52562 Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 

20 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

3The current FINRA rulebook consists of (1) 

FINRA Rules; (2) NASD Rules; and (3) rules 

incorporated from NYSE (‘‘Incorporated NYSE 

Rules’’) (together, the NASD Rules and Incorporated 

NYSE Rules are referred to as the ‘‘Transitional 

Rulebook’’). While the NASD Rules generally apply 

to all FINRA members, the Incorporated NYSE 

Rules apply only to those members of FINRA that 

are also members of the NYSE (‘‘Dual Members’’). 

The FINRA Rules apply to all FINRA members, 

unless such rules have a more limited application 

by their terms. For more information about the 

rulebook consolidation process, see Information 

Notice, March 12, 2008 (Rulebook Consolidation 

Process). 

4For convenience, the Incorporated NYSE Rules 

are referred to as the NYSE Rules. 

5FINRA notes that NYSE Rule 405(4) was 

eliminated from the Transitional Rulebook on June 

14, 2010 pursuant to a previous rule filing. See 

Securities Exchange Act Release No. 61808 (March 

31, 2010), 75 FR 17456 (April 6, 2010) (Order 

Approving File No. SR–FINRA–2010–005); see also 

Regulatory Notice 10–21 (April 2010). 

provisions of 5 U.S.C. 552, will be 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549, on official 

business days between the hours of 10 

a.m. and 3 p.m. Copies of the filing also 

will be available for inspection and 

copying at the principal office of the 

Exchange. All comments received will 

be posted without change; the 

Commission does not edit personal 

identifying information from 

submissions. You should submit only 

information that you wish to make 

available publicly. All submissions 

should refer to File Number SR–Phlx– 

2010–113 and should be submitted on 

or before September 16, 2010. 

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.20

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. 2010–21178 Filed 8–25–10; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–62718A; File No. SR– 

FINRA–2010–039] 

Self-Regulatory Organizations; 

Financial Industry Regulatory 

Authority, Inc.; Notice of Filing of 

Proposed Rule Change To Adopt 

FINRA Rules 2090 (Know Your 

Customer) and 2111 (Suitability) in the 

Consolidated FINRA Rulebook; 

Correction 

August 20, 2010. 

Need for Correction 

On August 13, 2010, the Commission 

published (and sent to the Federal 

Register for publication) Release No. 

34–62718—a Notice that the Financial 

Industry Regulatory Authority, Inc. 

(‘‘FINRA’’) had proposed rule changes to 

adopt FINRA Rules 2090 and 2111 (the 

‘‘August 13 Notice’’). On August 18, 

2010, Commission staff discovered that 

several footnote cross-references in the 

August 13 Notice were inaccurate. The 

staff believes this was the result of its 

reorganization of the discussion of the 

rules to parallel the numerical order of 

those rules. 

This correction does not substantively 

amend the August 13 Notice. The sole 

purpose of this correction is to rectify 

the footnote errors and alleviate any 

resulting confusion. As the number of 

footnotes affected is significant, the 

entire August 13 Notice is being 

republished with corrected footnotes. 

Correction of Publication 

Accordingly, the August 13 Notice is 

republished in whole to correct certain 

footnotes and footnote cross-references 

as follows: 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–62718; File No. SR–FINRA– 

2010–039] 

Self-Regulatory Organizations; 

Financial Industry Regulatory 

Authority, Inc.; Notice of Filing of 

Proposed Rule Change To Adopt 

FINRA Rules 2090 (Know Your 

Customer) and 2111 (Suitability) in the 

Consolidated FINRA Rulebook 

August 13, 2010. 

Pursuant to Section 19(b)(1) of the 

Securities Exchange Act of 1934 

(‘‘Act’’) 1 and Rule 19b–4 thereunder,2

notice is hereby given that on July 30, 

2010, Financial Industry Regulatory 

Authority, Inc. (‘‘FINRA’’) (f/k/a 

National Association of Securities 

Dealers, Inc. (‘‘NASD’’)) filed with the 

Securities and Exchange Commission 

(‘‘SEC’’ or ‘‘Commission’’) the proposed 

rule change as described in Items I and 

II below, which Items substantially have 

been prepared by FINRA. The 

Commission is publishing this notice to 

solicit comments on the proposed rule 

change from interested persons. 

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

FINRA is proposing to adopt FINRA 

Rule 2090 (Know Your Customer) and 

FINRA Rule 2111 (Suitability) as part of 

the Consolidated FINRA Rulebook. The 

proposed rules are based in large part on 

Incorporated NYSE Rule 405(1) 

(Diligence as to Accounts) and, NASD 

Rule 2310 (Recommendations to 

Customers (Suitability)) and its related 

Interpretative Materials (‘‘IMs’’) 

respectively. As further detailed herein, 

the proposed rule change would delete 

those NASD and Incorporated NYSE 

rules and related NASD IMs and 

Incorporated NYSE Rule Interpretations. 

The text of the proposed rule change 

is available on FINRA’s Web site at 

http://www.finra.org, at the principal 

office of FINRA and at the 

Commission’s Public Reference Room. 

In addition, the text of the proposed rule 

change is included as Exhibit 5 on the 

Commission’s Web site at: http:// 

www.sec.gov/rules/sro/finra.shtml, 

under the heading SR–FINRA–2010– 

039. 

II. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

In its filing with the Commission, 

FINRA included statements concerning 

the purpose of and basis for the 

proposed rule change and discussed any 

comments it received on the proposed 

rule change. The text of these statements 

may be examined at the places specified 

in Item IV below. FINRA has prepared 

summaries, set forth in sections A, B, 

and C below, of the most significant 

aspects of such statements. 

A. Self-Regulatory Organization’s 

Statement of the Purpose of, and 

Statutory Basis for, the Proposed Rule 

Change 

1. Purpose 

As part of the process of developing 

a new consolidated rulebook 

(‘‘Consolidated FINRA Rulebook’’),3

FINRA is proposing to adopt FINRA 

Rule 2090 (Know Your Customer) and 

FINRA Rule 2111 (Suitability). The 

rules are based in large part on NYSE 

Rule 405(1) (Diligence as to Accounts) 

and NASD Rule 2310 

(Recommendations to Customers 

(Suitability)) and its related IMs, 

respectively.4 As further discussed 

below, the proposed rule change would 

delete NASD Rule 2310, IM–2310–1 

(Possible Application of SEC Rules 15g– 

1 through 15g–9), IM–2310–2 (Fair 

Dealing with Customers), IM–2310–3 

(Suitability Obligations to Institutional 

Customers), NYSE Rule 405(1) through 

(3) (including NYSE Supplementary 

Material 405.10 through .30), and NYSE 

Rule Interpretations 405/01 through/ 

04.5

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Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 52563 

6See Proposed FINRA Rule 2090. 

