FINRA 2111 Suitability Rule
Definition and the Three Main Obligations
The FINRA Suitability Rule was created in 2011 to address the growing number of reports that financial planners were steering their older clients into risky investments without regard to the client’s assets. FINRA knows this type of investing is bad for many reasons. First, it assumes past returns are an indicator of future returns, which can be very risky. Second, it could mean taking on too much risk for the client’s desired level of retirement income. Third, older clients can develop an emotional attachment to their portfolios that lead them to maintain high-risk portfolios at inappropriate times. FINRA found that investment advisers were not always adhering to the suitability rule when recommending products like annuities and whole life insurance policies to their older clients. FINRA believed that creating a specific suitability rule could help financial professionals better understand how to recommend products that meet the needs of their clients while still conforming to ethical standards.
Importance of the FINRA 2111 Suitability Rule
The FINRA Suitability Rule is important for a few reasons. First, it helps define the level of risk that a financial professional will consider when making a recommendation. For example, a newer investor with a high-risk tolerance may be frustrated by a broker’s refusal to recommend an investment or product even though they have been trained in compliance with the FINRA Suitability Rule. This rule helps define that risk tolerance. Second, the compliance standards for many products are very specific, and failing to comply with these standards can subject a financial professional to significant fines imposed by FINRA. For example, a broker who recommended and sold an inappropriate annuity to an older client could face the possibility of a $50,000 fine and loss of license. Third, the FINRA Suitability Rule improves communication between financial professionals and their clients. For instance, a retirement planner might be required to discuss whether or not his or her client has outlived their financial resources and needs additional products that may provide future income stability.
The Three Main Obligations
In general, the FINRA Suitability Rule requires that investment professionals consider financial objectives, risk tolerance, and other factors specific to the client when recommending a security or financial product. This means that recommendations may be based on age, investment objectives, financial resources, income needs, and other associated risks. This is called “suitability.” Specifically, this rule requires that every recommendation must abide by the following three obligations:
Reasonable Basis Suitability
This requires that the investment professional has a reasonable basis to believe that the recommendation is suitable for the client. The investment professional must have a reasonable basis to believe that the recommendation is in line with the client’s financial objectives. The investment professional must have a reasonable basis to believe that the client has enough information to make an informed decision about the recommendation.
This means that the investment professional must take into account the customer’s financial profile and only recommend products that are appropriate for that customer. This also requires that any recommendation be made only after the investment professional conducts a suitability analysis, which is a thorough analysis of a client’s risk tolerance and financial objectives. The financial professional
This means that the investment professional must use specific criteria to determine what investments can be recommended. These criteria could include quantitative measurements, such as total risk exposure and volatility of the product. This also means that the investment professional must monitor these measurements on a regular basis to make sure they are still appropriate. In addition, the rule recommends that the following measures be considered
- Risk of loss and expected return on investments
- Stability of value and risk of principal fluctuation
- Liquidity and costs associated with investment
The degree to which the investment is consistent with the client’s other investments, financial goals, and overall risk tolerance.
Consequences of Violating the FINRA 2111 Suitability Rule
A financial professional who violates any of these three obligations could face a variety of penalties, including a fine, suspension, or loss of license. FINRA regulates more than 5,000 firms and 630,000 financial professionals. FINRA investigates complaints about investment professionals. If the complaint is found to be valid, sanctions may be imposed on the professional. The sanctioning process allows for an opportunity to submit a written response before fines are assessed.
The FINRA Suitability Rule is important because it helps to ensure that recommendations are appropriate for the client. The rule requires that investment professionals consider a variety of factors when making a recommendation, including the customer’s risk tolerance and financial objectives. This rule helps to protect investors by ensuring that they are not being recommended products that are unsuitable for their profiles. Financial professionals are required to have a reasonable basis to believe that the recommendation is suitable for the client. This means that they cannot just recommend a product because it is performing well in the market. The FINRA Suitability Rule is an important part of protecting investors and ensuring that recommendations are appropriate for each individual investor.
FINRA 2111 Suitability Rule FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.