Reuters: Regulatory News: COMPLY-Advice from FINRA on new suitability rule

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COMPLY-Advice from FINRA on new suitability rule May 25th 2012, 16:33 By Suzanne Barlyn Fri May 25, 2012 12:33pm EDT May 25 (Reuters) - After nearly two years of waiting for a new suitability rule to take effect, brokers will finally be put to the test. Brokers with a knack for record-keeping and doing the right thing for their customers are likely to make a smooth transition to complying with the Financial Industry Regulatory Authority's new rule, which takes effect on July 9. But for those who fall short on those skills, now is the time to get your house in order. The new rule, approved by the U.S. Securities and Exchange Commission in 2010, expands existing suitability requirements for brokers and their firms. Going forward, securities and strategies that brokers recommend must be suitable for investors at all times, not just during each transaction. Many brokerages have trained their employees and put in new monitoring technology to prepare for the new rule, but some last-minute questions are causing angst. Not understanding those finer points, or how to properly document efforts to comply with the rule, could ultimately lead to problems with regulators. FINRA has not stinted on advice for brokerages and their brokers. Newly released guidance includes tips on what FINRA considers "investment strategies," how to avoid certain conflicts of interests, and when to document "hold" recommendations. Regulators at FINRA's annual conference in Washington this week also had plenty to say on the topic. One key piece for staying out of trouble: Brokers need to understand the products and strategies they recommend. While the suggestion may seem obvious, not knowing the mechanics of certain products and their risks has been factored into disciplinary actions against brokers and their firms. That is especially true in this low-interest era, when investors are chasing yield and Wall Street is responding with risky complex securities, such as leveraged and inverse exchange-traded funds, which are designed to amplify short-term returns by using derivatives. FINRA officials raised concerns this week about whether brokers know enough about some of these securities and are properly representing them to investors. One good measure that brokers can use to assess their own understanding came directly from FINRA Chief Executive Officer Richard Ketchum. They "should be able to write down on a single page why this investment is in the best interests of (the) client" before offering complex products to retail investors, he told nearly 1,000 attendees on Monday. He also suggested discussing the risks of complex products and how they may perform under different market conditions. Also be prepared to tell customers how they can lose money, not just how they can make it, Ketchum said. FINRA's new rule requires brokers to consider numerous elements before making recommendations, including a client's time horizon, tax status and liquidity needs. But since some brokerages have required brokers to consider some of those factors, such as risk tolerance, for quite some time, day-to-day record-keeping may not change dramatically for them. One small brokerage, for example, was able to modify the software available through its clearing firm so that brokers were able to enter notes about transactions on customers' account profiles, a panelist said at the FINRA conference. Panelists also had suggestions for documenting "hold" strategies, paperwork that may seem onerous at first. One idea: Before discussing investments, ask the client about a recent life event, such as a vacation, to have a time frame to include in the notation. That will make the conversation easier to remember in case the brokerage compliance department or regulators question the recommendation years later. If investment changes are not needed, a simple note about the "hold" strategy should suffice as documentation. It could say, for example: "The client caught a swordfish on his vacation. We talked about his strategy, and I recommended that he does not make any changes." The process for brokers to comply with the new suitability rule could be a prelude to a fiduciary regulation that the U.S. Securities and Exchange Commission is considering. The SEC's rule, if proposed and adopted, would require brokers to act in their clients' best interests -- or as fiduciaries -- the way investment advisers must now do. FINRA's guidance makes the common thread between its rule and the SEC's project quite clear: "(T)he suitability rule and concept that a broker's recommendation must be consistent with the customer's best interest are inextricably intertwined." Link this Share this Digg this Email Reprints

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