Securities Suitability: What brokers need to know to stay out of trouble
Suitability remains an issue of concern for financial services regulators. Even though regulatory bodies have promulgated tighter regimens for assuring suitable sales, especially to seniors, evidence persists that financial advisors often recommend unsuitable products and/or fail to document the discussions they have with clients about risk and appropriate product solutions.
Consequently, the National Ethics Association and its errors-and-omissions affiliate, EOforLess.com, encourage all financial advisors to get back to basics when it comes to making suitable product recommendations.
Last month, we shared basic guidance on the topic as well as information for insurance-licensed advisors. In this article, we’d like to zero in on the suitability concepts securities brokers must understand to avoid legal and errors-and-omissions insurance problems in the future.
However, let’s pull the camera back for a minute. It’s important to state that suitability has been an issue in the securities industry for decades, with about a third of all FINRA arbitration claims arising from unsuitability claims. However, marketing conditions and case law have evolved, spurring FINRA to update NASD Rule 2310 with FINRA Rule 2111. Released in 2012, the latter rule features broader definitions and a stronger focus on product recommendations than the prior rule did. It also developed a new three-part test that brokers must follow in order to prove their sales are suitable.
The first key difference between the new and old suitability rules was the notion of “investment strategies.” According to Robins Kaplan LLP, a securities law firm with offices in Boston, New York, and five other U.S. cities, NASD Rule 2310 concerned itself with the suitable “purchase, sale, or exchange of any security.” Rule 2111 now applies suitability to any “recommended transaction or investment strategy involving a security.” The law firm explains the broader focus this way: “...imagine a broker recommends that a client sells property in order to invest the profits in a retirement account. In this scenario, the entire recommendation, even though it includes non-security property, is considered part of the overall strategy when looking at a potential suitability problem.”
The firm also points out that broadening the suitability focus to include investment recommendations and not just securities products also means brokers must maintain suitability when they suggest holding a security regardless of whether they sold the security initially to the client.
Next page: the 3 types of suitability
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