FINRA Backtracks From its Earlier Interpretation of Suitability Rule
On July 9, 2012, FINRA Rule 2111, the new suitability rule enacted by the Financial Industry Regulatory Authority (“FINRA”), took effect. Rule 2111 states, in pertinent part, that a broker “must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer….”
FINRA first provided explanatory guidance on the new suitability rule in May 2012 with Regulatory Notice 12-25 (“RN 12-25”). Now, FINRA has issued Regulatory Notice 12-55 (“RN 12-55”) in which FINRA substantially backtracks from its earlier interpretations of the terms “customer” and “investment strategy.”
Initially, FINRA broadly defined “customer” as any individual or entity (who is not a broker-dealer) with whom a brokerage firm has even an informal business relationship related to brokerage services, including potential investors, even if that potential investor does not have an account at the firm.
Now, presumably because of pressure from the industry, FINRA has revised the definition of “customer” to exclude “potential investors,” and to limit the application of the new suitability rule to investors who actually open a brokerage account at the brokerage firm, or who purchase a security for which the firm will receive compensation.
In addition, FINRA’s RN 12-55 explicitly states that the new suitability rule does not apply to a recommended investment strategy that only involves a non-security investment. RN 12-55 specifically excludes from the new suitability requirement a recommendation by a stock broker to purchase a non-security investment made as part of the broker’s outside business activity.
A copy of FINRA’s Regulatory Notice 12-55 can be found here.