This post is the second in our three-part series on the three separate and distinct suitability obligations outlined in FINRA Rule 2111 (Suitability). As with our previous post, “FINRA Rule 2111: Reasonable-Basis Suitability”, we will begin with a brief overview of the three main suitability obligations imposed on broker-dealers and their registered representatives; then, this particular blog will focus in on Customer-Specific Suitability.
Suitability Obligations Overview
FINRA Rule 2111 imposes three main suitability obligations on broker-dealers and their registered representatives:
- Reasonable-Basis Suitability (a reasonable basis to believe, based on reasonable due diligence, that a recommendation is suitable for at least some investors)
- Customer-Specific Suitability (a reasonable basis to believe that a recommendation is suitable for the specific customer based on the customer’s investment profile)
- Quantitative Suitability (a reasonable basis to believe, when possessing actual or de facto control over a customer account, that a series of recommended transactions are not excessive or unsuitable for the customer when taken together in light of the customer’s investment profile)
Customer-Specific Suitability
The customer-specific suitability obligation requires that a broker-dealer or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer’s investment profile. FINRA Rule 2111 requires a broker-dealer or associated persons to attempt to obtain and analyze a broad array of customer-specific factors. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the broker-dealer or registered representative in connection with such recommendation.
This suitability determination should precede any recommendation of a security or investment strategy to a customer. To achieve compliance with the customer-specific suitability requirement, a firm’s policies and procedures should require the registered representative to verify that each recommended security is suitable for the specific customer to whom it is recommended. The registered representative should make a reasonable effort to determine, among other things, the following:
- Whether the customer has a net worth, including liquid net worth, sufficient to sustain the risks involved, including the total loss of investment proceeds;
- Whether the customer is in a financial position appropriate to enable him to realize, to a significant extent, the benefits described in the prospectus, memorandum, term sheet, and/or other such offering documents;
- Whether the customer meets any applicable suitability requirements, such as those found in the firm’s procedures or transaction guidelines;
- Whether the customer has sufficient investment knowledge and sophistication to properly understand and appreciate the features, terms, conditions, risks, and potential rewards of the recommended security.
For more on the three main suitability obligations FINRA Rule 2111 imposes on broker-dealers and their associated persons, please see the other blogs in this series, “FINRA Rule 2111: Reasonable-Basis Suitability” and “FINRA Rule 2111: Quantitative Suitability”.
Furthermore, please consult our other posts on FINRA Rule 2111 for additional information on the topic.