On May 18, 2012, the Financial Industry Regulatory Authority (FINRA) announced
further guidance on its new rules concerning Know Your Customer and Suitability
of Investment Recommendations. FINRA Rules 2111 and 2090 are modeled after
former NASD Rule 2310 (Suitability) and former NYSE Rule 405(1) (Know
Your Customer). These new rules retain the core features of the previous
rules while codifying a number of important interpretations of the rules
and imposes new obligations on broker-dealers. These new rules become
effective on July 9, 2012. Investors who have suffered investment losses
in their securities accounts maintained at FINRA member broker-dealers
should consult with an attorney experienced in broker-dealer securities
law to determine their rights under the new FINRA rules. Pearson, Simon
& Warshaw attorneys have extensive experience in FINRA arbitrations
brought on behalf of investors.
New FINRA Rule 2111 clarifies and expands a broker-dealer's obligation
when making recommendations on the purchase or sale of securities. A significant
change from the former rule is that Rule 2111 now explicitly covers any
recommendation to "hold" a securities position. Other significant
changes or clarifications include:
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Reasonable-Basis Suitability -- Broker must perform reasonable diligence to understand the nature of
the recommended security or investment strategy, as well as the potential
risks and rewards of the particular security or strategy. Based upon such
analysis the broker must determine if the recommended investment is at
least suitable for some investors.
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Customer-Specific Suitability - Broker must have a reasonable basis to believe that a security or investment
strategy recommendation is suitable for the particular customer based
upon that customer's investment profile.
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Quantitative Suitability - Broker who controls a customer's account must have a reasonable
basis to believe that a series of recommended securities transactions
are not excessive.
A further significant change in the suitability rule is an expanded explicit
list of customer-specific factors that firms must obtain and consider
in determining a customer's investment profile. The new rule adds
age, investment experience, time horizon, liquidity needs and risk tolerance
to list of specific factors that must be considered before making investment
recommendations.
As with the securities laws in general and the suitability obligations
of brokers specifically, understanding your rights as a customer is a
legal and fact intensive inquiry. For example, the Reasonable-Basis Suitability
analysis brokers are required to make under Rule 2111 requires that the
broker understand the recommended investment strategy. With increasingly
complex investment products offered by Wall Street firms such as derivative
hedging strategies or 2X inversed EFTs many brokers have limited understanding
of the securities and investment strategies they recommend. The recent
hedging loss sustained by J.P. Morgan Chase, the largest U.S. bank, shows
the degree to which even the most sophisticated investors fail to understand
the true risks a specific strategy entails.
Investors who wish to discuss their individual situation can contact Pearson,
Simon & Warshaw's at
info@pswplaw.com or at (818) 788-8300. For additional information about the new FINRA Rule
2111, see
FINRA Regulatory Notice 12-25, "Suitability." For a copy of that notice click
here.