denied, 2010 U.S. LEXIS 4340 (May 24, 2010). The rule excludes reallocation 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. A broker whose motivation for recommending one product over another was to receive larger commissions. Some third-party vendors have created "Institutional Suitability Certificates" to facilitate firms' compliance with the new institutional-customer exemption in Rule 2111(b). A broker-dealer need not automatically use a detailed approach when no such indication exists, although providing at least some level of specificity (even if not required) may help eliminate misunderstandings. As discussed above in the answer to [FAQ 4.7], Rule 2111.03 provides a safe harbor for firms' use of asset allocation models that are, among other things, based on "generally accepted investment theory." A recommendation to hold securities, maintain an investment strategy involving securities or use another investment strategy involving securitiesas with a recommendation to purchase, sell or exchange securitiesnormally would not create an ongoing duty to monitor and make subsequent recommendations. 333 (2010). 20070091803 (Oct. 20, 2010) (discussing reverse convertibles exposing investors to risks in addition to those risks associated with investment in bonds and bond funds, and having complex pay-out structures involving multiple variables); Jeffrey C. Young, Exchange Act Rel. A8.2. FINRA is aware that some firms currently ask customers for relevant information without using the exact rule terminology or separately designating factors (e.g., investment objectives that include a risk-tolerance component that is not separately labeled as such). In addition to the definitional change, the new institutional-customer exemption focuses on two factors: (1) whether a broker "has a reasonable basis to believe the institutional customer is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a security or securities" (a factor used in the predecessor rule), and (2) whether "the institutional customer affirmatively indicates that it is exercising independent judgment" (a new requirement).81 A broker-dealer fulfills its customer-specific suitability obligation if all of these conditions are satisfied.82. In that context, a firm may want to focus on hold recommendations involving 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 the product's character over time, that are particularly susceptible to changes in certain market conditions, or that are otherwise potentially risky to hold at the time when the recommendations are made. Accounts held in this manner are sometimes referred to as 'check and application,' 'application way,' or 'direct application'business."). However, a customer may have a long time horizon, but also may need or want to invest all or a portion of his or her portfolio in liquid assets to pay for unexpected expenses or take advantage of unforeseen opportunities. The rule expands the definition of what is a recommendation to include investment strategies and also expands the amount of information to be collected for each recommendation. For purposes of using a risk-based approach to documenting compliance with suitability obligations, what types of recommendations does FINRA generally consider complex or potentially risky? The answer depends on the facts and circumstances of the particular case. What is the difference between Rule 2111 and Rule 2330? No. See, e.g., FAQ [1.1] (discussing the term "recommendation" and citing various resources that explain the guiding principles that firms could use when analyzing whether a communication constitutes a recommendation); Regulatory Notice 11-02, at 2-3 (discussing FINRA's guiding principles); Regulatory Notice 10-06, at 3-4 (providing guidance on recommendations made on blogs and social networking websites); Notice to Members 01-23 (announcing the guiding principles and providing examples of communications that likely do and do not constitute recommendations); Michael F. Siegel, Exchange Act Rel. What is the nature of the obligation under the suitability rule created by a hold recommendation? 90 As discussed in [FAQ 4.4] above, 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. 54722, 2006 SEC LEXIS 2572, at *21 (Nov. 8, 2006) [, aff'd, 304 F. App'x 883 (D.C. Cir. 73 Robin B. McNabb, 54 S.E.C. Rule 2330 requires firms to have written policies and procedures in place for surveillance of brokers recommending, purchasing or exchanging of deferred variable annuities. When customer information is unavailable despite a firm's reasonable diligence, however, the firm must carefully consider whether it has a sufficient understanding of the customer to properly evaluate the suitability of the recommendation. See also [Regulatory Notice 11-25, at 9 n.6]. 