FINRA Rule 2111 requires a broker to have a reasonable basis to believe that a recommended security transaction or investment strategy is suitable for the customer. The “quantitative suitability” component of Rule 2111 (prohibiting “churning”) also requires that brokers who have actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions are not excessive and unsuitable in the aggregate. FINRA added the “quantitative suitability” obligation in 2010 to conform to the long-standing line of churning cases.
On April 20, 2018, FINRA proposed to eliminate the “control” element from a broker’s quantitative suitability obligation under Rule 2111. In other words, under the proposed new rule, FINRA would need only to establish that a broker recommended a transaction to establish that a broker violated his or her quantitative suitability obligation, if the trading is “excessive” in light of the customer’s investment profile.
FINRA explains the reason for its proposed amendment to Rule 2111 in Regulatory Notice 18-13 (here). FINRA does not identify what leads it to conclude that the “control element” is no longer a necessary element of churning, or what justifies Rule 2111’s departure from more than 60 years of settled American jurisprudence on the issue of churning. FINRA suggests that removing the “control element” from the quantitative suitability rule is necessary for two reasons.
- First, FINRA seeks to conform Rule 2111 to Securities and Exchange Commission’s recently proposed “Regulation Best Interest.” But Regulation Best Interest has not been adopted and in fact will remain open for comment until August 7, 2018.
- Second, FINRA states that the proposed amendment to Rule 2111 is necessary because establishing that the broker controlled the trading in the account imposes a “heavy and unnecessary burden on customers,” and therefore FINRA is concerned that the control element poses an “impediment” to investor protection. (Regulatory Notice 18-13, p. 2.)
But all broker defenses are potential “impediments” to customer recovery. And indeed, removing the control element from Rule 2111 will not remove a perceived “impediment” to customer recovery because customers cannot state a claim for civil liability based on an alleged violation of an industry rule. Rather, to impose civil liability on a member firm or broker for churning, a customer still will be required to establish that a broker controlled the trading in the account, the trading was excessive given the customer’s investment objectives, and the broker acted with fraudulent intend. Having differing standards for “quantitative suitability” under FINRA Rule 2111 and for a civil claim for churning under federal law will not aid customer protection, but it does risk customer (and possibly arbitrator) confusion.
The regulatory rules and regulations should be in harmony with prevailing law, not contrary to it. Equally important, FINRA’s mission of customer protection must exist in tandem with the equally important goal of providing a fair regulatory framework for brokers. FINRA’s proposed amendment to Rule 2111 ignores the customer’s vital role in exercising the final say as to whether to buy or sell securities that have been recommended to him or her. For these reasons, Keesal, Young & Logan has submitted a comment letter to FINRA (here) in response to the proposed amendment to Rule 2111 and Regulatory Notice 18-13. For the reasons set forth in the attached comment letter to FINRA, we likewise have urged the SEC to revise Regulation Best Interest and specifically the FINRA-analogous language proposed at 17 C.F.R. §240.15l-1(a)(2)(ii)(C) to conform to long-standing precedent governing churning claims and to require that a violation of the this subsection can exist only where the broker had actual or de facto control over the trading (here).
The comment period in response to the proposed amendment to Rule 2111 remains open until June 19, 2018. FINRA’s web page regarding the proposed amendment to Rule 2111 is available here. Comments may be submitted via e-mail to pubcom@finra.org or via U.S. Mail to Jennifer Piorko Mitchell, Office of the Corporate Secretary, FINRA, 1735 K Street, NW, Washington, DC 2006-1506.
The comment period in response to proposed Regulation Best Interest remains open until August 7, 2018. Comments may be submitted via a-mail to rule-comments@sec.gov or via U.S. Mail to Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F Street, NE Washington, DC 20549-1090. The SEC’s file number (S7-07-18) should appear on the subject line of the e-mail or on the “re:” line of the letter.
– Keesal, Young & Logan Securities Group
This information has been prepared by Keesal, Young & Logan for informational purposes only and is not legal advice. Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship between you and Keesal, Young & Logan. You should not act upon this information without seeking professional counsel.