7See Proposed FINRA Rule 2090.01. As 

discussed infra at Item II.C. of this filing, FINRA 

changed the explanation of ‘‘essential facts’’ in 

response to comments. 

8See, e.g., SEC Regulation NMS (National Market 

System), 17 CFR 242.600–242.612; FINRA Rule 

7400 Series (Order Audit Trail System); NASD Rule 

2320 (Best Execution and Interpositioning) 

[proposed FINRA Rule 5310; see Regulatory Notice 

08–80 (December 2008)]; NASD Rule 2400 Series 

(Commissions, Mark-Ups and Charges); NASD IM– 

2110–2 (Trading Ahead of Customer Limit Order) 

[proposed FINRA Rule 5320; see SR–FINRA–2009– 

090]; and IM–2110–3 (Front Running Policy) 

[proposed FINRA Rule 5270; see Regulatory Notice 

08–83 (December 2008)]. 

9FINRA is proposing to adopt NASD Rule 3010 

as FINRA Rule 3110, subject to certain 

amendments. See Regulatory Notice 08–24 (May 

2008). 

10FINRA is proposing to adopt NASD Rule 

3110(c)(1)(C) as FINRA Rule 4512(a)(1)(C), subject 

to certain amendments. See Regulatory Notice 08– 

25 (May 2008). Proposed FINRA Rule 4512(a)(1)(C) 

would clarify that members maintain the signature 

of the partner, officer or manager denoting that the 

account has been accepted in accordance with the 

member’s policies and procedures for acceptance of 

accounts. 

11See 31 CFR 103.122. 

12See 31 CFR 103.19. 

13See, e.g., SEA Rule 15g–1 through 15g–9 

(Penny Stock Rules); FINRA Rule 2360 (Options); 

FINRA Rule 2370 (Security Futures); FINRA Rule 

2130 (Approval Procedures for Day-Trading 

Accounts). 

14As noted previously, FINRA is proposing to 

adopt NASD Rule 3110(c) as FINRA Rule 4512 

(Customer Account Information), subject to certain 

amendments. See Regulatory Notice 08–25 (May 

2008). 

The ‘‘know your customer’’ and 

suitability obligations are critical to 

ensuring investor protection and fair 

dealing with customers. Under the 

proposal, the core features of these 

obligations set forth in NYSE Rule 

405(1) and NASD Rule 2310 remain 

intact. FINRA, however, proposes 

modifications to both rules to strengthen 

and clarify them. In Regulatory Notice 

09–25 (May 2009), FINRA sought 

comment on the proposal. The current 

filing includes additional proposed 

changes that respond to comments. 

Item II.C. of this filing provides a 

detailed discussion of the proposed 

modifications, comments FINRA 

received, and FINRA’s responses 

thereto. In brief, however, the proposed 

FINRA ‘‘Know Your Customer’’ 

obligation, designated FINRA Rule 

2090, captures the main ethical standard 

of NYSE Rule 405(1). As proposed, 

broker-dealers would be required to use 

‘‘due diligence,’’ in regard to the opening 

and maintenance of every account, in 

order to know the essential facts 

concerning every customer.6 The 

obligation would arise at the beginning 

of the customer/broker relationship, 

independent of whether the broker has 

made a recommendation. The proposed 

supplementary material would define 

‘‘essential facts’’ as those ‘‘required to (a) 

effectively service the customer’s 

account, (b) act in accordance with any 

special handling instructions for the 

account, (c) understand the authority of 

each person acting on behalf of the 

customer, and (d) comply with 

applicable laws, regulations, and 

rules.’’ 7

The proposal would eliminate the 

requirement in NYSE Rule 405(1) to 

learn the essential facts relative to 

‘‘every order.’’ FINRA proposes 

eliminating the ‘‘every order’’ language 

because of the application of numerous, 

specific order-handling rules.8 In 

addition, the reasonable-basis obligation 

under the suitability rule requires 

broker-dealers and associated persons to 

perform adequate due diligence so that 

they ‘‘know’’ the securities and strategies 

they recommend. 

FINRA also is proposing to delete 

NYSE Rule 405(2) through (3), NYSE 

Supplementary Material 405.10 through 

.30, and NYSE Rule Interpretation 405/ 

01 through/04 because they generally 

are duplicative of other rules, 

regulations, or laws. For instance, NYSE 

Rule 405(2) requires firms to supervise 

all accounts handled by registered 

representatives. That provision is 

redundant because NASD Rule 3010 

requires firms to supervise their 

registered representatives.9

NYSE Rule 405(3) generally requires 

persons designated by the member to be 

informed of the essential facts relative to 

the customer and to the nature of the 

proposed account and to then approve 

the opening of the account. A number 

of other existing and proposed FINRA 

rules do or will create substantially 

similar obligations. Proposed FINRA 

Rule 2090, discussed herein, would 

require members to know the essential 

facts as to each customer. NASD Rule 

3110(c)(1)(C) requires the signature of 

the member, partner, officer or manager 

who accepts the account.10

A firm’s account-opening obligations 

also are impacted by FINRA Rule 3310, 

which requires a firm to have 

procedures reasonably designed to 

achieve compliance with the Bank 

Secrecy Act and the implementing 

regulations. One of those regulations 

requires the firm to verify the identity 

of a customer opening a new account.11

Another requires due diligence that 

would enable the firm to evaluate the 

risk of each customer and to determine 

if transactions by the customer could be 

suspicious and need to be reported.12

Moreover, before certain customers can 

purchase certain types of investment 

products (such as options, futures or 

penny stocks) or engage in certain 

strategies (such as day trading), the firm 

must explicitly approve their accounts 

for such activity.13

NYSE Supplementary Material 405.10 

is redundant of other FINRA proposed 

and existing requirements, and the cross 

references provided in .20 and .30 are 

no longer necessary. NYSE 

Supplementary Material 405.10 

generally discusses the requirements 

that firms know their customers and 

understand the authority of third-parties 

to act on behalf of customers that are 

legal entities. Proposed FINRA Rule 

2090 and proposed FINRA 

Supplementary Material 2090.01, 

discussed herein, would require firms to 

know the essential facts as to each 

customer. NYSE Supplementary 

Material 405.10 also discusses certain 

documentation obligations regarding 

persons authorized to act on behalf of 

various types of customers that are legal 

entities. NASD Rule 3110(c) (Customer 

Account Information), however, 

similarly requires firms to maintain a 

record identifying the person(s) 

