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- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
More than a year after revamping its suitability rule, the Financial Industry Regulatory Authority has issued a study guide of sorts for BDs to help them prep for suitability exams.
Notice to Members 13-31 discusses issues that have cropped up during exams in the last year, with some of the infractions serious enough to be referred to enforcement. It highlights exam areas, common findings and effective practices when complying with the revised suitability rule, which became effective on July 9, 2012.
The notice provided eight questions every BD should be able to answer. Josh Horn, a partner in the Securities Industry Practice at Fox Rothschild in Philadelphia, summed those questions up in a recent blog post.
“If you cannot answer them in some fashion, you likely do not have adequate protocols in place,” Horn warns. “Take the time to revisit your policies and procedures before FINRA does it for you.”
The suitability rule requires a firm or associated person to “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.”
Horn told ThinkAdvisor that to get up to speed with the new rule’s requirements over the past year, he suspects “that there are firms that had to undertake a wholesale review of their policies and procedures to get them current to the new suitability rule.”
Here is his summation of FINRA's eight questions:
- What training has the firm deployed regarding the change in suitability rules?
- Does the firm offer training for associated persons to address investment strategies and hold recommendations?
- How are investment strategies (including hold recommendations) defined and supervised?
- What are the firm’s supervisory and compliance procedures for determining whether there was a reasonable basis for the investment recommendation?
- What tools does the firm deploy to uncover in-and-out trading, high turnover rates and commission-equity ratios?
- How does the firm go about determining if a client constitutes an institutional investor for the purposes of being capable to independently evaluate investment risks?
- What protocols does the firm use to ensure that it obtains an affirmative acknowledgement from an institutional client that it is exercising independent judgment?
- If the firm uses a portfolio analytic tool or model, how does it determine whether the tools or models make recommendations subject to the suitability rule or satisfy the safe harbor criteria in Rule 2111.03?
In 2012, suitability violations were the top fine-getter for FINRA, with fines totaling $19.4 million in suitability cases, up 152% from the $7.7 million in fines reported in 2011.
FINRA states that most of these deficiencies were addressed through a “Cautionary Action” that cited firms for inadequate supervisory procedures. However, FINRA said that it would also consider formal disciplinary action for more serious violations when appropriate, such as cases involving unsuitable recommendations.
FINRA notes that the few exam findings that have already resulted in referrals to the FINRA enforcement department involved suitability violations that were actionable under the predecessor suitability rule, Davis Polk says.
Check out ‘Big Switch’ RIAs Now Regulated by States Exhibit Similar Deficiencies on Exams: NASAA on ThinkAdvisor.