Suitability And The “Recidivist Broker”

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On January 2, 2014, the Financial Industry Regulatory Authority (“FINRA”) published its annual regulatory and examination priorities letter for 2014.  In the publication, FINRA addressed a number of matters, including suitability of recommendations, addressing issues involving the solicitation, advertising, due diligence and suitability of private placements, and focusing its attention on “recidivist brokers.”

FINRA has always addressed the issue of suitability.  Specifically, FINRA Rule 2111 explains the requirements, which are further explained in Regulatory Notice 13-31 (dated September 2013).  In the recent publication, FINRA explained that “it remains concerned about the suitability of recommendations to retail investors for complex products.”  Firms are “urged” to review FINRA notices and guidance for practices that may “enhance the effectiveness of their suitability determinations.”  In addition, FINRA examinations will include a review of the training that firms give to brokers to determine whether they understand the products they recommend.  If firms have not done so already, this would be an opportune time to review their policy and procedures regarding suitability, due diligence and disclosure requirements, and re-examine their procedures for training brokers.

Private placements have also been an ongoing concern for FINRA for a number of reasons, including the high commissions that brokers and firms receive in some cases.  Private placements usually fall under Regulation D, which is an exemption to the rule that securities must be registered with the SEC pursuant to the Securities Act of 1933.  If an exemption applies, the private placement can only be sold to certain qualified investors, who meet certain requirements including, but not limited to, being an accredited investor.  FINRA examinations will continue to focus on whether firms are taking “reasonable steps to validate that investors meet accredited investor standards.”  To pass the test, firms and brokers will need to conduct sufficient due diligence on the potential investor, and compile evidence supporting the investors accreditation.  “He told me he was accredited” is not a defense that one wants to rely on in a later investor suit claiming unsuitable investments.

Finally, FINRA will be focusing its attention this year on “recidivist brokers.”  FINRA explained that some “brokers have a pattern of complaints or disclosures for sales practice abuses and could harm investors as well as the reputation of the securities industry and financial markets.”  To address the concern, FINRA will create a dedicated enforcement team to prosecute such cases.  FINRA will be examining brokers, “brokers who move from a firm that has been expelled, or otherwise has a serious disciplinary history to another FINRA-regulated firm, and the firms that hire such individuals.”  During the examination, FINRA will focus on the brokers’ clients’ accounts.  Again, this is a good time for firms to review their policies and procedures to make sure that they adequately address the hiring process and due diligence conducted on their brokers.  In addition, firms should determine if any brokers need to be placed on heightened supervision, and for those that are already on heightened supervision, that those brokers are being adequately supervised.

While this is a good time for firms and brokers to review the policy and procedures, it is by no means the only time to do so.  The policy and procedures should be reviewed on an on-going basis, and amended as needed.

Topics:  Advertising, Compliance, Due Diligence, FINRA, Investigations, Private Placements

Published In: 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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