FINRA regulates the conduct of brokers in the securities industry to protect investors from suffering losses due to financial advisor misconduct.
The agency formulates rules to outline the behavior expected of broker-dealers and financial advisors when dealing with their investment clients.
Nevertheless, FINRA receives thousands of customer complaints every year alleging violations of FINRA Rules.
FINRA Rule 2090, the Know Your Customer (KYC) rule, and FINRA Rule 2111, the suitability rule, mandate minimum knowledge requirements for brokers when making investment recommendations and commonly appear in these customer complaints.
If you suffered investment losses due to unsuitable investment recommendations, The Law Offices of Robert Wayne Pearce, P.A., can help you determine if your broker violated one of these rules. Contact our office today for a free consultation.
FINRA Rule 2090: Know Your Customer Rule
FINRA Rule 2090, or the Know Your Client rule, requires financial advisors to know the “essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer” when opening and maintaining a client investment account.
The “essential facts” described in the rule include details that are required to:
- Service the account effectively;
- Satisfy any special handling instructions for the account;
- Understand the authority of anyone acting on the customer’s behalf; and
- Comply with applicable laws, regulations, and rules.
The KYC rule protects clients from investment losses by requiring their financial advisor to learn detailed information about their personal financial circumstances.
The rule protects financial advisors by outlining the essential information about customers at the outset of the relationship, prior to any recommendations.
Additionally, the financial adviser receives notification of any third parties authorized to act on the customer’s behalf. The Know Your Client rule acts in tandem with the suitability rule, FINRA Rule 2111.
The information learned by financial advisors through the KYC requirement factors into the analysis of whether an investment recommendation is suitable.
FINRA Rule 2111: Suitability
Alleged violation of investment suitability requirements resulted in 1,220 customer complaints filed with FINRA in 2020 alone, down from 1,580 complaints in 2019.
The suitability rule requires financial advisors to have a “reasonable basis” to believe that a recommended transaction or investment strategy is suitable for the customer.
A financial advisor determines the suitability of a transaction or investment strategy through ascertaining the customer’s investment profile. Factors involved in a suitability analysis include the customer’s:
- Age,
- Investment experience,
- Financial situation,
- Tax status,
- Investment goals,
- Investment time horizon,
- Liquidity needs, and
- Risk tolerance.
Numerous cases interpret the FINRA suitability rule as requiring financial advisors to make recommendations that are in the best interest of their customers. FINRA outlines situation where financial advisors have violated the suitability rule by placing their interests above the interests of their client, including:
- A broker who recommends one product over another to receive larger commissions;
- Financial advisors who recommend that clients use margin to purchase a larger number of securities to increase commissions; and
- Brokers who recommend speculative securities with high commissions because of pressure from their firm to sell the securities.
Any indication that a financial advisor has placed his or her interests ahead of the client’s interest can support a claim for a violation of the suitability rule.
Rule 2111 consists of three primary obligations: (1) reasonable basis suitability, (2) customer-specific suitability, and (3) quantitative suitability.
Reasonable Basis Suitability
Reasonable basis suitability requires a financial advisor to have a reasonable basis to believe, based on reasonable diligence, that a recommendation is suitable for the public at large.
A financial advisor’s reasonable diligence should provide him or her with an understanding of risks and rewards associated with the recommended investment or strategy.
A failure to comprehend the risks and rewards associated with a particular investment prior to recommending the investment to a client can result in allegations of misrepresentation or fraud. If a broker fails to perform reasonable diligence regarding either component, the financial advisor violates this obligation.
Customer-Specific Suitability
Customer-specific suitability involves considering the specific details about an individual customer to determine if a transaction or investment strategy is suitable. The financial advisor reviews the details outlined above to determine the suitability of a particular transaction or strategy for each customer.
Quantitative Suitability
The quantitative suitability element requires financial advisors to recommend transactions that are suitable when viewed as a whole, not only when viewed in isolation.
This element aims to prevent financial advisors from making excessive trades in a client’s account solely for the purpose of generating commission fees.
Factors such as turnover rate, cost-equity ratio, and use of in-and-out trading indicate that the quantitative suitability obligation was violated.
What Constitutes “Reasonable Diligence”
FINRA’s suitability rule requires brokers to exercise “reasonable diligence” in attempting to obtain customer-specific information. The reasonableness of a financial advisor’s effort to obtain such information will depend on the facts and circumstances of each investment relationship.
A financial advisor typically relies on the responses provided by the customer in compiling information relevant to the customer’s investment profile. Some situations may prevent a broker from relying exclusively on a customer’s responses, including times when:
- A financial advisor poses misleading or confusing questions to a degree that the information-gathering process is tainted;
- The customer exhibits clear signs of diminished capacity; or
- Red flags exist that indicate the information may be inaccurate.
Additionally, the suitability rule requires brokers to consider any other information provided by the customer in connection with investment recommendations.
Hiring an Investment Loss Attorney
Violation of FINRA Rules 2090 and 2111 result in significant financial losses for investors every year. If you suffered losses because of unsuitable investment recommendations, you have the right to seek compensation from the parties responsible for your losses.
Cases against brokers and registered investment advisors can be complex for attorneys without experience in securities law.
Robert Wayne Pearce has over 40 years of experience representing investors in disputes against financial advisors and broker dealers. Mr. Pearce has tried, arbitrated, and mediated hundreds of investment-related disputes involving complex securities and FINRA rule violations.
In fact, Mr. Pearce serves as a FINRA mediator from time to time. Having an attorney experienced in suitability matters is crucial to obtaining the best possible results in your investment loss matter.
Contact The Law Offices of Robert Wayne Pearce, P.A., today for a free review of your case.
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