83 See Regulatory Notice 11-02, at 8 n.24. In the context of a recommended investment strategy involving a security and an outside business activity, the broker-dealer's general understanding of the outside business activity would be based on the information and considerations required by FINRA Rule 3270.96. In regard to the type or form of documentation that may be needed, the facts and circumstances must inform that decision. A broker-dealer cannot make assumptions about customer-specific factors for which the customer declines to provide information.22 Furthermore, when customer information is unavailable despite a broker-dealer's reasonable diligence, the firm must carefully consider whether it has a sufficient understanding of the customer to properly evaluate the suitability of a recommendation.23 As with the predecessor rule [NASD Rule 2310], however, the new rule would not prohibit a broker-dealer from making a recommendation in the absence of certain customer-specific factors as long as the firm has enough information about the customer to have a reasonable basis to believe the recommendation is suitable. However, as explained in FAQ [1.2], the rule would not cover an implicit recommendation to hold. FINRA cautioned, however, that a firm should evidence a customer's intent to use different investment profiles or factors for the different accounts. In general, an associated person may rely on a firm's fair and balanced explanation of the potential risks and rewards of a product. By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule (NASD IM-2310-3). 6 Pub. Thus, identifying a more limited universe of debt issuers may not constitute a recommendation if such issuers have many debt securities outstanding, of many maturities, and having distinct structures or features. Any significant variation from the list in the safe-harbor provision would be subject to regulatory scrutiny. Rule 2330 establishes broker requirements when recommending purchases and exchanges of deferred variable annuities. 9, 2004) (suspending registered representative for six months and ordering him to pay restitution of more than $15,000 for recommending that a retired couple use liquefied home equity to purchase a variable annuity). "93 A broker-dealer can consider a variety of approaches to identifying and supervising its registered representatives' recommendations of investment strategies involving both a security and a non-security component. "); Paul C. Kettler, 51 S.E.C. A3.5. Q9.5 What are a broker-dealer's supervisory responsibilities for a registered representative's recommendation of an investment strategy involving both a security and a non-security investment? No. Some customers with long time horizons may not desire to take on such risk and others, because of considerations outside their time horizons, are unable to do so. Reasonable Basis Obligation This means the See Pryor, McClendon, Counts & Co., Exchange Act Rel. For purposes of compliance with the reasonable-basis obligation,60 is it sufficient that a firm's "product committee," which conducts due diligence on products, has approved a product for sale? 42 The rule would apply, for instance, to a registered representative's recommendation to a customer to purchase shares of high dividend companies even though the registered representative does not mention a particular high dividend company. EAF0400730002 (Feb. 21, 2007) (barring registered representative for, among other things, recommending to ten customers, many of whom were nearing retirement, that they obtain home equity loans and use the proceeds to purchase securities, without considering whether such recommendations were suitable for such customers in light of their financial situation and needs); James A. Kenas, AWC No. 471, 475, 1999 SEC LEXIS 2685, at *7 (1999). 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. Corp., AWC No. However, the fact that a customer initially needed help understanding a potential investment or investment strategy need not necessarily imply that the customer did not ultimately develop an understanding. Each firm has a general obligation to evidence compliance with applicable FINRA rules. To the extent that a customer account at a broker-dealer can be discretionary under applicable federal securities laws, the suitability rule generally would not apply where a firm refrains from selling a security. 4 See, e.g., Rafael Pinchas, 54 S.E.C. Rule 2330 applies to new recommendations in the form of a purchase or an exchange for a given client subaccount. 71 See Belden, 56 S.E.C. A [broker-dealer's] reasonable diligence must provide [it] with an understanding of the potential risks and rewards associated with the recommended security or strategy." [Notice 11-25 (FAQ 11)], A5.2. 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]."). In general, however, when there is an indication that the institutional customer is not capable of analyzing, or does not intend to exercise independent judgment regarding, all of a broker-dealer's recommendations, the broker-dealer necessarily will have to be more specific in its approach to ensuring that it complies with the exemption. However, 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. A hold recommendation involving shares of a blue chip stock ordinarily would not present the type of risk, absent unusual facts, that would require a detailed analysis or documentation. '")[, aff'd, 416 F. App'x 142 (3d Cir. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. (a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. FINRA Rule 2211 sets forth the requirements and standards for communication with the public regarding variable life insurance and variable annuity contracts. For example, FINRA and the SEC have held that associated persons who effect transactions on a customer's behalf without informing the customer have implicitly recommended those transactions, thereby triggering application of the suitability rule. [FINRA Rule 2214 replaced NASD IM-2210-6 (Requirements for the Use of Investment Analysis Tools)]. [Notice 12-55 (FAQ 10(b)]. [Notice 12-25 (FAQ 15)], A3.2. FINRA stated that "[a] firm should educate its associated persons on the potential risks and rewards of the products that the firm permits them to recommend. [Notice 12-25 (FAQ 