This blog post is part of a series addressing FINRA Suitability Rule 2111. Our suitability experts will examine the genealogy of the rule and how it has evolved over the years through Notices to Members, Regulatory Notices, and changes to the rule itself. In particular, customer-specific and reasonable-basis suitability will be examined.
In this post we examine hold recommendations.
Hold as a Recommendation
Advice to hold a security is now clearly considered a recommendation, and is captured in the “investment strategy” language of Rule 2111. FINRA RN 11-25 makes it clear that even recommendations which do not result in transactions come under the aegis of the Rule:
The rule explicitly states that the term “strategy” should be interpreted broadly.The rule would cover a recommended investment strategy regardless of whetherthe recommendation results in a securities transaction or even references a specificsecurity or securities. For instance, the rule would cover a recommendation topurchase securities using marginor liquefied home equityor engage in daytrading,irrespective of whether the recommendation results in a transaction orreferences particular securities. (Emphasis added)
And then even more specifically:
The term also would capture an explicit recommendation to hold a security or securities. 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. An explicit recommendation to hold is tantamount to a “call to action” in the sense of a suggestion that the customer stay the course with the investment. The rule would apply, for example, when an associated person meets 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. (Emphasis added).
Importantly, FINRA RN 12-25 addresses the documentation of hold recommendations, and highlights those involving leveraged and inverse ETFs:
For "hold" recommendations, FINRA has stated that a firm may want to focus on securities that by their nature or due to particular circumstances could be viewed as having a shorter-term investment component; that have a periodic reset or similar mechanism that could alter a product's character over time; that are particularly susceptible to changes in market conditions; or that are otherwise potentially risky or problematic to hold at the time the recommendations are made.
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)…” (Emphasis added)
These requirements are in addition to the general obligation of member firms to evidence compliance with applicable FINRA rules.
The Accelerant Securities Practice Group has many experts on FINRA Suitability Rule 2111, including: Gerry Guild, John Duval, Sr., Tom Brakke, and Jack Duval.
Portions of this blog originally appeared in the Accelerant white paper Leveraged and Inverse ETFs: Trojan Horses for Long-Term Investors, by Jack Duval.
 Under NYSE Rule 472 (Communication with the Public) a hold was included in the definition of a recommendation. Under Rule 472.10/09: “For purposes of these standards, the term ‘recommendation’ includes any advice, suggestion or other statement, written or oral, that is intended, or can reasonably be expected to influence a customer to purchase, sell or hold a security.” (Emphasis added); available at http://finra.complinet.com/en/display/display.html?rbid=2403&record_id=15076&element_id=11054&highlight=472#r15076; accessed August 1, 2013.
 FINRA Regulatory Notice 11-25, Know Your Customer and Suitability; May 2011; (Implementation Date: July 9, 2012); A7; available at http://finra.complinet.com/net_file_store/new_rulebooks/f/i/finra_11-25.pdf; accessed June 19, 2013.
 The “call to action” standard is addressed in NASD NTM 01-23, which was issued in response to the proliferation of online trading firms putting out generic “tip sheets”, “top 10 lists” and other communications regarding stocks. The primary question this NTM addresses is whether or not these types of generic communication constitute a recommendation and thus would be subject to Rule 2310. In short, they do not.
The guidance principles enumerated in NTM 01-23 were that: (1) the communication had to be a call to action on the part of the investor; and (2) the more tailored the communication was to an individual’s particular facts and circumstances, the more likely it was to be a recommendation.
While generic tip sheets may constitute a call to action (buy these five stocks now!), they fail in the second criteria, and thus are not recommendations.
 FINRA Regulatory Notice 12-25 at A13.
 Id. at A12.