FINRA’s New “SR-FINRA-2010-039” Suitability Rules: Good for Investor Protection?

Representing Investors Nationwide

As of July 9, FINRA has upgraded its suitability requirements. The new standards require broker dealers to exercise a higher degree of diligence when getting to know the needs and goals of their clients. As a result of the new rules, stock brokers must be more careful to gather and consider facts regarding their clients’ age, risk preferences, liquidity requirements, and other information when making recommendations.

These changes aren’t incredibly drastic and I believe that there is a lot more to be done; however, I do think they’re a positive step in the right direction.

How Are the New Rules Different?
In the past, suitability standards applied more toward the individual recommendations made by a broker and less toward a broker’s overall portfolio investment strategy. This was not good for investors because it is much harder to prove that an individual investment is unsuitable as compared to an entire portfolio that is unsuitable.

For example, one blue chip stock investment might be suitable for an 80-year-old retiree with limited assets available for investment, however, if that same 80-year-old had a portfolio comprised of 100% blue chip stocks, it might be considered extremely unsuitable. A 100% equity position provides zero protection from the ups and downs of the stock market so obviously it’s risky. The question is: Was it suitable for the broker to advise his client to invest 100% of his portfolio into stocks when standard investment practice says this strategy is extremely risky? Shouldn’t the broker have recommended reallocation?

When “Staying the Course” Is Not a Suitable Option
When a broker’s advice to “hold on” to a portfolio of rapidly declining stocks, rather sell, is just as risky as the advice to buy a portfolio full of volatile and risky stocks, should suitability standards apply? In other words, if a retiree has experienced a 50% decline in the value of his life savings, wouldn’t it be speculative and unsuitable for him to “stay the course” and risk losing everything? Well, it appears that the new suitability rules will add further protections against this kind of problem too.

Yes, Looks like Positive News for Suitability Claims
It’s always good when a new FINRA rule increases a stockbroker’s duty to know his or her customer better, to know the investments he or she recommends better, to know how those investments will affect his or her client’s exposure to risk, and finally, to use all that information in order to keep his or her client as safe as possible. All in all, I think the new rules are an encouraging move for FINRA, and I’m hopeful that they will make more reforms like this in the near future.

If you would like to read more about FINRA’s new suitability requirements, I’d encourage you to take a look at a Reuters and AdisorOne articles.