authorized to transact business on 

behalf of a customer that is a legal 

entity.14 NYSE Supplementary Material 

405.20 and .30 provide cross references 

to NYSE Rule 382 (Carrying 

Agreements) and NYSE Rule 414 (Index 

and Currency Warrants), respectively, 

which are no longer necessary or 

appropriate for inclusion in proposed 

FINRA Rule 2090. 

The NYSE Rule Interpretations also 

are redundant. NYSE Rule 

Interpretations 405/01 (Credit 

Reference—Business Background) and/ 

02 (Approval of New Accounts/Branch 

Offices) recommend that the credit 

references and business backgrounds of 

a new account be cleared by a person 

other than the registered representative 

opening the account and require a 

designated person to ultimately approve 

a new account. These obligations are 

substantially similar to the requirements 

in NASD Rule 3110(c)(1)(C) and FINRA 

Rule 3310, discussed above. 

NYSE Rule Interpretation 405/03 

(Fictitious Orders) states that firm 

‘‘personnel opening accounts and/or 

accepting orders for new or existing 

accounts should make every effort to 

verify the legitimacy of the account and 

the validity of every order.’’ The 

interpretation contemplates knowing 

the customer behind the order as part of 

the process of ensuring that the order is 

bona fide. Proposed FINRA Rule 2090 

and FINRA Rule 3310 together place 

similar requirements on firms to know 

their customers. 

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52564 Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 

15See, e.g., Terrance Yoshikawa, Securities 

Exchange Act Release No. 53731, 2006 SEC LEXIS 

948 (April 26, 2006) (upholding finding that 

president of broker-dealer violated just and 

equitable principles of trade and anti-fraud 

provisions by fraudulently entering orders designed 

to manipulate the price of securities). 

16See Proposed FINRA Rule 2111(a). 

17See Proposed FINRA Rule 2111(a). As 

discussed infra at Item II.C. of this filing, FINRA 

modified various aspects of the proposed 

information-gathering requirements in response to 

comments. 

18FINRA is proposing to adopt NASD IM–2210– 

6 as FINRA Rule 2214, without material change. See 

Regulatory Notice 09–55 (September 2009). 

19See Proposed FINRA Rule 2111.02. As 

discussed infra at Item II.C. of this filing, FINRA 

included this exception to the rule’s coverage in 

response to comments. 

20See Proposed FINRA Rule 2111.03. 

21See Proposed FINRA Rule 2111(b). The 

requirement in Proposed FINRA Rule 2111(b) that 

the firm or associated person have a reasonable 

basis to believe that ‘‘the institutional customer is 

capable of evaluating investment risks 

independently, both in general and with regard to 

particular transactions and investment strategies’’ 

comes from current IM–2310–3. As FINRA 

explained in that IM, ‘‘[i]n some cases, the member 

may conclude that the customer is not capable of 

making independent investment decisions in 

general. In other cases, the institutional customer 

may have general capability, but may not be able 

to understand a particular type of instrument or its 

risk.’’ FINRA further stated that, ‘‘[i]f a customer is 

either generally not capable of evaluating 

investment risk or lacks sufficient capability to 

evaluate the particular product, the scope of a 

member’s customer-specific obligations under the 

suitability rule would not be diminished by the fact 

that the member was dealing with an institutional 

customer.’’ FINRA also stated that ‘‘the fact that a 

customer initially needed help understanding a 

potential investment need not necessarily imply 

that the customer did not ultimately develop an 

understanding and make an independent decision.’’ 

22See Proposed FINRA Rule 2111(b). 

23See Proposed FINRA Rule 2111(b). As 

discussed infra at Item II.C. of this filing, FINRA 

substituted this requirement for another in response 

to comments. FINRA emphasizes that the 

institutional-customer exemption applies only if 

both parts of the two-part test are met: (1) There is 

a reasonable basis to believe that the institutional 

customer is capable of evaluating investment risks 

independently, in general and with regard to 

particular transactions and investment strategies, 

and (2) the institutional customer affirmatively 

To the extent NYSE Rule 

Interpretation 405/03 seeks to guard 

against the use of fictitious trades as a 

means of manipulating markets, various 

FINRA rules cover such activities. 

FINRA Rule 5210 (Publication of 

Transactions and Quotations) prohibits 

members from publishing or circulating 

or causing to publish or circulate, any 

notice, circular, advertisement, 

newspaper article, investment service, 

or communication of any kind which 

purports to report any transaction as a 

purchase or sale of, or purports to quote 

the bid or asked price for, any security 

unless such member believes that such 

transaction or quotation was bona fide. 

FINRA Rule 5220 (Offers at Stated 

Prices) prohibits members from making 

an offer to buy from or sell to any 

person any security at a stated price 

unless such member is prepared to 

purchase or sell at such price and under 

such conditions as are stated at the time 

of such offer to buy or sell. Moreover, 

the use of fictitious transactions by a 

member or associated person to 

manipulate the market would violate 

FINRA’s just and equitable principles of 

trade (FINRA Rule 2010) and anti-fraud 

provision (FINRA Rule 2020).15

NYSE Rule Interpretation 405/04 

(Accounts in which Member 

Organizations have an Interest) 

discusses requirements regarding 

transactions initiated ‘‘on the Floor’’ for 

an account in which a member 

organization has an interest. The 

interpretation is directed to the NYSE 

marketplace. Moreover, Section 11(a) of 

the Act and the rules thereunder 

address trading by members of 

exchanges, brokers and dealers. For the 

reasons discussed above, FINRA 

believes NYSE Rule 405(1) through (3), 

NYSE Supplementary Material 405.10 

through .30, and NYSE Rule 

Interpretations 405/01 through/04 are 

no longer necessary. They will be 

eliminated from the current FINRA 

rulebook upon Commission approval 

and implementation by FINRA of this 

current proposed rule change. 

