FINRA has recently released Regulatory Notice 12-55, which provides additional suitability guidance related to FINRA Rule 2111 that partially supersedes the guidance given in Regulatory Notice 12-25. In particular, the Notice addresses the scope of the terms “customer” and “investment strategy.”
FINRA has also created a suitability webpage, which consolidates selective information and resources regarding FINRA’s suitability requirements.
Customers and Potential Investors
The Notice clarifies that, in general, a “customer” for purposes of FINRA’s suitability rule is a person who is not a broker or dealer who either opens a brokerage account at a broker-dealer or purchases a security for which the broker-dealer receives or will receive, directly or indirectly, compensation even though the security is not held by the broker-dealer.
The Notice highlights that suitability obligations apply when a broker-dealer makes a recommendation to a potential investor, but only if the potential investor executes the transaction through the broker-dealer or if the broker-dealer receives compensation. The suitability obligations attach when the transaction occurs, but the suitability of the recommendation is evaluated based on the circumstances that existed at the time the recommendation was made. In contrast, when a broker-dealer makes a recommendation to a customer (as opposed to a potential investor), suitability obligations attach at the time the recommendation is made, irrespective of whether a transaction occurs.
The Notice emphasizes that the term “investment strategy” is to be interpreted broadly, and the rule’s focus is on whether the recommendation was suitable when it was made. A recommendation to invest generally in equity or fixed income securities would not usually be an investment strategy. However, the investment strategy language would apply to recommendations to invest in more specific types of securities or in a market sector, regardless of whether the recommendations identify particular securities. The term would also capture an explicit recommendation to hold a security or to continue to use an investment strategy involving a security.
The Notice states that the suitability rule covers a broker-dealer’s recommendation of an investment strategy involving both security and non-security components. While the Notice states that the suitability rule is not applicable where the recommendation does not refer to a security or securities, other FINRA rules, such as rules concerning communications with the public, standards of commercial honor and principles of trade and outside business activities, may still apply.