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Holiday Cheer From FINRA

Last Monday, FINRA issued its new Regulatory Notice 12-55, “Suitability – Guidance on FINRA’s Suitability Rule.” This guidance backpedaled on a couple of significant matters provided in its previous guidance with respect to its definition of a “customer” under the new suitability rule.

In May, two months prior to the July 9, 2012, effective date for the new rule, FINRA issued Regulatory Notice 12-25 (“RN 12-25”), which defined the term “customer” to “include an individual or entity with whom a broker-dealer has an informal business relationship related to brokerage services, as long as that individual or entity is not a broker or dealer.” In an attempt to explain what an “informal business relationship” might mean, RN 12-25 stated that, “A broker-customer relationship would arise and the suitability rule would apply, for example, when a broker recommends a security to a potential investor, even if that potential investor does not have an account at the firm.”

The guidance issued last Monday withdraws the rather expansive “even if” clause above and now states that, “the term customer includes a person … who opens a brokerage account at a broker-dealer or purchases a security for which the broker-dealer receives or will receive, directly or indirectly, compensation even though the security is held at an issuer, the issuer’s affiliate or a custodial agent (e.g., ‘direct application’ business, ‘investment program’ securities, or private placements), or using another similar arrangement.” Therefore, the suitability rule does not apply to a potential investor unless that person becomes a customer of the firm or the representative who made the recommendation by opening an account and placing the trade, which essentially puts FINRA’s guidance back to the way it was always previously understood.

 

The second significant revision relates to the application of the suitability rule to non-securities products. In the guidance from May, FINRA applied the suitability rule widely to cover even non-securities product recommendations (e.g., fixed annuities or universal life insurance).  The new guidance draws some clarifying distinctions, but makes clear that the suitability rule applies only to the securities component of the recommendation or investment strategy.   However, as for a potentially “unsuitable” recommendation of a non-securities product, FINRA rules still pick up this misconduct under Rule 2120 (Standards of Commercial Honor and Principles of Trade), Rule 3270 (Outside Business Activities), and Rule 2210 (Communications with the Public).  For further information on this point, see endnote No. 18 in the new release, which is available by clicking here.

Given the new guidance, you’ll want to be sure that whatever new suitability policies and procedures you adopted under the new rule that went into effect on July 9, 2012, are revised accordingly to ensure you don’t inadvertently and unnecessarily subject your firm to the expansive requirements and related recordkeeping of the older guidance.