The proposed new suitability rule, 

designated 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* * *.’’ 16 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.’’ 17

The proposal would add the term 

‘‘strategy’’ to the rule text so that the rule 

explicitly covers a recommended 

strategy. Although FINRA generally 

intends the term ‘‘strategy’’ to be 

interpreted broadly, the proposed 

supplementary material would exclude 

the following communications from the 

coverage of Rule 2111 as long as they do 

not include (standing alone or in 

combination with other 

communications) a recommendation of 

a particular security or securities: 

• General financial and investment 

information, including (i) basic 

investment concepts, such as risk and 

return, diversification, dollar cost 

averaging, compounded return, and tax 

deferred investment, (ii) historic 

differences in the return of asset classes 

(e.g., equities, bonds, or cash) based on 

standard market indices, (iii) effects of 

inflation, (iv) estimating future 

retirement income needs, and (v) 

assessment of a customer’s investment 

profile; 

• Descriptive information about an 

employer-sponsored retirement or 

benefit plan, participation in the plan, 

the benefits of plan participation, and 

the investment options available under 

the plan; 

• Asset allocation models that are (i) 

based on generally accepted investment 

theory, (ii) accompanied by disclosures 

of all material facts and assumptions 

that may affect a reasonable investor’s 

assessment of the asset allocation model 

or any report generated by such model, 

and (iii) in compliance with NASD IM– 

2210–6 (Requirements for the Use of 

Investment Analysis Tools) if the asset 

allocation model is an ‘‘investment 

analysis tool’’ covered by NASD IM– 

2210–6; 18 and 

• Interactive investment materials 

that incorporate the above.19

The proposal also would codify 

interpretations of the three main 

suitability obligations, listed below: 

• Reasonable basis (members must 

have a reasonable basis to believe, based 

on adequate due diligence, that a 

recommendation is suitable for at least 

some investors); 

• Customer specific (members must 

have reasonable grounds to believe a 

recommendation is suitable for the 

particular investor at issue); and 

• Quantitative (members must have a 

reasonable basis to believe the number 

of recommended transactions within a 

certain period is not excessive).20

In addition, the proposal would 

modify the institutional-customer 

exemption by focusing on whether there 

is a reasonable basis to believe that the 

institutional customer is capable of 

evaluating investment risks 

independently, both in general and with 

regard to particular transactions and 

investment strategies,21 and is 

exercising independent judgment in 

evaluating recommendations.22 The 

proposal, moreover, would require 

institutional customers to affirmatively 

indicate that they are exercising 

independent judgment.23 The proposal 

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Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 52565 

indicates that it is exercising independent judgment 

in evaluating recommendations. 

24See Proposed FINRA Rule 2111(b). FINRA is 

proposing to adopt NASD Rule 3110(c)(4) as FINRA 

Rule 4512(c), without material change. See 

Regulatory Notice 08–25 (May 2008). 

25See Proposed Rule 2111(a). 

26See SEA Rule 15g–1 through 15g–9. 

27See Section 10(b) of the Act; FINRA Rule 2020. 

28See Proposed Rule 2111(a). 

29See Proposed Rule 2111.03. 

30See Proposed Rule 2111.04. 

31See Proposed Rule 2111.01. 

32See, e.g., Robert L. Gardner, 52 S.E.C. 343, 344 

n.1 (1995), aff’d, 89 F.3d 845 (9th Cir. 1996) (table 

format); Keith L. DeSanto, 52 S.E.C. 316, 317 n.1 

(1995), aff’d, 101 F.3d 108 (2d Cir. 1996) (table 

format); Jonathan G. Ornstein, 51 S.E.C. 135, 137 

(1992); Dep’t of Enforcement v. Griffith, No. 

C01040025, 2006 NASD Discip. LEXIS 30, at *11– 

12 (NAC Dec. 29, 2006); Dep’t of Enforcement v. 

Puma, No. C10000122, 2003 NASD Discip. LEXIS 

22, at *12 n.6 (NAC Aug. 11, 2003). 

33 15 U.S.C. 78o–3(b)(6). 

34See, e.g., William A. Jacobson and Sang Joon 

Kim, Cornell Securities Law Clinic, June 27, 2009 

(‘‘Cornell Letter’’). 

35See Bari Havlik, SVP and Chief Compliance 

Officer for Charles Schwab & Co., June 29, 2009 

(‘‘Charles Schwab Letter’’); Matthew Farley, Drinker, 

Biddle & Reath LLP, June 29, 2009 (‘‘Drinker Biddle 

Letter’’); Mike Hogan, President and CEO of 

FOLIOfn Investments, Inc., June 29, 2009 (‘‘FOLIOfn 

Letter’’); Lisa Roth, National Ass’n of Independent 

Broker-Dealers, Inc., June 29, 2009 (‘‘NAIBD 

Continued 

also would harmonize the definition of 

institutional customer in the suitability 

rule with the more common definition 

of ‘‘institutional account’’ in NASD Rule 

3110(c)(4).24

Finally, the suitability proposal 

would eliminate or modify a number of 

the IMs associated with the existing 

suitability rule because they are no 

longer necessary. Some of the 

discussions are not needed because of 

the changes to the scope of the 

suitability rule proposed herein (e.g., 

the proposed rule text would capture 

‘‘strategies’’ currently referenced in IM– 

2310–3).25 Others are redundant 

because they identify conduct explicitly 

covered by other rules (e.g., 

inappropriate sale of penny stocks 

referenced in IM–2310–1 is covered by 

the SEC’s penny stock rules,26

fraudulent conduct identified in IM– 

2310–2 is covered by the FINRA and 

SEC anti-fraud provisions 27). 

