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supervise the advisor’s participation in the transaction as
if the transaction were actually executed through and on
behalf of the member firm.
Rule 2111: Suitability
There are two aspects of FINRA’s Suitability Rule
2111 that apply to doing business in securities not
offered by Commonwealth. The rule requires:
1.
Member firms to have a reasonable basis to believe
that a recommended transaction or investment
strategy involving a security or securities is suitable
for at least some of its customers; and
2.
Advisors to have a reasonable basis to believe that a
recommended transaction or investment strategy
involving a security or securities is suitable for each
customer in accordance with each customer’s unique
investment profile.
The due diligence that a member firm carries out on a
particular product must provide, both to the advisor and
to the member firm, an understanding of the potential
risks and rewards associated with the recommended
security or strategy. So, for example, if Commonwealth
does not perform sufficient due diligence on a security
and form an understanding of the product’s risks and
rewards before the advisor recommends the security or
strategy, both the advisor and Commonwealth would
be in violation of the suitability rule. Even if the
recommendation turned out to be the right call, the
advisor and Commonwealth would be deemed in violation
of the suitability rule if these obligations were not fully met.
If the recommendation ends up working out for the
client, how can it be considered unsuitable?
If no
firm-level due diligence were performed on the product
and sponsor, compliance with the rule would not have
been satisfied. Moreover, the advisor most likely would
not have reviewed the product offering documents and all
relevant materials well enough to understand the
product and determine its suitability.
What if the recommendation doesn’t lead to a
transaction?
The applicability of the suitability rule
is triggered upon the recommendation of a security or
an investment strategy involving a security or securities,
regardless of whether or not a transaction actually occurs.
This would apply to explicit recommendations to sell,
buy, or hold. As discussed above, any call to action or
inaction relating to buying, selling, or holding a security
or following an investment strategy involving a security
would trigger the suitability obligations under FINRA’s
Suitability Rule 2111.
May an advisor provide advice on unapproved
products through Commonwealth’s Wealth
Management Consulting program? After all, it
is an investment advisory service, and the service
is not conducted through the broker/dealer.
No.
Providing advice on securities that have not been approved
by Commonwealth is referenced as a “prohibited
consulting service” in Commonwealth’s Wealth
Management Consulting Manual. An advisor who is
both an investment adviser representative (IAR) and a
registered representative (RR) cannot put aside his or her
obligations as an RR. FINRA’s suitability rule applies to
all RRs who make recommendations that relate to securities
and investment strategies involving securities, even if
done so while working in an investment advisory capacity.
In conclusion, although I expect most Reg D offerings to
continue to be issued pursuant to the existing (though
newly named) Rule 506(b) exemption, the ban on the
prohibition of general solicitation and advertising means
that you may start to receive more questions from clients
on these offerings. A thorough knowledge of what you may
and may not do in response to such questions (as outlined
in Rules 3040 and 2111) will stand you in good stead
and help protect both your business and Commonwealth’s
from penalties under the law.
Rob Molinari is the vice president of compliance. He is
available at x9828 or at
.
Compliance & Regulation
