The Financial Industry Regulatory Authority (FINRA)’s new Rule 2111 will help prevent broker misconduct resulting from a failure to adhere to the suitability standard by adding several factors to determining suitable recommendations. Previously, the only factors brokers were required to consider when offering investments to customers were investment objectives, tax status and financial status. Under the new rule, broker-dealers must take into account age, risk tolerance, time horizon, liquidity needs, other investments and experience, in addition to the factors previously outlined.
When questioned about the definition of the terms “risk tolerance,” “time horizon” and “liquidity needs,” FINRA provided the following guidelines:
- Risk Tolerance: “A customer’s ability and willingness to lose some or all of [the] original investment in exchange for greater potential returns.”
- Time Horizon: “The expected number of months, years, or decades [a customer plans to invest] to achieve a particular financial goal.”
- Liquidity Needs: “The extent to which a customer desires the ability or has financial obligations that dictate the need to quickly and easily convert to cash all or a portion of an investment or investments without experiencing significant loss in value from, for example, the lack of a ready market, or incurring significant cost or penalties.”
Though FINRA will not require firms to update all previously-existing account documents, the authority did make it clear that the state of their documentation would have an effect on future FINRA suitability investigations. Essentially, in the case of a FINRA investigation, the better the documentation, the better the firm’s position.
In the case of multiple accounts under one entity or individual, it is possible for different accounts to have different investment profiles. However, FINRA clarifies by stating that “a firm could not borrow profile factors from the different accounts to justify a recommendation that would not be appropriate for the account for which the recommendation was made.” Essentially, if an investor has two accounts, one with high risk and one with low risk, broker-dealers cannot use the high-risk profile to justify recommendations for the low-risk one.
The new Rule 2111’s implementation is scheduled for July 9, 2012.