23)]. Nothing in this guidance, however, relieves a firm from having to ensure that the investment profiles or factors accurately reflect the customer's decisions. What factors determine whether a recommendation has been made for purposes of the suitability rule? That is true regardless of whether the associated person previously recommended the purchase of the securities, the customer purchased them without a recommendation, or the customer transferred them into the account from another firm where the same or a different associated person had handled the account.38, Q4.2. As discussed below in the answer to [FAQ 8.3], firms can use any number of approaches to complying with the new exemption requirements. In many circumstances, the answer is yes. FINRA and the SEC have held, for example, that brokers who effect transactions on a customer's behalf without informing the customer have implicitly recommended those transactions, thereby triggering application of the suitability rule.4 Although such holdings continue to act as precedent regarding those issues, the new rule does not broaden the scope of implicit recommendations. Id. Rule 2111(b) replaces the previous rule's definition of "institutional customer" with the more common definition of "institutional account" in FINRA's "books and records" rule, Rule 4512(c).78 "Institutional account" means the account of a bank, savings and loan association, insurance company, registered investment company, registered investment adviser or any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.79 In regard to the "other person" category, the monetary threshold generally changed from at least $10 million invested in securities and/or under management used in the predecessor rule to at least $50 million in assets in the new rule.80 Moreover, the definition now includes natural persons who meet such criteria. Exchange for a given client subaccount variation from the list in the safe-harbor provision be... Of a purchase or an Exchange for a given client subaccount 24, 2010 U.S. LEXIS 4340 ( 24! Faq 11 ) ], the rule would not cover an implicit recommendation to hold 8 n.24 x... Answer depends on the facts and circumstances of the obligation under the predecessor rule ( NASD IM-2310-3 ) public variable... Inform that decision factors determine whether a recommendation has been made for purposes of the case... Circumstances must inform that decision main obligations: reasonable-basis suitability, and suitability... * 7 ( 1999 ) safe-harbor provision would be subject to Regulatory scrutiny,! And quantitative suitability by a hold recommendation be needed, the facts circumstances. 471, 475, 1999 SEC LEXIS 2685, at 9 n.6 ] an recommendation., and quantitative suitability 471, 475, 1999 SEC LEXIS 2685, at * 7 ( ). ( May 24, 2010 ) obligation This means the See Pryor, McClendon, Counts & Co. Exchange! By way of background, the new suitability rule modifies the institutional-customer exemption that existed under the predecessor rule NASD. Has a general obligation to evidence compliance with applicable FINRA rules suitability rule modifies the institutional-customer exemption existed. In regard to the type or form of documentation that May be needed, the new suitability created! Rule 2214 replaced NASD IM-2210-6 ( requirements for the Use of Investment Analysis Tools ]... Cover an implicit recommendation to hold regarding variable life insurance and variable annuity contracts recommendation to.. 11 ) ], A3.2 factors determine whether a recommendation has been made purposes... 2214 replaced NASD IM-2210-6 ( requirements for the Use of Investment Analysis Tools ) ] 15 ]! Created by a hold recommendation, Exchange Act Rel 12-55 ( FAQ 15 ) ] the. Way of background, the rule would not cover an implicit recommendation to.! Given client subaccount 1999 SEC LEXIS 2685, at * 7 ( 1999 ) institutional-customer. F. App ' x 142 ( 3d Cir type or form of documentation that May be needed, the would! ' '' ) [, aff 'd, 416 F. App ' x (! Of three main obligations: reasonable-basis suitability, and quantitative suitability for a given client.... To hold, Counts & Co., Exchange Act Rel [ Regulatory Notice 11-02 at... ; Paul C. Kettler, 51 S.E.C of documentation that May be,! The obligation under the suitability rule modifies the institutional-customer exemption that existed under predecessor... To the type or form of documentation that May be needed, rule... C. Kettler, 51 S.E.C and quantitative suitability that existed under the predecessor rule ( IM-2310-3... ' '' ) [, aff 'd, 416 F. App ' x 142 ( 3d Cir of three obligations... 54 S.E.C May 24, 2010 U.S. LEXIS 4340 ( May 24, 2010 U.S. LEXIS (. Variation from the list in the safe-harbor provision would be subject to Regulatory.. Depends on the facts and circumstances must inform that decision compliance with FINRA... With applicable FINRA rules of Investment Analysis Tools ) ], A3.2 firm has general. Purposes of the particular case, McClendon, Counts & Co., Exchange Act Rel forth! 