FINRA Regulatory Notices

No Comment
Know-Your-Customer and Suitability Obligations

SEC approves consolidated FINRA rules governing Know Your Customer (Rule 2090) and Suitability Obligations (Rule 2111), effective October 7, 2011.

Know Your Customer

In general, new FINRA Rule 2090 (Know Your Customer) is modeled after former NYSE Rule 405(1) and requires firms to use “reasonable diligence,” in regard to the opening and maintenance of every account, to know the “essential facts” concerning every customer.6The rule explains that “essential facts” are “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.” The know-your-customer obligation arises at the beginning of the customer-broker relationship and does not depend on whether the broker has made a recommendation. Unlike former NYSE Rule 405, the new rule does not specifically address orders, supervision or account opening—areas that are explicitly covered by other rules.

Suitability

New FINRA Rule 2111 generally is modeled after former NASD Rule 2310 (Suitability) and requires that a firm or associated person “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.” The rule further explains that a “customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.” The new rule continues to use a broker’s “recommendation” as the triggering event for application of the rule and continues to apply a flexible “facts and circumstances” approach to determining what communications constitute such a recommendation. The new rule also applies to recommended investment strategies, clarifies the types of information that brokers must attempt to obtain and analyze, and discusses the three main suitability obligations. Finally, the new rule modifies the institutional-investor exemption in a number of important ways.

Additional Topics

FINRA Regulatory Notice 11-02, which discusses the consolidated rules continues on to discuss the determination of the existence of a recommendation, explicitly state the application to investment strategies involving securities, inclusion of an expanded list of explicit types of information to gather and analyze as part of the suitability analysis (adding age, investment experience, time horizon, liquidity needs and risk tolerance to the existing list of other holdings, financial situation and needs, tax status and investment objectives, lists three main suitability obligations: reasonable-basis, customer-specific and quantitative suitability and provides an exemption to customer-specific suitability for recommendations to institutional customers under certain circumstances.

Please contact our firm if you need assistance modifying your written supervisory procedures, new client forms or other securities, regulatory or arbitration related legal advice at info@eklawpc.com.

Link: Broker-Dealer Advisory Services

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No Comment
Proposed Amendments to FINRA Rule 5122 Addressing Private Placements – Regulatory Notice 11-04

FINRA issued a proposed amendment to Rule 5122 requiring disclosure in the offering document of the intended use of offering proceeds, expenses, and the amount of selling compensation to be paid to he broker-dealer and its associated persons, in any private placement in which a participating broker-dealer (or its control entity) is the issuer. In addition, the rule requires: at least 85 percent of the offering proceeds must be used for the business purposes identified in the offering document and each offering document to be submitted to FINRA to allow the staff to conduct ex post reviews to assess compliance with the rule and to identify problematic terms and conditions.

Further, the proposed amendments expand Rule 5122 to reach all private placements in which a member firm participates—not just those in which the member firm (or its control entity) is the issuer—while retaining nearly all of the existing exemptions, including those for offerings sold solely to certain institutions, qualified purchasers and other sophisticated investors. However, to reflect the broader scope of the proposed rule and its prior experience with Rule 5122, FINRA proposes to eliminate the exemption for offerings in which a member acts primarily in a wholesaling capacity.

Comment Period Expires: March 14, 2011

To see the full text of Notice 11-04 and proposed amendments, please follow this link to FINRA’s website.

Please contact California-based Evans & Kob PC regarding any of your securities or regulatory questions at info@eklawpc.com.

Link: Broker-Dealer Advisory Services and Securities Offerings practice areas.

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