Suitability

Earlier this month, the Securities and Exchange Commission filed its first-ever civil lawsuit seeking to enforce Regulation Best Interest. The case, filed in a federal district court in California, seeks permanent injunctions, disgorgement with prejudgment interest and civil penalties against broker-dealer Western International Securities Inc. and five of its registered representatives. Regulation Best Interest, also known as “Reg BI,” became effective in mid-2020, requiring broker-dealers and their associated persons to act in the best interest of their retail clients when making recommendations.

Reg BI does not apply to registered investment advisers, but, at the time of its adoption in 2019, the SEC issued guidance in which it affirmed and substantially clarified its view of what investment advisers must do to comply with their fiduciary obligations to their clients. Among those obligations is to act in the client’s best interests at all times. Both broker-dealers and investment advisers are required to deliver Client Relationship Summaries to their clients and prospective clients at various times. This document, among other things, describes conflicts of interests the firm has relating to the services it provides or the fees it receives.

The Financial Industry Regulatory Authority (FINRA) released a Regulatory Notice in May clarifying its new suitability rule, Rule 2111. The rule, which was approved by the Securities and Exchange Commission (SEC) in November 2010, will be implemented on July 9, 2012. The Notice is intended to answer industry questions and provide guidance on the new rule.

According to FINRA, the new rule imposes the same obligations as the predecessor rule and related case law. It is intended to clarify and codify three main suitability obligations.

The first obligation is reasonable-basis suitability, which has two components: a broker must (1) perform reasonable diligence to understand the nature of the recommended security or investment strategy involving a security or securities, as well as the potential risks and rewards, and (2) determine whether the recommendation is suitable for at least some investors based on that understanding.

The second obligation is customer-specific suitability, in which the broker must have a reasonable basis to believe that a recommendation of a security or investment strategy is suitable for the particular customer based on the customer’s investment profile.
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Articles Tagged with Suitability

SEC Files First Regulation Best Interest Enforcement Case

FINRA Issues Regulatory Notice Clarifying New Suitability Rule