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Regulation and Compliance > Federal Regulation > FINRA

Broker Suitability Rule Takes Effect

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A new FINRA rule on suitability of recommendations by brokerages and brokers to customers—and to prospective customers—took effect on July 9, and with it come a number of issues of which firms and advisors alike need to be aware.

Brian Rubin, partner at the law firm Sutherland, said in an interview that one issue is that of the “potential” investor. “In the past when we’ve dealt with suitability,” said Rubin, “it has always been addressing actual customers or clients.” This time, however, guidance that he said many characterize as “bizarre” was issued in May that “talks about potential investors, even if that person doesn’t have an account at the firm.”

Firms that are already concerned about the recommendations made to clients based on their existing portfolios now have this new wrinkle: the prospective customer. While it’s usual for a firm to try to win customers by looking at existing holdings and suggesting possible additional investments and strategies, now that will have to be done in a way more like the way existing customers are treated—which will likely mean considerably more attention to how prospects are approached.

And that doesn’t even touch on those casual conversations that take place over drinks at the club or at parties and other social events. Said Rubin, “I think firms are going to need to address that issue and train reps on the issue, and reps are going to have to be careful when they’re at cocktail parties or swim clubs talking to people about what they do.”

There are two other aspects of the rule, said Rubin, “that are significantly different from the way the suitability and know-your-customer rules have been previously interpreted and applied.” The first of those is “recent guidance that says that brokers’ recommendations have to be in the customer’s ‘best interests.’”

In the past, Rubin explained, the phrase “best interests” denoted the fiduciary standard, “which doesn’t apply to the normal customer/registered rep experience.” It’s unclear, he added, why FINRA used this wording, although he theorized that “it may be that they’re trying to back-door a fiduciary standard.”

The second aspect that differs from previous history is the use in the regulatory notice of the wording “risk-based approach.” While Rubin said that this applies more to firms than to reps, in one instance the notice mentioned a risk-based approach in documenting compliance with supervisory staff, and in another the phrase was used regarding the supervising of recommendations and investment strategies.

“In the past, FINRA has not used that [wording],” said Rubin. “Reasonableness has applied. So I think firms are going to have to adjust and figure out what risk-based means.”

Last but not least is the application of the standard to hold recommendations. This, said Rubin, “is a very controversial issue, because normally when people talk about recommendations [in the context of suitability], they are to buy or sell, not to hold; so firms are dealing with that issue as well.”

Given the obvious room for interpretation in the absence of more specific guidance on some of these new approaches to suitability, while Rubin said that he didn’t think FINRA would “use a ‘gotcha’ standard and bring enforcement cases within the first year if firms don’t get it exactly right,” he added, “I think firms have to read through the rules and regulatory notices and come up with a reasonable interpretation of what FINRA is doing.”

If they do that, he said, “it may not be exactly what FINRA is looking for, but I think if FINRA thinks the firms have been working on it, I don’t think we’ll see enforcement on these issues in the first year.”

On the other hand, he concluded, “if firms just ignore, for example, the ‘potential’ investor or the hold recommendation entirely, they will likely be facing enforcement actions.”


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