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Understanding FINRA Suitability Rule 2111 - Prospectus Delivery and Suitability

Posted by Jack Duval

Dec 19, 2013 10:27:00 AM

This blog post continues our expert 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 this post we examine the obligation of prospectus delivery and how it interacts with the suitability rule.

Prospectus Delivery and Suitability

Many securities transactions require the delivery of a prospectus.  At the same time, the obligation to deliver a prospectus exists side by side with the suitability obligation.  However, the delivery of a prospectus does not remove the suitability obligation, nor is it a substitute for the the customer-specific and reasonable-basis suitability process that must accompany each recommendation.

More directly, FINRA has been, and remains, crystal clear in its position that the delivery of a prospectus to a client does not cure an otherwise unsuitable recommendation nor any material misstatements or omissions that were made during the recommendation.

This position goes back in the FINRA literature at least to 1994.  For instance, in NASD NTM 94-16, the (then) NASD advised:

Members are also advised that, although the prospectus and sales material of a fund include disclosures on many matters, oral representations by sales personnel that contradict the disclosures in the prospectus or sale literature may nullify the effect of the written disclosures and may make the member liable for rule violations and civil damages to the customers that result from such oral representations.[1] (Emphasis added)

Furthermore, a number of FINRA Enforcement decisions reiterate this position, including the following:

  • Department of Enforcement v. Hornblower & Weeks, 2004. “Respondent could not cure defects in disclosure by providing more detail and further disclosure in the same package or by answering questions.” [2]
  • Department of Enforcement v. Ryan Mark Reynolds, 2001.  “The SEC has held that, in the enforcement context, a registered representative may be found in violation of the NASD’s rules and the federal securities laws for failure to fully disclose risks to customers even through such risks may have been discussed in a prospectus delivered to customers.”[3] (Emphasis added)
  • Department of Enforcement v. Pacific On-Line Trading & Securities, 2002. “Finding that the subsequent dissemination of disclosure information does not cure earlier misleading disclosures.”[4]

Lastly, under Rule 2111, Supplementary Material 2111.02 states explicitly:  “Disclaimers. A member or associated person cannot disclaim any responsibilities under the suitability rule.” This is consistent with all of FINRAs previous guidance.[5] 

The Accelerant Securities Practice Group has many experts on FINRA Suitability Rule 2111, including: Gerry Guild, John Duval, Sr., Tom Brakke, and Jack Duval.

Notes

Portions of this blog originally appeared in the Accelerant white paper Leveraged and Inverse ETFs:  Trojan Horses for Long-Term Investors, by Jack Duval.  

[1]        NASD NTM 04-16, Mutual Fund Sales Practice Obligations; available at http://finra.complinet.com/en/display/display.html?rbid=2403&record_id=1759&element_id=1518&highlight=94-16#r1759; accessed June 23, 2013.

[2]        FINRA NTM 05-59, Structured Products; available at http://www.complinet.com/file_store/pdf/rulebooks/nasd_0559ntm.pdf; accessed June 23, 2013.

[3]        Id.

[4]        Id.

[5]        See, for instance, FINRA RN 12-25, “FINRA reiterates, however, that many of the obligations under the new rule are the same as those under the predecessor rule and related case law. Existing guidance and interpretations regarding suitability obligations continue to apply to the extent that they are not inconsistent with the new rule.”  (Emphasis added) May 2012, 2.

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Topics: FINRA Suitability Rule 2111, Suitability Expert, Customer-specific Suitability, Prospectus Delivery, Reasonable

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