, may desire all recommendations to be consistent with their stated risk tolerance, investment time horizon or liquidity needs. A8.3. 26 See www.sec.gov/investor/pubs/assetallocation.htm. What is a firm's responsibility when customers indicate that they have multiple investment objectives that appear inconsistent? 2010), cert. 58737, 2008 SEC LEXIS 2459, at *21-27 (Oct. 6, 2008) (applying the guiding principles to the facts of the case to find a recommendation), aff'd in relevant part, 592 F.3d 147 (D.C. 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). 52 Nonetheless, FINRA has stated that the safe-harbor provision would be strictly construed. In general, the focus remains on whether the recommendation was suitable at the time when it was made. Q3.11. 71 See Belden, 56 S.E.C. Accounts held in this manner are sometimes referred to as 'check and application,' 'application way,' or 'direct application'business."). Can a broker make recommendations based on a customer's overall portfolio, including investments held at other financial institutions? No. 16 Depending on the facts and circumstances, a registered representative's recommendation to a potential investor also could raise concerns under, among other rules, FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade); FINRA Rule 2020 (Use of Manipulative, Deceptive or Other Fraudulent Devices); Rule 2210 (Communications with the Public); and NASD Rule 3040 (Private Securities Transactions of an Associated Person); see also Dep't of Enforcement v. Salazar, No. "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." Corp., AWC No. 83 See Regulatory Notice 11-02, at 8 n.24. What if a customer refuses to provide certain customer-specific information? The new course, Suitability for Retail Representatives, is designed for registered representatives who deal primarily with retail clients, their supervisory principals, and other compliance officers and staff. See Cody, 2011 SEC LEXIS 1862, at *49 & *55 (finding cost-to-equity ratio of 8.7 percent excessive); Thomas F. Bandyk, Exchange Act Rel. Would a broker, for example, be responsible for a hold recommendation involving blue chip stocks that a customer transferred into an account at the broker-dealer? See Pryor, McClendon, Counts & Co., Exchange Act Rel. However, this standard does require that the system be a product of sound thinking and within the bounds of common sense, taking into consideration the factors that are unique to a member's business." 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. Furthermore, a broker-dealer "must keep a record of its compliance with these obligations with respect to each written notice received and must preserve this record for the period of time and accessibility specified in SEA Rule 17a-4(e)(1)." See SEA Rules 17a-3(a)(6) and 17a-4(b)(1) and (b)(4). [Notice 11-25 (FAQ 5)]. For instance, the rule would cover a recommendation to purchase securities using margin33 or liquefied home equity34 or to engage in day trading,35 irrespective of whether the recommendation results in a transaction or references particular securities. SEA Rule 17a-3 also states that the broker-dealer must furnish such customer or owner a copy of the required account record information or alternative document with all information required by SEA Rule 17a-3(a)(17)(i)(A), including an explanation of any terms regarding investment objectives, for verification within 30 days of account opening and at least once every 36 months thereafter. See [FAQ 4.1], Regulatory Notice 11-02, at 3. These models often take into account the historic returns of different asset classes over defined periods of time. However, please be aware that, in case of any misunderstanding, the rule language prevails. The new rule, for example, does not apply to implicit recommendations to hold a security or securities. 4, 1997 ("[T]he staff agrees that a reference to an investment company or an offer of investment company shares in an advertisement or piece of sales literature would not by itself constitute a 'recommendation' for purposes of [the suitability rule]."). See, e.g., NASD Rules 1014, 1021 and 1031, and FINRA Rule 1240. 20100224056, 2012 FINRA Discip. For instance, some relatively liquid products can be complex and/or risky and therefore unsuitable for some customers. 1990); Arceneaux v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 767 F.2d 1498, 1502 (11th Cir. 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). 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