On April 20, 2018, following the Securities and Exchange Commission’s (SEC) introduction of “Regulation Best Interest” and related conflict of interest reform proposals, the Financial Industry Regulatory Authority (FINRA) issued its own Regulatory Notice 18-13, seeking comment on proposed amendments to the “quantitative suitability obligation” under FINRA Rule 2111.
According to a Law Alert publication shared by Wagner Law Group, 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.” As the Wagner attorneys note, 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, the attorneys explain.
With its latest proposal, FINRA suggests it may “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,” the Wagner attorneys suggest. “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 SEC’s Regulation Best Interest.”
According to the Wagner attorneys, SEC’s Regulation Best Interest also includes a prohibition on excessive trading, but it excluded the control element. Importantly, the comment period for the amendments to Rule 2111 expires on June 19, 2018, giving readers less than a month to weigh in.
“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,” the attorneys warn.
Taking a deep dive into FINRA Regulatory Notice 18-14
Turning to a separate but also relevant matter, the Wagner attorneys weigh in on FINRA Regulatory Notice 18-14, issued shortly after Notice 18-13.
“Notice 18-14 announces the 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,” the attorneys observe.
Under the relevant FINRA rules, a broker/dealer firm is not required to hold an in-person meeting for this purpose.
“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,” the attorneys add. “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.”
Readers may also note that FINRA is concurrently reassessing its requirements for RIAs to monitor the outside business activities of their reps; experts argue it is likely that, if the final rule reflects the proposed rule, many plan advisers who serve plans through an independent registered investment adviser (RIA) (as opposed to the broker/dealer’s “corporate” RIA) will seek to renegotiate their compensation arrangements relating to their independent RIA revenue.
The FINRA Regulatory Notice comment portal is here.