It has always been our position that a stockbroker owes his or her customer both a suitability obligation under FINRA rules and (at least in our home state of Ohio) the broad duties of a fiduciary under state law. Thus, we’ve consistently asserted in securities arbitrations that any investment-related recommendation must be in the customer’s best interests and that the broker must take into account a wide variety of customer-specific factors in determining whether any such recommendation — including one to hold or sell a security or to engage in a particular trading strategy — is suitable for that customer.
Stockbrokers have always contended that we and our like-minded colleagues around the country were wrong. Brokers have claimed that they owe no fiduciary duties except in the rare circumstance where they’ve been granted discretionary authority over an account. They further have argued that the suitability rule applies solely to a broker’s recommendation to buy an investment product, as opposed to a recommendation to sell or hold a security or pursue a particular investment strategy.
As we discussed in some detail back in our March 9, 2012 entry, the new FINRA suitability rule, goes into effect today. Regardless of which side was right or wrong (cough…we were right, they were wrong), Rule 2111 is pretty much an explicit adoption of what we thought was required all along. It is being widely reported that brokers are in near panic over their supposedly “new” responsibilities, even though the rule was approved way back in November 2011 and they’ve had twenty months to prepare for its implementation.
The new rule won’t prevent bad brokers from making unsuitable recommendations – nothing will accomplish that – but it will make it a lot easier to prove that an aggrieved customer is entitled to compensation.
Among other things, the rule requires a broker to perform reasonable due diligence with respect to investment products he or she sells, to understand those investments, and to have a reasonable basis to believe that a security or investment strategy is suitable for the customer to whom it is recommended. The new rule also adds to the list of stated factors that affect a suitability determination. It expressly requires the broker to consider the investor’s age, investment experience, time horizon, liquidity needs, and risk tolerance. These factors had always been interpreted by FINRA to be part of the rule, but now have been made explicit.
Perhaps the most interesting part of the new rule is the imposition of suitability obligations on investment strategies. In its rule filing, FINRA said the term “investment strategy” would be interpreted broadly and cover a recommendation to hold an investment as well as a “buy” or “sell” recommendation.
Brokers also are nervous about Regulatory Notice 12-25, written guidance issued by FINRA in May 2012. The Notice laid out a “best interests” standard of care for customers, which standard isn’t stated anywhere in the rule. Brokers complain that it sounds suspiciously like FINRA will be imposing a fiduciary standard. FINRA’s response has been that this is nothing new and that brokers have always been required to protect the best interests of the customer.
Finally, the May 2012 guidance notice also said that the new suitability rule would apply to “potential” customers and to “investment-related” products that were not securities – presumably things like controversial so-called fixed index annuities which the annuity industry has touted as being pure insurance and not subject to regulation as securities.
We admit we’d be happier if FINRA had simply announced that henceforth, a straightforward fiduciary standard would apply to brokerage firms. But all in all, the rollout of this new rule can only be seen as good news for investors.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.