Suitability Requirements
Suitability is one of the most important obligations for securities professionals. Understanding FINRA Rule 2111 and Regulation Best Interest is essential for serving customers appropriately.
FINRA Rule 2111 (Suitability)
FINRA Rule 2111 requires that recommendations be suitable for customers based on their investment profile.
The Three Suitability Obligations
| Obligation | Description |
|---|---|
| Reasonable-Basis Suitability | Recommendation is suitable for at least some investors |
| Customer-Specific Suitability | Recommendation is suitable for this particular customer |
| Quantitative Suitability | Total number of transactions is not excessive |
Reasonable-Basis Suitability
Before recommending any security, the representative must:
- Understand the product's features and risks
- Perform reasonable diligence on the investment
- Determine it's suitable for at least some investors
Key Point: This obligation applies even before considering a specific customer.
Customer-Specific Suitability
The representative must have a reasonable basis to believe the recommendation is suitable for this specific customer based on their investment profile.
Customer Investment Profile
| Factor | Description |
|---|---|
| Age | Life stage and time horizon |
| Other Investments | Existing portfolio composition |
| Financial Situation | Income, net worth, liquidity |
| Tax Status | Tax bracket, tax-advantaged needs |
| Investment Objectives | Growth, income, preservation |
| Investment Experience | Sophistication level |
| Time Horizon | When funds will be needed |
| Liquidity Needs | Need for accessible funds |
| Risk Tolerance | Ability and willingness to take risk |
Quantitative Suitability
Even if each individual recommendation is suitable, the total volume of trading must not be excessive. This prevents churning.
Indicators of Excessive Trading:
- High turnover ratio
- Cost-to-equity ratio
- Frequent in-and-out trading
- Trading without apparent purpose
Regulation Best Interest (Reg BI)
Regulation Best Interest enhances suitability standards for broker-dealers when dealing with retail customers.
Reg BI's Four Obligations
| Obligation | Requirement |
|---|---|
| Disclosure | Provide Form CRS and disclose material facts |
| Care | Exercise reasonable diligence, care, and skill |
| Conflict of Interest | Establish policies to address conflicts |
| Compliance | Implement procedures to achieve compliance |
Care Obligation Details
Under Reg BI, the broker-dealer must:
- Understand the potential risks and rewards of the recommendation
- Have a reasonable basis to believe the recommendation is in the customer's best interest
- Have a reasonable basis to believe the recommendation doesn't place the broker's interest ahead of the customer's
- Consider reasonably available alternatives
Key Enhancement: Reg BI explicitly requires considering costs as a factor.
Form CRS (Customer Relationship Summary)
Form CRS is a disclosure document that must be provided to retail investors:
| Requirement | Details |
|---|---|
| Length | Maximum 2 pages |
| Content | Services, fees, conflicts, disciplinary history |
| Timing | Before or at time of recommendation |
| Format | Plain English, prescribed format |
Reg BI vs. Rule 2111
| Feature | Rule 2111 | Reg BI |
|---|---|---|
| Standard | Suitable | Best interest |
| Scope | All customers | Retail customers only |
| Costs | Not explicitly required | Must consider costs |
| Conflicts | Less explicit | Explicit conflict policies required |
| Disclosure | Various requirements | Form CRS required |
Key Point: Compliance with Reg BI satisfies Rule 2111, but not vice versa.
Know Your Customer (KYC)
KYC obligations require firms to gather customer information for suitability and regulatory purposes.
FINRA Rule 2090
FINRA Rule 2090 requires firms to:
- Use reasonable diligence to know essential facts about customers
- Understand the authority of persons acting on behalf of customers
- Verify customer identity (for AML purposes)
Essential Facts
| Category | Information Needed |
|---|---|
| Identity | Name, address, date of birth, SSN |
| Financial | Income, net worth, liquid assets |
| Investment Profile | Objectives, experience, risk tolerance |
| Employment | Employer, industry affiliation |
| Account Purpose | Investment goals, time horizon |
Documentation Requirements
Representatives must document:
- Customer investment profile
- Basis for recommendations
- Customer's acknowledgment of risks
- Any changes to customer information
Retention: Records typically must be kept for 6 years.
On the Exam
The Series 7 exam frequently tests:
- Three suitability obligations
- Customer investment profile factors
- Reg BI's four obligations
- Differences between suitability and best interest
- KYC requirements
Which suitability obligation requires that a recommendation be suitable for at least some investors?
Under Regulation Best Interest, which obligation requires broker-dealers to provide Form CRS to retail customers?
A registered representative makes 50 trades in a customer's account over one month, each individually suitable. However, the combined effect generates excessive commissions relative to the account size. This violates which suitability obligation?
Which of the following is NOT a factor in a customer's investment profile under FINRA Rule 2111?
Which statement about Regulation Best Interest and FINRA Rule 2111 is TRUE?
12.3 Communications with the Public
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