In May 2009, the Financial Industry Regulatory Authority (FINRA) issued guidance in Regulatory Notice 09-25 to broker-dealers concerning the proposed integration of the NASD and NYSE rules concerning suitability and know-your-customer into FINRA's consolidated Rulebook. FINRA requested comment from the industry regarding the proposed rules by June 29, 2009. FINRA is in the process of considering the comments. This alert summarizes the key concerns raised by the industry in their comments.
Proposed FINRA Rule 2111 (Suitability) - FINRA's proposed Rule 2111 will eliminate NASD Rule 2310 and is, according to FINRA, intended to codify SEC and FINRA decisions and other interpretations. These decisions and interpretations include the SEC/FINRA's determination that the suitability rule covers both recommended securities and strategies, as well as ensures that the new rule covers the three main suitability obligations (reasonable basis, customer specific and quantitative) currently located in several customer interpretative materials. The industry largely focused on the following key concerns:
- Definition of "Investment Strategy" - The industry is concerned that applying proposed Rule 2111 to "investment strategies" creates the risk of inconsistent application of the rule to member firms. Notably, proposed Rule 2111 does not define the word "strategy." The lack of a definition poses problems for member firms and FINRA examiners alike.
- A New Legal Standard For Institutional Customer Exemption - One suggested modification to the rule changes the way the exemption has operated since inception by requiring an affirmative representation that the customer is "willing to forego the protection of the customer-specific obligation of the suitability rule." The industry expressed concern that institutional investors lack the statutory and contractual authority to waive liability of the member firm.
- Requirements Related to Information Gathering - The proposed Rule 2111 requires member firms to take into consideration information "known by the member [firm] or associated person." The term "known" is extremely vague and the industry comments suggested striking the language.
Proposed FINRA Rule 2090 (Know Your Customer) - FINRA states that proposed Rule 2090 is designed to capture the due diligence standards of NYSE Rule 405(1) in relation to the opening and maintenance of customer accounts to ensure essential information is known regarding every customer including the "financial profile" and "investment objectives or policy." Concerns regarding this proposed rule include the following:
- "Financial profile" is not defined.
- Collection of this information may not be necessary for all clients (e.g., a client who intends to direct all of his or her own trading).
- The proposed rule does not discuss FINRA's expectations of the use of these materials if collected.
Additional Comments/Concerns - An overarching concern of the industry relates to the current effort by Congress and regulatory/self-regulatory organizations to create consistent standards of conduct applicable to securities professionals working in a broker-dealer or investment adviser capacity. Adoption of such standards would likely impact both the suitability and know-your-customer rules. Accordingly, industry representatives suggested that FINRA hold off on integrating the NASD and NYSE rules on suitability and know-your-customer until the fate of a comprehensive fiduciary standard is known.
Additionally, FINRA requested comment on whether suitability obligations should extend to all investments, whether or not they involve securities. The industry expressed serious concern about FINRA's interest in expanding its jurisdiction beyond securities-related products, noting that regulators already exist in non-securities fields (e.g., insurance). Accordingly, multiple regulators covering the same products would over-burden the industry and be unnecessarily duplicative and expensive.