FINRA Reverses Course and Issues Guidance Changing Its Interpretation Regarding the Key Issues of "Potential Investors" and Non-Security Recommendations

Background -

FINRA’s new suitability requirement, Rule 2011, went into effect July 9, 2012. Because the rule was such a departure from prior standards, FINRA issued Regulatory Notice 12-25 (May 2012) to explain the rule and to clarify its implications. In an unusual regulatory do-over, on December 10, 2012, less than six months after the effective date of the rule, FINRA issued Regulatory Notice 12-55 (December 2012) changing its interpretation regarding certain key issues.

“Potential Investors” (Also Known as Non-Customers) -

FINRA’s new suitability rule does not explicitly address the issue of suitability obligations to non-customers, which FINRA calls “potential investors.” In Question 6 to its Regulatory Notice 12-25, FINRA raised quite a few eyebrows when it noted that a broker-dealer’s suitability obligations may extend to “an individual or entity with whom a broker dealer has even an informal business relationship…(such as) when a broker recommends a security to a potential investor, even if that potential investor does not have an account at the firm.” (emphasis in original) This language led some to conclude that suitability obligations could apply even to informal recommendations made at a social gathering, such as a holiday party. In RN 12-55, FINRA withdrew Question 6 issued in May and instead substituted a new Question and Answer 6(b). This clarification appears to resolve the issue of when the suitability rule applies to informal investment advice provided by an associated person in a non-traditional setting. According to RN 12-55, “the suitability rule would not apply to the recommendation... if the potential investor does not act on the recommendation or executes the recommended transaction away from the broker-dealer with which the registered person is associated without the broker-dealer receiving compensation for the transaction.”

If the potential investor, in fact, establishes an account and acts on the recommendation (and thus becomes a “customer”), the suitability of the recommendation is evaluated based upon the circumstances that existed at the time the recommendation was made, and the suitability obligation is triggered after the account is opened and the transaction occurs.

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Topics:  Broker-Dealer, FINRA, Investment Adviser, Suitability Rule

Published In: Administrative Agency Updates, Finance & Banking Updates, Securities Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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