From the August 2012 issue of Investment Advisor • Subscribe!

Unleash the Hounds

By hounds, we mean lawyers; not that we’re necessarily comparing lawyers to dogs, but the former do have something of a Pavlovian response to new regulation and the potential “opportunity” it affords … we’ll leave it at that.

FINRA Rule 2111 went into effect on July 9 with surprisingly little fanfare, but its implication for brokers, advisors and the industry as a whole could be major. Forgive the passive voice, but in the days following its implementation, the Investment Adviser Association’s Executive Director David Tittsworth and Neil Simon, the advocacy organization’s vice president for government relations, were still evaluating the rule and not prepared to comment as to whether it represented an end-run around the DOL’s (and just about everyone else’s) fiduciary debate.

The Financial Planning Association’s David Cohen, assistant director of government relations, however, was quick to comment, deploying a rapid response on the same day the rule went into effect. It began with a little context:

“The previous suitability rule (Rule 2310) stated, ‘In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.”

Cohen went on to explain that under the new Rule 2111, there is a broadening of scope of what constitutes a “recommendation” by including the recommendation of either an “investment strategy” or “transaction” that involves a security or securities.

“An associated person shall: ‘Have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile,’” according to Cohen, quoting from the rule.

As for broker-dealers, Rule 2111 expands their suitability obligations by defining three separate suitability assessments they’re required to make: reasonable-basis suitability, customer-specific suitability and quantitative suitability. All are sufficiently vague to give necessary wiggle room to aggrieved parties.

“The rule also makes it clear that the term ‘investment strategy’ is to be interpreted broadly and covers explicit recommendations to hold a security, not just those to buy or sell a security,” Cohen concluded.

Surprise, surprise.

Cynicism is an ugly trait and one I try to avoid. But I can’t help thinking the true beneficiaries of this latest rule won’t be advisors or their clients.

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