FINRA has issued RN 13-31 to highlight effective practices for member firms when complying with Suitability Rule 2111. (RN 13-31)
A number of highlights are worth noting, including:
- The manner in which the firm supervises explicit hold recommendations, including the method of documentation the firm uses when documentation occurs, as well as the information the firm considers in conducting the review...
- Transaction red flags such as: those that appear to deviate from the firm’s internal suitability guidelines for a particular security; a long-term investment for an investor with a short-term horizon; a speculative investment or strategy held in the account of an investor with a conservative investment objective; and the same security held in the account or strategy implemented for...
The RN also emphasized compliance with the reasonable-basis component of Rule 2111:
As referenced above, reasonable-basis suitability requires a firm or associated person to perform reasonable diligence to understand the nature of a recommended security or investment strategy involving a security, as well as its potential risks and rewards, and to determine whether the recommendation is suitable for at least some investors based on that understanding. FINRA observed during examinations that many firms have in place a new product vetting process that assists them in executing reasonable diligence obligations. While many large firms have extensive frameworks for assessing products, even smaller firms established investment committees to vet complex or risky products to determine whether the product met the reasonable-basis suitability standard for retail customers, and if so, the type of customer profile for which the product would be suitable if recommended.
A firm’s vetting of new products does not, standing alone, satisfy the need for associated persons to understand the securities and investment strategies they recommend to customers. In this regard, some firms post due diligence on products (and accompanying documents) to an internal website that associated persons can access when recommending a product. Such information includes audited financial statements, notes of interviews with key individuals of the product sponsor or issuer, and other information relevant to understanding the product and its features. Some firms use the vetting process to aid in product-focused training of their associated persons, supervisors and compliance staff.
Compliance with the reasonable-basis suitability requirement will be an important issue in the next securities litigation cycle. Chief Compliance Officers are right to focus on this issue before the next cycle is upon them.