FINRA was created by the merger of the National Association of Securities Dealers and the enforcement arm of the New York Stock Exchange in 2007. As a consequence, FINRA has been updating and combining the organizations’ rules on a section-by-section basis.
As part of this process, the Securities and Exchange Commission has published a notice of the filing of proposed FINRA Rule 2111, which governs suitability, and FINRA Rule 2090, the “know your customer” rule, in the Federal Register last week. This process is a precursor to allowing these new rules to “go live.” The SEC can take from 45-90 days to decide whether to approve the rules as is or to hold further proceedings. Public comments are due September 9.
Most significantly for our purposes, FINRA is leaving non-securities products out of the proposed rule updates. Because the SEC classifies variable insurance products as securities, FINRA has jurisdiction over the individuals and organizations that sell those products. The new proposed “know your customer” rule is based upon NYSE 405(1), and it creates an obligation for broker-dealers to use “due diligence” when they open and maintain customer accounts, and to “know the essential facts concerning every customer.” This proposed rule would eliminate the current NYSE Rule 405(1) requirement that broker-dealers learn the essential facts relative to every order.
The proposed suitability rule, FINRA Rule 2111, would require a broker-dealer or associated person to have “a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer.” This assessment must be “based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile, including, but not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.”
FINRA had been considering whether it ought to apply the suitability rule to members’ sales of non-securities products, such as insurance. But many insurer groups, producer groups and regulators advised FINRA that it should not. “This issue generated the greatest number of comments, most of which were against extending the rule’s reach,” FINRA officials reported.
The vast majority of commenters argued that FINRA does not have jurisdiction over non-securities products. Some asserted that FINRA has no expertise in regulating non-securities products, and some pointed out that other regulatory agencies and self-regulatory groups already regulate products such as insurance.
“FINRA does not agree with the commenters’ reasoning against extending the scope of the suitability rule,” FINRA officials said. “FINRA acknowledges, however, that future developments in regulatory restructuring could impact any such proposal. FINRA emphasizes, moreover, that the proposed new suitability rule (including the explicit coverage of recommended strategies and expanded list of the types of information that members must seek to gather and analyze) and the proposed ‘Know Your Customer’ rule together provide enhanced protection to investors. Consequently, FINRA will not include explicit references to nonsecurities products in the rule at this time.”