NASAA Encourages FINRA to Strengthen Suitability Standards

In a comment letter to the Financial Industry Regulatory Authority (FINRA), the North American Securities Administrators Association (NASAA) has encouraged FINRA to strengthen the suitability standards applicable to broker-dealers. NASAA submitted its comments in response to FINRA's proposed rule consolidation for NASD Rule 2310 and NYSE 405 that would alter the obligations of broker-dealers for suitability and "Know Your Customer" standards. Echoing language from recent testimony of FINRA Chairman and CEO Richard Ketchum before the Senate Committee on Banking, Housing, and Urban Affairs, NASAA urged FINRA to "choose the best" standards for all types of investors who hold, invest, and receive advice from investment professionals in a broker-dealer context.

NASAA strongly encouraged FINRA not to diminish any investor protections or specificity requirements that currently exist in suitability rules through the process of rulebook consolidation. NASAA noted that the Interpretive Materials (IMs) that are included within the current FINRA manual for suitability add specificity to the rule language and help those in the industry and those investing in securities understand how the suitability rule applies to specific transactions and situations. Accordingly, NASAA encouraged FINRA to codify the existing IMs by mirroring the specific language contained within them.

NASAA also questioned FINRA's codification of suitability as a three pronged approach to suitability principles. NASAA stated that the interpretation described in the Supplementary Material to proposed Rule 2111 appears to create several new standards: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. In NASAA's view, the description of what "reasonable-basis suitability" means is not particularly clear, or helpful to the general public. Moreover, NASAA questioned whether the three pronged approach could lead industry defendants to make an argument in the future that suitability standards are strictly limited to the three prongs only, without room for the later addition of new prongs or measurements.

Among its other comments, NASAA encouraged FINRA to carefully examine the existing carve backs or exemptions from suitability standards. For example, NASAA observed that proposed Rule 2111(b) appears to provide a "box check" waiver of the customer-specific obligation of the suitability rule for institutions. NASAA expressed concern over the appropriateness of this approach, given how securities such as auction rate securities were marketed and sold to both wealthy individuals and institutions. NASAA also expressed concern over the removal of language from NYSE Rule 405 that requires the use of due diligence in "every order." NASAA fears that removal of this language could be construed to eliminate the requirement for due diligence on a transactional basis.

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