The Know-Your-Customer and Suitability Rules are Coming; Are You Prepared?

June 11, 2012 – In The News
Westlaw News & Insight Securities Blog

With Rules 2090 and 2111, FINRA has attempted to define what it means to know your customer, as well as the information that must be gathered to ensure suitable investment recommendations. Following the guidance of these rules will assist you in the development of your standard set of inquiries that should be used for all customers, both new and longstanding. These rules are effective as of July 9, 2012, and should likewise guide registered investment advisers regarding their know your customer and suitability analysis.

Rule 2090 requires the use of reasonable diligence when opening and throughout the maintenance of client accounts. You must know and retain “essential facts” concerning every customer, including the authority to act for the customer. FINRA has defined essential facts as those required to: “(a) effectively service the customer’s account, (b) act in accordance with any special handling instructions for the account, (c) understand the authority of each person acting on behalf of the customer, and (d) comply with applicable laws, regulations, and rules.” If you do not have the answers these basic questions, you do not know your customer. You should stop, revisit with your client, and then proceed.

Under Rule 2111, FINRA has now defined “suitability”. According to Rule 2111, there must be a reasonable basis to believe that the recommended transaction or investment strategy involving a security is suitable for a customer. Importantly, an investment strategy includes recommendations to buy, sell or hold a security, an area that was open to some debate in the past. Suitability is also “based on the information obtained through the reasonable diligence . . . to ascertain the customer’s investment profile.” Rule 2111 goes so far as to describe the categories of information that must be obtained to ascertain the investment profile and evaluate the suitability of an investment recommendation. The list, although helpful, should not be the end of analysis or be considered all inclusive. If anything, the list represents the floor, the starting point of the analysis to assess whether an investment recommendation is suitable.

Rules 2090 and 2111 must be taken seriously as they will set the floor for minimally accepted conduct. Any member firm who does not have policies and procedures to ensure that these rules are followed, will be on the short end of the stick when faced with a customer complaint. These rules and your written supervisory procedures will be on trial, and I fear the result will not be one to your liking. Time is running out before these rules are in effect.