Still other IM discussions have been 

incorporated in some form into the 

proposed rule or its supplementary 

material. For example, the exemption in 

IM–2310–3 dealing with institutional 

customers is modified and moved to the 

text of proposed FINRA Rule 2111.28 In 

addition, the explication of the three 

main suitability obligations, currently 

located in IM–2310–2 and IM–2310–3, 

are consolidated into a single discussion 

in the proposed rule’s supplementary 

material.29 Similarly, the proposed 

rule’s supplementary material includes 

a modified form of the current 

requirement in IM–2310–2 that a 

member refrain from recommending 

purchases beyond a customer’s 

capability.30 The supplementary 

material also retains the discussion in 

IM–2310–2 and IM–2310–3 regarding 

the suitability rule’s significance in 

promoting fair dealing with customers 

and ethical sales practices.31

The only type of misconduct 

identified in the IMs that is neither 

explicitly covered by other rules nor 

incorporated in some form into the 

proposed new suitability rule is 

unauthorized trading, currently 

discussed in IM–2310–2. However, it is 

well-settled that unauthorized trading 

violates just and equitable principles of 

trade under FINRA Rule 2010 

(previously NASD Rule 2110).32

Consequently, the elimination of the 

discussion of unauthorized trading in 

the IMs following the suitability rule in 

no way alters the longstanding view that 

unauthorized trading is serious 

misconduct and clearly violates 

FINRA’s rules. 

FINRA will announce the 

implementation date of the proposed 

rule change in a Regulatory Notice to be 

published no later than 90 days 

following Commission approval. The 

implementation date will be no later 

than 240 days following Commission 

approval. 

2. Statutory Basis 

The proposed rule change is 

consistent with the provisions of 

Section 15A(b)(6) of the Act,33 which 

requires, among other things, that 

FINRA’s rules must be designed to 

prevent fraudulent and manipulative 

acts and practices, to promote just and 

equitable principles of trade, and, in 

general, to protect investors and the 

public interest. The proposed rule 

change furthers these purposes because 

it requires firms and associated persons 

to know, deal fairly with, and make only 

suitable recommendations to customers. 

B. Self-Regulatory Organization’s 

Statement on Burden on Competition 

FINRA does not believe that the 

proposed rule change will result in any 

burden on competition that is not 

necessary or appropriate in furtherance 

of the purposes of the Act. 

C. Self-Regulatory Organization’s 

Statement on Comments on the 

Proposed Rule Change Received From 

Members, Participants, or Others 

As noted above, the proposed rule 

change was published for comment in 

Regulatory Notice 09–25 (May 2009). A 

copy of the Notice can be viewed at 

http://www.finra.org/web/groups/ 

industry/@ip/@reg/@notice/documents/ 

notices/p118709.pdf. FINRA received 

2,083 comment letters, 389 of which 

were individualized letters and 1,694 of 

which were form letters. An index to the 

comment letters received in response to 

the Notice can be viewed at http:// 

www.finra.org/Industry/Regulation/ 

Notices/2009/P118711, and copies of 

the comment letters received in 

response to the Notice can also be 

accessed through that Web site. In 

addition, these documents, submitted 

with FINRA’s filing as Exhibits 2a, 2b, 

and 2c, respectively, can be viewed at 

the Commission’s Web site at: http:// 

www.sec.gov/rules/sro/finra.shtml, 

under the heading SR–FINRA–2010– 

039. 

Comments came from broker-dealers, 

insurers, investment advisers, 

academics, industry associations, 

investor-protection groups, lawyers in 

private practice, and a state government 

agency. Commenters had myriad 

different views regarding nearly every 

aspect of the proposal. A discussion of 

those comments and FINRA’s responses 

thereto follows. 

Know Your Customer (Proposed FINRA 

Rule 2090) 

The proposal would require brokerdealers to use ‘‘due diligence, in regard 

to the opening and maintenance of 

every account, to know (and retain) the 

essential facts concerning every 

customer and concerning the authority 

of each person acting on behalf of such 

customer.’’ Although there were some 

comments generally in favor of the 

proposal,34 most comments addressed 

specific language, as discussed below. 

Essential Facts 

The proposal states that brokerdealers must attempt to learn the 

‘‘essential facts’’ concerning every 

customer. Supplementary Material .01 

that was discussed in the Notice seeking 

comment clarified that ‘‘facts ‘essential’ 

to ‘knowing the customer’ included the 

customer’s financial profile and 

investment objectives or policy.’’ That 

language generated a fairly large number 

of comments. 

• Comments: 

A number of commenters argued that 

the collection of financial profile and 

investment objective information under 

the proposed ‘‘know your customer’’ rule 

is a new requirement and unnecessarily 

confuses ‘‘know your customer’’ 

obligations with suitability 

obligations.35 One commenter believed 

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52566 Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 

Letter’’); Joan Hinchman, Executive Director, 

President, and CEO of the National Society of 

Compliance Professionals Inc., June 29, 2009 

(‘‘NSCP Letter’’); Amal Aly, Managing Director and 

Associate General Counsel, Securities Industry and 

Financial Markets Association, June 29, 2000 

(‘‘SIFMA Letter’’); John S. Markle, Deputy General 

Counsel for TD Ameritrade, June 29, 2009 (‘‘TD 

Ameritrade Letter’’); Sarah McCafferty, Vice 

President and Chief compliance Officer at 

T.RowePrice, June 29, 2009 (‘‘T.RowePrice Letter’’); 

Ronald C. Long, Director of Regulatory Affairs for 

Wells Fargo Advisors, LLC, June 29, 2009 (‘‘Wells 

Fargo Letter’’). 

36See T.RowePrice Letter, supra note 35. 37See Charles Schwab Letter, supra note 35; 

Drinker Biddle Letter, supra note 35; FOLIOfn 

Letter, supra note 35; SIFMA Letter, supra note 35; 

TD Ameritrade Letter, supra note 35; Wells Fargo 

Letter, supra note 35. One commenter made the 

same claim in the context of clearing firms and also 

stated that requiring a clearing firm to maintain this 

information as well as the introducing firm—which 

has the primary if not exclusive contact with the 

customer—would create a needless redundancy of 

effort, expense and information storage. See Drinker 

Biddle Letter, supra note 35. 

38See SIFMA Letter, supra note 35; Wells Fargo 

Letter, supra note 35. 

39See SIFMA Letter, supra note 35; TD 

Ameritrade Letter, supra note 35; Wells Fargo 

Letter, supra note 35. 

40See FOLIOfn Letter, supra note 35. 

41See Cornell Letter, supra note 34. 

42See Cornell Letter, supra note 34. 

