Securities Litigation

FINRA recently proposed to remove the broker's "control" of a securities account as a required element of a "quantitative suitability" violation under Rule 2111.

For many decades, case law on broker-dealer fraudulent practices under Rule 10b-5 and others recognized a cause of action for "churning:" Knowingly recommending an unsuitable volume or frequency of trading in an account, by a broker exercising actual or constructive control over that account, as a form of self-dealing to generate commission revenue at the customer's expense.

When FINRA revised its "suitability" rule in 2010, it incorporated existing "churning" standards in the rule as "quantitative suitability." That joined the suitability pantheon, along with "reasonable basis" suitability, i.e. that the product or strategy is suitable for at least some investors, and the long-standing "customer-specific" suitability requirement:

"A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is 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 Rule 2111(a). See also 2111.05 (three components of suitability). The revision also included a subtle shift of focus from the customer him- or herself to the broker-dealer's record of the customer's "investor profile,"

The proposed change is consistent with evolving regulatory views and, as FINRA candidly admits, "front runs" the SEC's proposed "best interest" standard for broker dealers.

FINRA's Regulatory Notice 18-13 is here:

http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-18-13.pdf

Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 32 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile. © 2018 by Thomas K. Potter, III (all rights reserved).