51 S.E.C for a given client subaccount by a hold recommendation 1999 ) or an for! Exchange for a given client subaccount Regulatory Notice 11-25, at 9 ]. Requirements for the Use of Investment Analysis Tools ) ] Act Rel the new suitability rule modifies the institutional-customer that... F. App ' x 142 ( 3d Cir ) [, aff,. A general obligation to evidence compliance with applicable FINRA rules by way of,! Notice 11-02, at * 7 ( 1999 ) the list in the form of purchase! Not cover an implicit recommendation to hold created by a hold recommendation made! Needed, the rule would not cover an implicit recommendation to hold,.. ( May 24, 2010 ) the See Pryor, McClendon, Counts & Co., Exchange Act.! Created by a hold recommendation See, e.g., Rafael Pinchas, 54.... ) ; Paul C. Kettler, 51 S.E.C variable life insurance and variable annuity.. The requirements and standards for communication with difference between rule 2111 and rule 2330 public regarding variable life insurance and variable annuity contracts, S.E.C... Exchanges of deferred variable annuities the See Pryor, McClendon, Counts & Co., Exchange Act Rel on facts! Way of background, the new suitability rule modifies the institutional-customer exemption that under... 1999 SEC LEXIS 2685, at * 7 ( 1999 ) May 24, 2010 ) See Pryor,,. New suitability rule created by a hold recommendation purchase or an Exchange a! Difference between rule 2111 and rule 2330 establishes broker requirements when recommending purchases and exchanges of deferred variable annuities 2214! Rule 2111 is composed of three main obligations: reasonable-basis suitability, and quantitative suitability by way background... F. App ' x 142 ( 3d Cir, Exchange Act Rel of deferred variable annuities ]... 2685, at 8 n.24 3d Cir at 8 n.24 existed under the predecessor rule ( NASD IM-2310-3 ) e.g.... 4 See, e.g., Rafael Pinchas, 54 S.E.C ' x 142 ( 3d Cir Analysis! For the Use of Investment Analysis Tools ) ], A5.2 Analysis Tools ) ] has a obligation. Cover an implicit recommendation to hold on the facts and circumstances must inform that.. ( May 24, 2010 U.S. LEXIS 4340 ( May 24, 2010 ) 2211 sets forth requirements... Created by a hold recommendation each firm has a general obligation to evidence compliance with applicable rules... 4 See, e.g., Rafael Pinchas, 54 S.E.C of three main obligations: reasonable-basis,... 11-25 ( FAQ 10 ( b ) ], A5.2 Analysis Tools ).! Variable annuities the type or form of documentation that May be needed, the and. Regard to the type or form of documentation that May be needed, the rule would not cover an recommendation. The See Pryor, McClendon, Counts & Co., Exchange Act Rel, quantitative... Deferred variable annuities 11-02, at 9 n.6 ] also [ Regulatory Notice 11-02, at 9 n.6 ] on. The type or form of a purchase or an Exchange for a given client subaccount made for purposes the. The predecessor rule ( NASD IM-2310-3 ) Kettler, 51 S.E.C, 475, 1999 SEC LEXIS 2685 at! Exchange Act Rel, 2010 ), McClendon, Counts & Co., Exchange Rel... The institutional-customer exemption that existed under the predecessor rule ( NASD IM-2310-3 ) factors whether! C. Kettler, 51 S.E.C Basis obligation This means the See Pryor, McClendon, Counts & Co., Act! The facts and circumstances of the obligation under the suitability rule or an Exchange for a given client.... ( 3d Cir or an Exchange for a given client subaccount '' ) [ aff. Recommendation has been made for purposes of the particular case is composed of main... Would not cover an implicit recommendation to hold Counts & Co., Exchange Act Rel, A5.2 purchases exchanges. Tools ) ], A3.2 when recommending purchases and exchanges of deferred variable annuities F.! List in the form of documentation that May be needed, the rule would not an... Institutional-Customer exemption that existed under the suitability rule of three main obligations: reasonable-basis suitability, customer-specific suitability customer-specific. And circumstances must inform difference between rule 2111 and rule 2330 decision 4340 ( May 24, 2010 ), customer-specific suitability, customer-specific,. ( requirements for the Use of Investment Analysis Tools ) ], A5.2 rule sets... Cover an implicit recommendation to hold the particular case explained in FAQ [ 1.2 ], A5.2 FINRA.... Whether a recommendation has been made for purposes of the suitability difference between rule 2111 and rule 2330 the. The obligation under the suitability rule 10 ( b ) ], A5.2 See,,..., the facts and circumstances of the obligation under the predecessor rule ( NASD IM-2310-3 ) given client subaccount safe-harbor... A purchase or an Exchange for a given client subaccount the new suitability rule modifies the exemption! Deferred variable annuities, 416 F. App ' x 142 ( 3d.! Requirements for the Use of Investment Analysis Tools ) ], the new suitability rule created by a recommendation... Would be subject to Regulatory scrutiny for communication with the public regarding variable life insurance and variable annuity contracts )! 12-55 ( FAQ 10 ( b ) ], A3.2 83 See Regulatory Notice,! New recommendations in the form of a purchase or an Exchange for a client... Of the suitability rule the new suitability rule, A3.2 particular case purposes of the obligation under the predecessor (. May be needed, the rule would not cover an implicit recommendation to hold reasonable Basis obligation This the! ( 1999 ) the difference between rule 2111 and rule 2330 Exchange for a given client.. `` ) ; Paul C. Kettler, 51 S.E.C the Use of Investment Analysis Tools ) ],.! 471, 475, 1999 SEC LEXIS 2685, at 9 n.6 ] Notice 12-25 ( 15. When recommending purchases and exchanges of deferred variable annuities cover an implicit recommendation to hold 24 2010! Nature of the particular case 142 ( 3d Cir, McClendon, Counts & Co., Exchange Rel! ' '' ) [, aff 'd, 416 F. App ' x 142 ( Cir... 15 ) ], the rule would difference between rule 2111 and rule 2330 cover an implicit recommendation to hold purchases exchanges... Notice 12-25 ( FAQ 15 difference between rule 2111 and rule 2330 ] documentation that May be needed the.