43See Clifford Kirsch and Eric Arnold, 

Sutherland Asbill & Brennan LLP for the Committee 

of Annuity Insurers, June 29, 2009 (‘‘Committee of 

Annuity Insurers Letter’’). 

44See Committee of Annuity Insurers Letter, 

supra note 43; Clifford E. Kirsch, Sutherland Asbill 

& Brennan LLP on behalf of John Hancock Life 

Insurance Co., MetLife Inc., and the Prudential 

Insurance Co. of America, June 29, 2009 (‘‘Hancock, 

MetLife and Prudential Letter’’). 

45See Committee of Annuity Insurers Letter, 

supra note 43; Hancock, MetLife and Prudential 

Letter, supra note 44. 

46Broker-Dealers should note, however, that, 

under SEA Rule 17a–3, they must, among other 

things, attempt to update certain account 

information every 36 months regarding accounts for 

which the broker-dealers were required to make 

suitability determinations. 

47See Cornell Letter, supra note 34; Rex A. 

Staples, General Counsel for the North American 

Securities Administrators Association, July 13, 2009 

(‘‘NASAA Letter’’). 

48See Cornell Letter, supra note 34; NASAA 

Letter, supra note 47. 

49See NASAA Letter, supra note 47. 

50See supra note 8. 

it would mislead customers into 

incorrectly thinking that a firm would 

only permit a customer to execute a selfdirected transaction if it has determined 

that the transaction is appropriate for 

that customer.36 Along those same lines, 

other commenters believed the 

requirement would be particularly 

problematic where a customer’s trading 

activity is self-directed or directed by an 

independent investment adviser 

because regulators or private litigants 

could seek to hold firms accountable for 

permitting unsolicited customer trading 

activity that is inconsistent with the 

‘‘know your customer’’ information that 

is on record at the firm.37

Some of these commenters supported 

‘‘know your customer’’ obligations, but 

believed they should be limited in scope 

to essential facts necessary to open the 

account—i.e., the identity and address 

of each account owner, the legal 

authorization of each person having 

investment authority with respect to the 

account, the source of funding for the 

account, and the credit status of the 

account owners.38 Some commenters 

suggested removing proposed 

Supplementary Material .01 to Rule 

2090 in its entirety and instead 

permitting each firm to interpret and 

apply the ‘‘essential facts’’ standard to 

their particular business model, 

recognizing that it is the nature of the 

relationship between the firm and 

customer that dictates those facts.39

Another commenter similarly stated that 

the information should be limited to an 

investor’s name, address, and tax 

identification number, which the 

commenter asserted was all the 

information that is needed to know the 

customer’s identity and to make a credit 

determination.40

One commenter, however, believed 

that firms should have to make 

reasonable efforts to collect the types of 

information delineated in paragraph (a) 

of proposed Rule 2111.41 This 

commenter indicated that each of those 

factors is essential to knowing the 

customer.42 Others suggested that the 

term should be clarified.43

• FINRA’s Response: 

After analyzing the comments, FINRA 

agrees with those commenters who 

stated that the ‘‘know your customer’’ 

obligation should remain flexible and 

that the extent of the obligation 

generally should depend on a particular 

firm’s business model, its customers, 

and applicable regulations. As a result, 

FINRA has modified proposed 

Supplementary Material .01 to FINRA 

Rule 2090 so that it is less prescriptive. 

That provision now states: ‘‘For 

purposes of this Rule, facts ‘essential’ to 

‘knowing the customer’ are those 

required to (a) effectively service the 

customer’s account, (b) act in 

accordance with any special handling 

instructions for the account, (c) 

understand the authority of each person 

acting on behalf of the customer, and (d) 

comply with applicable laws, 

regulations, and rules.’’ 

Maintenance of Every Account 

A few commenters focused on the 

‘‘maintenance’’ aspect of the ‘‘know your 

customer’’ requirement. 

• Comments: 

Two commenters stated that the 

‘‘maintenance’’ language was both new 

and vague and would lead to practical 

implementation issues, particularly in 

the retirement plan marketplace.44 The 

commenters stated that FINRA should 

provide more guidance on what it 

means by ‘‘maintenance’’ and an 

opportunity to comment if it keeps the 

term.45

• FINRA’s Response: 

FINRA believes that it is self-evident 

that a broker-dealer must know its 

customers not only at account opening 

but also throughout the life of its 

relationship with customers in order to, 

among other things, effectively service 

and supervise the customer accounts. 

Since a broker-dealer’s relationship with 

its customers is dynamic, FINRA does 

not believe that it can prescribe a period 

within which broker-dealers must 

attempt to update this information. 

Firms should verify the essential facts 

about customers at intervals reasonably 

calculated to prevent and detect any 

mishandling of customer accounts that 

might result from changes to the 

‘‘essential facts’’ about the customers.46

The reasonableness of a broker-dealer’s 

efforts in this regard will depend on the 

facts and circumstances of the particular 

case. 

Not Applicable to Every Order 

At present, NYSE Rule 405(1) applies 

to ‘‘every order.’’ The proposal 

eliminates this language. 

• Comments: 

Two commenters argued that the 

proposed ‘‘know your customer’’ rule 

should, as is true currently under NYSE 

Rule 405(1), require due diligence as to 

‘‘every order’’ and not simply as to every 

account.47 These commenters stated 

that it was a mistake to focus on 

knowing the customer rather than 

knowing both the customer and the 

product.48 One of these commenters did 

not believe that reasonable-basis 

suitability provides enough protection 

in that respect in part because the 

suitability rule applies only when a 

recommendation is made.49

• FINRA’s Response: 

FINRA is not proposing to adopt the 

NYSE requirement to learn the essential 

facts relative to every order in NYSE 

Rule 405(1), given the application of 

specific order-handling rules.50 In 

addition, as noted by a commenter, the 

reasonable-basis obligation under the 

suitability rule requires broker-dealers 

and associated persons to know the 

securities and strategies they 

recommend through performing 

adequate due diligence. 

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51NASAA Letter, supra note 47. 

52See NSCP Letter, supra note 35; Committee of 

Annuity Insurers Letter, supra note 43. In addition, 

491 individuals and entities made this point, among 

others, using one form letter (‘‘Form Letter Type A’’) 

and 1,203 individuals did so using another form 

letter (‘‘Form Letter Type B’’). 

53See NSCP Letter, supra note 35. 

