Since FINRA implemented FINRA Rule 2111 (aptly named, the “Suitability Rule”) in July 2012, broker-dealers have been scrambling to update their internal systems and educate their brokers to prepare for the rigors of the rule change. Indeed, the Suitability Rule creates a totally ambiguous (and borderline impossible) standard that brokers are expected to meet before he or she makes an investment recommendation to a client. In sum, the rule requires a broker to have a “reasonable basis” for recommending a particular investment or investment strategy to a client.
While the jury is still out as to what “reasonable basis” means, below is a list of 5 “best practices” that, if implemented, will help protect a broker from potential liability in the face of FINRA Rule 2111.
1) Brokers should know their clients’ investment objective and work with their clients to keep it up to date.
Even though this tip is explained in detail in the rule itself, it is nevertheless important to reiterate it again here. Understanding a clients’ investment objective goes beyond simply knowing the box that the client checked on his or her new account documents. Indeed, a thorough understanding of “objective” runs deeper than that. What are the client’s goals? How old is the client? Has the client’s financial situation changed since they selected their investment objective? What is the client’s tax status?
Too often, clients select their investment objectives the day they open their accounts. But despite routine changes in the client’s financial situation, their investment objective is never changed. This is particularly relevant when the client retires during the course of the broker-client relationship. This can lead to a client maintaining an aggressive investment objective when their age, tax status, and overall financial situation suggests a more conservative approach.
Accordingly, brokers should require their clients to update their investment objectives every year. That way, if a dispute arises, the client’s information with respect to investment objective is current.
2) Disclosure, disclosure, disclosure!
When a broker advises a client on a particular investment or investment strategy, he or she must disclose all relevant risks. It is not enough to rely on the disclosures made in the relevant prospectus or marketing material provided by the broker-dealer. Brokers should make their own verbal and written disclosures as well. Brokers should confirm, however, that their verbal and written disclosures mirror the disclosures made in any applicable prospectus and/or marketing material. Once the broker makes these disclosures, he or she should then document the fact that the disclosures were made.
3) Document, document, document!
Brokers should document every time he or she speaks to a client. The more detail, the better. Many broker-dealers make available (and some require) note-taking systems. Sadly, not enough brokers use these features until it is too late. It is particularly important to document conversations that lead up to, or include, strategy recommendations. In addition to adding notes about what happened during these conversations, brokers should also include their impression of the client’s understanding of the strategy recommended as well as any objections or comments the client made about the strategy.
For more information about this topic or related topics, please Email Attorney Patrick Mahoney.
**This article is intended for informational purposes only and does not constitute legal or investment advice. Any views expressed are those of the author only.**