Recent FINRA Notices Seek Comment on Proposed Amendment to Quantitative Suitability and Efficacy of Supervision Rule
On the heels of the Security and Exchange Commission's (the "Commission") April 18, 2018 release of the proposed Regulation Best Interest rule package ("Regulation BI") (which was covered in our April 20, 2018 Law Alert), the Financial Industry Regulatory Authority ("FINRA") on April 20, 2018 issued Regulatory Notice 18-13 ("Notice 18-13") seeking comment on its proposed amendments to the quantitative suitability obligation under FINRA Rule 2111.
Under Rule 2111, quantitative suitability requires a broker who has control over a customer's account to have a reasonable basis for believing that a series of recommended transactions is not excessive or unsuitable for the customer, although the individual transactions may be suitable when viewed in isolation. The element of control in this requirement may be evidenced by actual or de facto control. If the broker does not control the customer's account, however, the quantitative suitability obligation is not triggered.
FINRA proposes to remove the element of control from Supplementary Material .05(c) of Rule 2111 in order to better address instances of excessive trading, sometimes referred to as "churning." From FINRA's perspective, the rationale for the amendment is threefold. First, the original basis for requiring the control element is rooted in the perceived need to ensure that culpability for excessive trading was attributed to the individual initiating the transaction. Since the rule requires a showing that the broker is the recommending party, the concern simply is not present under the rule. Second, FINRA is concerned that the control element has been or may be used as a shield for brokers engaged in excessive trading. The third reason is FINRA's consideration of the Commission's Regulation BI. Regulation Best Interest also includes a prohibition on excessive trading, but excluded the control element. The comment period for the amendments to Rule 2111 expires on June 19, 2018.
Although many firms have existent supervisory policies in place with regard to churning activity, it would be timely to review and consider an update to such policies, especially where the element of control is not clearly defined.
FINRA Regulatory Notice 18-14
FINRA conducts retrospective reviews of its rulemaking on a regular basis in order to ensure that the rules themselves are meeting investor protection goals and that the process to administer such rules continues to be effective. On April 24, 2018, FINRA released Regulatory Notice 18-14 ("Notice 18-14") announcing its retrospective review of Rule 3110(a)(7) and Supplementary Material .04 (Annual Compliance Meeting), which requires each registered representative and registered principal to participate in an annual interview or meeting at which compliance matters relevant to the individual are discussed. A broker-dealer firm is not required to hold an in-person meeting; however, if the compliance meeting is conducted by using another method (e.g., on-demand webcast, video conference, classroom, telephone or electronic), each registered person must attend the entire meeting, and the firm must ensure that registered persons are able to ask questions and receive answers in a timely fashion. FINRA is seeking comments to six specific questions set forth in Notice 18-14. The questions relate to whether the rule has been effective, registered individuals' experience with the implementation of the rule, the rule's economic impacts such as the cost and benefits of the annual meetings, and asks whether FINRA can make the rules, interpretations and administrative processes more efficient and effective. FINRA also invited comments on any other aspects of Rule 3110. The comment period expires on June 19, 2018.