FINRA proposed amendments to its suitability rule that would remove the requirement that a broker-dealer must have "control" over a customer account in order for there to be a violation by the broker-dealer of its "quantitative suitability" obligation. According to FINRA, the proposal is being made "to more effectively address instances of excessive trading in customers' accounts."
Under the quantitative suitability obligation under FINRA Rule 2111 (which largely is intended to prevent broker-dealers from "churning," or excessive trading in a customer's account) a broker-dealer with "actual or de facto control over a customer account" must have a reasonable basis to believe that a series of recommended transactions is suitable regardless of whether the individual transactions are suitable in isolation. FINRA expressed concern that it is difficult to prove that a broker-dealer has "de facto" control over an account, as it may require customers to acknowledge a lack of sophistication, a result that could shield bad actors from accountability.
In proposing the amendment, FINRA represented that proving a broker-dealer's culpability under Rule 2111 would still require a demonstration that the broker-dealer recommended the transactions at issue. FINRA further stated that recognizing excessive trading activity would still depend on the facts and circumstances of each case and "would continue to be assessed in light of the customer's investment profile." FINRA also clarified that while no single metric can be used to identify excessive trading, "factors such as turnover rate, cost-to-equity ratio or the use of in-and-out trading may provide a basis for a finding of excessive trading."
FINRA noted that it reconsidered the quantitative suitability obligations in light of the SEC's recently proposed Regulation Best Interest, which would establish certain standards for broker-dealers recommending securities transactions or investment strategies to customers.
Comments on the proposed changes to the suitability rule must be submitted by June 19, 2018.
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