54Release Nos. IC–22579, IA–1623, S7–24–95, 

1997 SEC LEXIS 673, at *26 (Mar. 24, 1997) (Status 

of Investment Advisory Programs under the 

Investment Company Act of 1940). See also 

Shearson, Hammill & Co., 42 S.E.C. 811 (1965) 

(finding willful violations of Section 206 of the 

Advisers Act when investment adviser made 

unsuitable recommendations). 

55 Investment Advisers Act Release No. 1406, 

1994 SEC LEXIS 797, at *4 (Mar. 16, 1994) 

(Suitability of Investment Advice Provided by 

Investment Advisers). 

56Raghavan Sathianathan, Securities Exchange 

Act Release No. 54722, 2006 SEC LEXIS 2572, at 

*21 (Nov. 8, 2006), aff’d, 304 F. App’x 883 (D.C. Cir. 

2008); see also Dane S. Faber, Securities Exchange 

Act Release No. 49216, 2004 SEC LEXIS 277, at 

*23–24 (Feb. 10, 2004) (explaining that a broker’s 

recommendations ‘‘must be consistent with his 

customer’s best interests’’); Daniel R. Howard, 55 

S.E.C. 1096, 1099–1100 (2002) (same), aff’d, 77 F. 

App’x 2 (1st Cir. 2003). 

57FINRA notes as well that the suitability rule is 

only one of many FINRA business-conduct rules 

with which broker-dealers and their associated 

persons must comply. Many FINRA rules prohibit, 

limit, or require disclosure of conflicts of interest. 

Broker-dealers and their associated persons, for 

instance, must comply with just and equitable 

principles of trade, standards for communications 

with the public, order-handling requirements, fairpricing standards, and various disclosure 

obligations regarding research, trading, 

compensation, margin, and certain sales and 

distribution activity, among others, in addition to 

suitability obligations. 

58See Notice to Members 96–32, 1996 NASD 

LEXIS 51, at *2 (May 1996); see also Notice to 

Members 05–68, 2005 NASD LEXIS 44, at *11 (Oct. 

2005) (stating that members and their associated 

persons ‘‘should perform a careful analysis to 

determine whether liquefying home equity [to 

facilitate the purchase of securities] is a suitable 

strategy for an investor’’); Notice to Members 04–89, 

2004 NASD LEXIS 76, at *7 (Dec. 2004) (same). 

(Change to footnote made per email from James 

Wrona, Associate Vice President and Associate 

General Counsel, FINRA, to Bonnie Gauch, Special 

Counsel, Division of Trading and Markets, 

Commission, dated August 12, 2010.) 

59See Securities Exchange Act Release No. 44178, 

2001 SEC LEXIS 731, at *28–29 (April 12, 2001), 

66 FR 20697, 20702 (April 24, 2001) (Notice of 

Filing and Immediate Effectiveness of FINRA’s 

Online Suitability Policy Statement). 

60See, e.g., Jack H. Stein, Securities Exchange Act 

Release No. 47335, 2003 SEC LEXIS 338, at *15 

(Feb. 10, 2003); Justine S. Fischer, 53 S.E.C. 734 

(1998); Stephen T. Rangen, 52 S.E.C. 1304, 1307– 

1308 (1997); Arthur J. Lewis, 50 S.E.C. 747, 748–50 

(1991). 

61See Barbara Black, Director of the Corporate 

Law Center of the University of Cincinnati College 

of Law, and Jill I. Gross, Director of the Investor 

Rights Clinic of the Pace University School of Law 

(‘‘Corporate Law Center & Investor Rights Clinic 

Letter’’), June 29, 2009; Peter J. Harrington, Christine 

Lazaro & Lisa A. Catalano, Securities Arbitration 

Continued 

Suitability (Proposed FINRA Rule 2111) 

Fiduciary Standard 

Although FINRA did not request 

comment on whether fiduciary 

obligations should influence the 

suitability proposal, more than a 

thousand commenters raised issues 

involving fiduciary obligations. A brief 

discussion of these issues is thus 

warranted. 

• Comments: 

One commenter suggested that FINRA 

should consider a fiduciary duty 

standard in addition to a suitability 

standard.51 Numerous other 

commenters argued that FINRA should 

not move forward with proposed 

changes to the suitability rule until after 

policymakers (e.g., Congress, the SEC, 

and/or FINRA) determine whether 

broker-dealers must comply with 

fiduciary obligations.52 One commenter 

further posited that it would be easier 

for firms to implement a single, 

integrated change to customer care 

standards adopted at one time.53

• FINRA’s Response: 

FINRA notes that the application of a 

suitability standard is not inconsistent 

with a fiduciary duty standard. In this 

regard, the SEC emphasized in one 

release that ‘‘investment advisers under 

the Advisers Act,’’ who have fiduciary 

duties, ‘‘owe their clients the duty to 

provide only suitable investment advice 

* * *. To fulfill this suitability 

obligation, an investment adviser must 

make a reasonable determination that 

the investment advice provided is 

suitable for the client based on the 

client’s financial situation and 

investment objectives.’’ 54 In another 

release, the SEC similarly explained that 

‘‘[i]nvestment advisers are fiduciaries 

who owe their clients a series of duties, 

one of which is the duty to provide only 

suitable investment advice.’’ 55

Suitability obligations constitute a 

material part of a fiduciary standard in 

the context of investment advice and 

recommendations. It also is important to 

note that case law makes clear that, 

under FINRA’s suitability rule, ‘‘a 

broker’s recommendations must be 

consistent with his customers’ best 

interests.’’ 56 Thus, the suitability 

obligations set forth in proposed Rule 

2111 would not be inconsistent with the 

addition of a fiduciary duty at some 

future date.57

Scope of the Suitability Rule 

FINRA sought comment on two main 

issues potentially impacting the scope 

of the suitability rule: Whether to add 

the term ‘‘strategy’’ to the rule language 

and whether to broaden the rule so that 

it reaches non-securities products. The 

second issue was not highlighted in the 

rule text. Rather, it was raised in a 

discussion in the Notice seeking 

comment. 

Scope of the Suitability Rule/Strategies 

The issue of whether the suitability 

rule applies to recommended strategies 

has been addressed previously. SEC and 

FINRA discussions in IMs, releases, and 

notices, as well as in some decisions, 

indicate that the current suitability rule 

applies to certain types of recommended 

strategies. 

