FINRA’s New Suitability Rule Edges Closer to ‘Fiduciary’: NAPFA Chairman

First, BDs would have to "undertake significant due diligence on the academic underpinnings (through academic research or back-testing) of various investment strategies, especially as to risks present."

Second, BDs would have to ensure this information is communicated to customers. Until now, Rhoades says, "suitability related primarily to gathering information about the client, from the clients, and did not require communication of that information back to clients. It also required due diligence at the product level."

Continues Rhoades: "Once you get into portfolio investment strategy that will evolve into communication of any adopted strategy back to the client, as a best practice—including the risks present in that strategy."

Moreover, Rhoades says, "the imposition and maintenance of a strategic or tactical asset allocation plan by a registered rep for a client may well result in a fiduciary relationship being formed."

In this respect, fiduciary status may be imposed under state common law—i.e., case law. Why? "Because the design and maintenance of an overall portfolio investment strategy for a client feels like much more than an 'arms-length' product sales relationship, and more like a relationship in which ongoing advice (of a comprehensive nature) is provided," Rhoades explains.

As a result, if FINRA interprets the investment strategy language broadly, "registered reps cannot just rely on the fact that the account statements say: 'This is a brokerage account, not an advisory account,'" Rhoades says, because "fiduciary status under state common law results from representations made and actions taken, evaluated on a case-by-case basis, and is generally not determined by the agreement of the parties."

Rhoades says that he suspects dual registrants "may find that it is just easier to avoid all of the ambiguity created where they are providing ongoing advice to a client, and just establish investment advisory accounts." Also, he says, "I suspect that greater use of written investment policy statements will occur, with disclosures of historical portfolio-level volatility contained within these statements."