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Regulation and Compliance > Federal Regulation > FINRA

FINRA Sticks With Securities in Suitability Proposal

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The Financial Industry Regulatory Authority (FINRA) is leaving “non-securities” products out of a proposed suitability rule update.

The U.S. Securities and Exchange Commission has published a notice of the filing of the proposed FINRA Rule 2111 rule change today in the Federal Register.

The SEC can take as little as 45 days or as long as 90 days to decide whether to approve the rule or hold further proceedings on the rule.

Comments are due Sept. 9.

FINRA, Washington, was formed by the merger of the National Association of Securities Dealers and the enforcement arm of the New York Stock Exchange (NYSE) in 2007.

Because the SEC classifies variable insurance products and variable annuities as securities, FINRA has jurisdiction over the individuals and organizations that sell those products.

The regulatory organization has been getting SEC approval to update and combine the organizations’ rules section by section.

FINRA now is seeking approval for FINRA Rule 2111 and for FINRA Rule 2090, the Know Your Customer rule.

The proposed Know Your Customer rule is based on NYSE 405(1), and it creates an obligation for the broker-dealers regulated by FINRA to use “due diligence” when they open and maintain customer accounts, and to “know the essential facts concerning every customer,” FINRA officials say in the description of the proposed rule published in the Federal Register.

The proposed rule would eliminate NYSE Rule 405(1) requirements for broker-dealers to learn the essential facts relative to every order, officials say.

The proposed suitability rule, FINRA Rule 2111, would require a broker-dealer 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,” officials say. “This assessment must be ‘based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile, including, but not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.”

Some commenters in the insurance industry told FINRA that the Know Your Customer language requiring them to exercise due diligence when maintaining customers’ accounts is vague and could be difficult to implement in the retirement plan market.

The commenters asked FINRA to do more to explain what it means by “maintenance.”

“FINRA believes that it is self-evident that a broker-dealer must know its customers not only at account opening but also throughout the life of its relationship with customers in order to, among other things, effectively service and supervise the customer accounts,” FINRA officials say.

When FINRA sought comments on the suitability rule, many suggested that it ought to impose a fiduciary standard on broker-dealers, even though FINRA

did not bring up the topic of a fiduciary standard.

A fiduciary standard would require broker-dealers to avoid conflicts of interest, work to put their clients’ interests ahead of their own, and disclose any potential conflicts of interest that might exist.

Verifying suitability of investments sold to customers is part of a fiduciary standard and is consistent with a fiduciary standard, FINRA officials say.

FINRA asked whether it ought to apply the suitability rule to members’ sales of non-securities products, such as insurance.

Many insurer groups, producer groups and regulators wrote to say that it should not.

“This issue generated the greatest number of comments, most of which were against extending the rule’s reach,” FINRA officials report.

“One commenter stated that the expansion was needed because broker-dealers market more than just securities and oftentimes customers do not understand that they may be afforded less protection when purchasing non-securities products,” officials say. “Another commenter stated that it would be unreasonable for a firm to allow a non-securities recommendation that was inconsistent with a customer’s suitability profile.”

The vast majority of commenters said FINRA does not have jurisdiction over non-securities products. Some said FINRA has no expertise in regulating non-securities products, and some point out that other regulatory agencies and self-regulatory groups already regulate products such as insurance.

“FINRA does not agree with the commenters’ reasoning against extending the scope of the suitability rule,” FINRA officials say. “FINRA acknowledges, however, that future developments in regulatory restructuring could impact any such proposal. FINRA emphasizes, moreover, that the proposed new suitability rule (including the explicit coverage of recommended strategies and expanded list of the types of information that members must seek to gather and analyze) and the proposed ‘Know Your Customer’ rule together provide enhanced protection to investors. Consequently, FINRA will not include explicit references to nonsecurities products in the rule at this time.”


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