The Financial Industry Regulatory Authority’s suitability rule may be phased out now that the Securities and Exchange Commission’s Regulation Best Interest has been adopted, according to attorney Hank Sanchez.
In a just-released paper for the National Society of Compliance Professionals, Sanchez, managing director of Bates Group, examines whether FINRA Rules 2010 (Standards of Commercial Honor and Principles of Trade) and 2111 (Suitability) “may become subsumed or nullified by Reg BI.”
Sanchez, a former SEC and FINRA attorney, argues that regarding Rule 2111, “FINRA may be more likely to bring cases for suitability violations under Reg BI,” stating that Reg BI “may have made Rule 2111 a non-factor in suitability cases going forward.”
The paper examines the potential enforcement aspect of any new FINRA procedures in light of Reg BI. Sanchez points out that Reg BI “does not create a new private right of action nor right of rescission.”
As he notes, the SEC is working with FINRA “to not only update any FINRA rules that are affected by Reg BI, but also to assist FINRA with implementing procedural changes into both its examination and enforcement processes,” as FINRA is Reg BI’s enforcer.
Similar to the best-interest standard in Reg BI, Rule 2010 “is quite vague,” Sanchez writes. The rule says: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”
Rule 2010, and its predecessors, have “been used as a catch-all violation for many cases where no specific FINRA rule has been identified as being violated. It also has typically been included as an add-on rule violation where other specific rules do apply,” Sanchez explains.
Reg BI, he continues, “will be used by the SEC like Rule 2010 has been used by FINRA, as a catch-all provision. It does not have the scienter requirement of a Rule 10b-5 fraud allegation and may likely be that mere negligence will be enough for a finding of a violation of Reg BI.”
What does this mean? “That the volume of SEC cases can increase using Reg BI as a tool,” Sanchez states. “Thus, firms must get their processes in line with both the word and the spirit of Reg BI.”
As for Reg BI and Rule 2111, the rules “track each other fairly closely,” he said.
So, are FINRA Rules 2010 and 2111 dead?
“From an enforcement perspective, it may be ‘easier’ for both the SEC and FINRA to bring actions under the undefined best interest of the client standard. FINRA will be able to use Reg BI in conjunction with Rule 2010 whenever a separate specific rule does not cover the activity in question,” Sanchez states.
As to firms’ compliance with Reg BI, Sanchez cautions broker-dealers not to wait for June 30, 2020 — Reg BI’s compliance date — “to begin to think about how they are going to implement the changes needed to fulfill the requirements of Reg BI.”
Firms, he warns, “will need to review all aspects of their business and compliance programs and, if firms haven’t done so already, have in place a process for a top-to-bottom review of conflicts of interest.”
Sanchez states that firms should get to work on the following to-do list:
- Immediately address Reg BI in its procedures. Update procedures to comply with Reg BI.
- Update new account documentation, if necessary, to ensure the rule is met at the opening of the account, and, if “monitoring” accounts, on an interim basis after opening.
- Create a conflicts-of-interest matrix to identify the conflicts and risks associated with such conflicts and put a process in place to address the conflicts.
- Train registered representatives, supervisors and compliance staff on the changes.
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