FINRA, the Financial Industry Regulatory Authority, regulates the conduct of brokers in the securities industry to protect you from losses tied to bad advice or outright misconduct. The agency writes rules spelling out exactly how broker-dealers and financial advisors have to treat their investment clients. And despite all those rules, FINRA still fields thousands of customer complaints every year.
Two rules show up again and again in those complaints. 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.
If you lost money because your broker recommended something that never fit your situation, the investment fraud attorneys at The Law Offices of Robert Wayne Pearce, P.A. can help you figure out whether Rule 2090 or Rule 2111 got broken along the way. Contact our office today for a free consultation.
FINRA Rule 2090: Know Your Customer Rule
FINRA Rule 2090 requires your financial advisor to learn the “essential facts” concerning you and concerning the authority of each person acting on behalf of such customer. Firms need this information before they open your account, and they need to keep it current for as long as they manage your money.
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 relevant laws, regulations, and rules.
The Know Your Client rule protects clients from investment losses by requiring their financial advisor to learn detailed information about their personal financial circumstances. This protects financial advisors by outlining the essential information about customers at the outset of the relationship, prior to any recommendations.
The financial adviser also receives notification of any third parties authorized to act on the customer’s behalf. The information learned by financial advisors through the KYC requirement factors into the analysis of whether an investment recommendation is suitable.
Anti-Money Laundering: Broker-Dealers’ Second KYC Duty
Suitability is only half of “know your customer.” Broker-dealers also run a second KYC process built to catch money laundering, and it comes from a different set of laws entirely.
The Bank Secrecy Act requires financial institutions, including broker-dealers, mutual funds, futures commission merchants, and introducing brokers, to build anti-money laundering programs and flag financial crimes. FINRA Rule 3310 makes that a FINRA-specific obligation. The Financial Crimes Enforcement Network (FinCEN) writes the money laundering regulations that financial firms and other financial institutions across the financial services industry follow, usually announced through a regulatory notice or the Federal Register.
Before opening your account, a firm’s Customer Identification Program runs identity verification on your customer accounts, so companies opening accounts understand exactly who they’re dealing with. Customer identification is the first checkpoint against potential money laundering. If a firm can’t confirm your customer identity, it can’t move forward with the business relationship.
Next comes customer due diligence. FinCEN’s CDD rule requires financial institutions to understand customer relationships well enough to build accurate customer risk profiles, covering a customer’s financial situation and, for business clients, a customer’s business activities. Firms must also identify the beneficial owners behind any legal entity, since beneficial ownership information exists to prevent money laundering through shell companies.
Firms assess accounts on a risk basis. Higher-risk customers trigger enhanced due diligence, while every account gets ongoing monitoring and a duty to report suspicious transactions to FinCEN.
The Financial Action Task Force sets the global standard that US financial institutions follow to improve financial transparency across the financial system and cut off terrorist financing. Sloppy KYC compliance is sloppy KYC compliance, no matter which rule it breaks.
FINRA Rule 2111: Suitability
Suitability complaints show up in FINRA’s Rule 4530 Customer Complaint Report every quarter, and they’re consistently one of the most-cited problem codes firms report.
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,
- Risk tolerance, and
- Other investments.
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.
Read up on FINRA Rule 2010 if a broader ethics violation might be in play, or check out stockbroker fraud, since suitability claims often overlap with both.
What Should You Do If Your Broker’s “Know Your Customer” File Is Wrong or Outdated?
If your broker’s “know your customer” file is wrong or outdated, you should correct it immediately because suitability depends on accurate facts about you. FINRA Rule 2090 equals an “essential facts” requirement, and your investment profile equals your age, time horizon, liquidity needs, tax status, and risk tolerance, so a stale profile can make a risky recommendation look “appropriate” on paper.
Start by requesting a copy of your new account form, any updates, and any risk-tolerance questionnaires, then compare them to your real finances (income, net worth, expenses) and goals (capital preservation, retirement, education). A red flag equals blanks filled in by someone else, aggressive objectives you never chose, or repeated “speculation” ratings that conflict with conservative holdings.
Send a written update (email or secure message) stating the corrected facts and the date, and ask the firm to acknowledge the change before any new trades. At the Law Offices of Robert Wayne Pearce, P.A., our lawyers have seen that documentation (statements, notes, recorded calls, disclosures, and trade confirmations) often becomes the proof that a recommendation was unsuitable or not in your best interest.
Hiring an Investment Loss Attorney
Violations of FINRA Rules 2090 and 2111 cost investors real money every year. If you lost money to an unsuitable recommendation, you have the right to pursue the people responsible for it.
Cases against brokers and registered investment advisors get complicated fast, especially without an attorney who actually knows securities law. Robert Wayne Pearce has spent over 45 years representing investors against financial advisors and broker-dealers, and has tried, arbitrated, and mediated hundreds of disputes involving FINRA rule violations. He even serves as a FINRA mediator from time to time.
If you’re in Florida, Texas, or anywhere else in the country, an attorney experienced in suitability claims changes how much you recover. Contact The Law Offices of Robert Wayne Pearce, P.A. today for a free review of your case.
