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Regulation and Compliance > Federal Regulation > FINRA

FINRA Rule 2111: The Broker-Dealer View

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When FINRA Rule 2111 goes into effect July 9, broker-dealers will be on the front lines of complying with new regulations stipulating how suitability reviews are completed on securities purchases (which include variable annuities). More information must be sought from clients and in a new wrinkle, broker-dealers are required to document the suitability of their investment strategy recommendations. Like any new rule, a difficult transition period is expected as advisors switch over to the new compliance measures. spoke to Paul Tolley, right, chief compliance officer at Commonwealth Financial Network in Waltham, Mass., about the run-up to the new FINRA regulation.

Preparations began about a year ago at the independent broker-dealer, said Tolley. New electronic forms were generated to include the additional suitability information broker-dealers must collect from their clients and a series of educational programs were held with the company’s advisors.

Most of the client data FINRA will now mandateage, investment experience, risk tolerance, time horizon and liquidity needswas already included in Commonwealth’s fact-finding forms, Tolley said. The only one missing was liquidity. For that, Commonwealth followed the FINRA template.

Yet despite all those preparations, Tolley said he expects some sales may decelerate as advisors adjust to the new rule and scramble to get the additional data from existing clients. Although the new regulation is not retroactive to already closed securities deals, broker-dealers and their advisors will have to backtrack and get the newly required information from in-place clients if they want future transactions to be approved, Tolley said.

“Firms have legacy accounts that have been on the books for years and if we don’t capture all that additional information it’s certainly going to cause advisors to have to go out en masse to their clients to get updated suitability information so they don’t get new transactions held up,” he said. “That’s likely to delay some executions of transactions because broker-dealers won’t have the information necessary to perform the suitability reviews.”

What constitutes an investment strategy is another potential challenge. FINRA has stated the term should be defined broadly, and has also published several notices more clearly defining what an investment strategy could be. Among those are purchases on the margin and day trading, Tolley revealed. However, there may be other investment strategies not outlined by FINRA that could fall under that requirement.

“It’s deemed to be used generically,” Tolley said. Therefore, Commonwealth has instructed its advisors to document all client interactions and transactions to prove they had done the suitability analysis on whatever strategy they may recommend.

“We have to make certain that if and when a particular transaction is called into question by a regulator, we must have these additional suitability components,” Tolley said.

Non-securities transactions?

Although the new rule excludes non-securities (something that was discussed but later rejected when the new regulation was being formulated), Tolley said there could be times when an advisor may be held responsible if, for example, securities are liquidated and used to purchase a non-security. “The broker dealer could be held accountable for still performing suitability reviews on the suitability of the entire transaction, not just the liquidation [of securities] but on the purchase [of a non-security] as well,” he said.

With the law less than a week away, Tolley predicted advisors will frantically scurry to get updated information from their clients as the new law takes effect. “That’s going to take some time and it’s going to be disruptive,” he said. “For most firms, that information is simply not there right now because it’s not required.”

Performing and documenting suitability reviews is nothing new for the industry, Tolley said. “But some of the components are,” he noted. “It’s probably going to be a rush in the beginning to get as much of this information on the record. But once it’s there it won’t be as disruptive on a going-forward basis. But initially it’s going to require some work.”

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