FINRA Rule 2111: Getting to Know Your Client

Suitability is one of the most important concepts for an investment professional to understand.  Before an investment professional can make recommendations or decisions on behalf of an investor, he must understand what investments are suitable for the investor’s account.  The purpose of FINRA establishing the suitability standard, FINRA Rule 2111, is so that brokers deal fairly with their customers.  FINRA Rule 2111 states that firms and their associated persons “must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.”

How is a “reasonable basis” determined? A reasonable basis is based on the information that the investment professional collects from the client prior to making any investments.  Collectively, this information is considered the investor’s profile.  The information collected to build an investor’s profile are the customer’s:

  • Age;
  • Other investments;
  • Financial situation and needs, such as annual income and liquid net worth;
  • Tax status;
  • Investment objectives;
  • Investment experience;
  • Investment time horizon;
  • Liquidity needs; and
  • Risk tolerance

The collection of the information mentioned above, will allow the broker to get to know his customer and gain a better understanding of what investment decisions he should make on behalf of the client.  It is important to understand that brokers are required to ask for the information but customers are not required to provide the information.  Therefore, in the case of missing information, the broker may have to narrow his range of recommendations.

Recently, on August 1, 2016, FINRA filed a complaint against broker Hank Mark Werner of Northport, New York.  Mr. Werner is charged with securities fraud for churning the account of his customer and excessive and unsuitable trading. It is alleged that Mr. Werner began aggressively trading his client’s accounts, a blind widow, to generate excessive commissions a few weeks after her husband passed.  Werner also maintained control of her accounts and recommended every trade.  She trusted him so she followed every recommendation.  FINRA alleges that in light of the customer’s investment objective, risk tolerance, and financial situation, Werner did not have a reasonable basis to believe his recommendations were suitable.

FINRA just filed the complaint against Werner so we do not know the final decision of the case.  However, this case is a good reminder of the importance that FINRA places on suitability.  Investment professionals should take the necessary steps to get to know their client.   The more a broker knows about their client, the better position he will be in to make recommendations to the client.

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