In connection with its continuing process of reconciling regulations as part of the FINRA consolidated rulebook, FINRA had proposed changes to FINRA Rule 2090, the know your customer rule, and Rule 2111, the suitability rule. In late August 2010, the final proposed rules were published for comment and the comment period closed last month.

The final proposed rules would implement a number of changes. Suitability determinations would apply to recommended investment strategies, not only to recommendations relating to specific securities. There are three elements or components of suitability identified by the rule: reasonable basis suitability, customer specific suitability and quantitative suitability. In considering quantitative suitability, the broker-dealer should make a determination that a series of transactions, when viewed together, would be considered suitable for the client.  

The list of items included as part of a retail investor’s profile would be expanded as part of the amended rule. These items will include age, other investments, financial situation and needs, tax status, investment objectives, investment experience and time horizon, liquidity needs and risk tolerance. The current rule lists a much smaller number of items.

The rule clarifies the means by which the customer suitability obligation may be discharged in respect of recommendations made to institutional accounts. This duty would be discharged if the broker-dealer has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently (both in general and with respect to particular transactions and investment strategies) and the customer affirmatively indicates that it is exercising independent judgment in evaluating the recommendation. An “institutional account” would include an institutional investor with $50 million in assets under management.  

We anticipate that the proposed rule will be adopted promptly. However, we also anticipate that suitability and related concepts will be revisited following the completion of the SEC’s study on standards of care, which was mandated by the Dodd-Frank Act.