NASD IM–2310–3 (Suitability 

Obligations to Institutional Customers) 

provides in its ‘‘Preliminary Statement’’ 

that broker-dealers’ ‘‘responsibilities 

include having a reasonable basis for 

recommending a particular security or 

strategy, as well as having reasonable 

grounds for believing the 

recommendation is suitable for the 

customer to whom it is made.’’ 

Similarly, Notices to Members have 

stated that broker-dealers’ 

responsibilities under Rule 2310 

‘‘include having a reasonable basis for 

recommending a particular security or 

strategy.’’ 58 Moreover, when the SEC 

published FINRA’s Online Suitability 

Policy Statement, Notice to Members 

01–23 (Apr. 2001) (‘‘NTM 01–23’’), in the 

Federal Register, the Commission 

included the following statement in the 

release: ‘‘The Commission notes that 

although [NTM] 01–23 does not 

expressly discuss electronic 

communications that recommend 

investment strategies, the NASD 

suitability rule continues to apply to the 

recommendation of investment 

strategies, whether that 

recommendation is made via electronic 

communication or otherwise.’’ 59

A number of SEC decisions also 

support application of the suitability 

rule to recommended strategies. The 

case often cited as standing for such a 

proposition is F.J. Kaufman & Co., 50 

S.E.C. 164 (1989), in which the SEC 

found that the respondent violated 

NASD Rule 2310 by recommending an 

unsuitable strategy to customers. A 

number of Commission decisions issued 

after Kaufman also lend support for 

applying the suitability rule to 

recommended strategies in certain 

situations. Many of these cases involved 

recommendations to purchase securities 

on margin (which can be viewed as a 

strategy).60

The proposed suitability rule 

explicitly covers recommended 

strategies. The commenters’ views on 

the inclusion of the term were varied. 

• Comments: 

A number of commenters supported 

the addition of the term to the rule 

text.61 Some commenters requested that 

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Clinic at St. John’s University, June 25, 2009 (‘‘St. 

John’s Letter’’); Cornell Letter, supra note 34; 

T.RowePrice Letter, supra note 35; Peter J. Mougey 

and Kristian P. Kraszewski, Levin, Papantonio, 

Thomas, Mitchell, Echsner & Proctor P.A., June 29, 

2009 (‘‘Mougey and Kraszewski Letter’’); Daniel C. 

Rome, General Counsel of Taurus Compliance 

Consulting LLC, June 29, 2009 (‘‘Taurus Letter’’). 

62See Cornell Letter, supra note 34; Mougey and 

Kraszewski Letter, supra note 61; St. John’s Letter, 

supra note 61. 

63See Mougey and Kraszewski Letter, supra note 

61; St. John’s Letter, supra note 61. 

64See Charles Schwab Letter, supra note 35. 

65See SIFMA Letter, supra note 35; NSCP Letter, 

supra note 35. 

66See NSCP Letter, supra note 35. A number of 

commenters stated that FINRA should eliminate the 

term strategy from the rule but argued that, if 

FINRA continues to use it, FINRA needed to clarify 

what the term means. See Committee of Annuity 

Insurers Letter, supra note 43; James Livingston, 

President and CEO of National Planning Holdings, 

Inc., June 29, 2009 (‘‘National Planning Holdings 

Letter’’); Stephanie L. Brown, Managing Director 

and General Counsel for LPL Financial Corporation, 

June 29, 2009 (‘‘LPL Letter’’). 

67See NSCP Letter, supra note 35. 

68See LPL Letter, supra note 66; Committee of 

Annuity Insurers Letter, supra note 43; Hancock, 

MetLife and Prudential Letter, supra note 44; 

National Planning Holdings Letter, supra note 66. 

69See Hancock, MetLife and Prudential Letter, 

supra note 44 (citing 29 CFR 2509.96–1(d)). 

70See, e.g., Dist. Bus. Conduct Comm. v. Nickles, 

Complaint No. C8A910051, 1992 NASD Discip. 

LEXIS 28, at *18 (NBCC Oct. 19, 1992) (holding that 

suitability rule ‘‘applies not only to transactions that 

registered persons effect for their clients, but also 

to any recommendations that a registered person 

makes to his or her client’’). 

71See, e.g., Rafael Pinchas, 54 S.E.C. 331, 341 

n.22 (1999) (‘‘Transactions that were not specifically 

authorized by a client but were executed on the 

client’s behalf are considered to have been 

implicitly recommended within the meaning of the 

NASD rules.’’); Paul C. Kettler, 51 S.E.C. 30, 32 n.11 

(1992) (stating that transactions broker effects for a 

discretionary account are implicitly recommended). 

72See Hancock, MetLife and Prudential Letter, 

supra note 44 (citing 29 CFR 2509.96–1(d)). 

73See Mougey and Kraszewski Letter, supra note 

61; Taurus Letter, supra note 61. 

74See Mougey and Kraszewski Letter, supra note 

61. 

75See Taurus Letter, supra note 61. 

76See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61. 

77See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61. 

FINRA make clear in the supplementary 

material that the term ‘‘strategy’’ should 

be interpreted broadly and include 

recommendations to hold an 

investment.62 Some of these 

commenters also believed that firms 

should have an affirmative duty to 

review portfolios that are transferred 

into a firm and that the lack of a 

recommendation to make any changes 

to the portfolio effectively constitutes an 

implicit recommendation to retain what 

is in the account.63

Other commenters supported the 

inclusion of the term strategy but asked 

FINRA to clarify that the suitability rule 

would apply only to recommended 

‘‘strategies resulting in the purchase, 

sale or exchange of a security or 

securities’’ 64 or where there is a 

‘‘reasonable nexus between the 

recommended investment strategy and a 

securities transaction in furtherance of 

the recommended strategy.’’ 65 Other 

commenters stated that FINRA should 

define or clarify the term ‘‘strategy.’’ 66

One of these commenters believed that, 

without a definition, there would be 

confusion among firms and FINRA 

examiners regarding whether all asset 

allocation programs and ‘‘buy and hold’’ 

recommendations should be viewed as 

strategies.67

A number of commenters opposed the 

inclusion of the term ‘‘strategy.’’ 68

However, one of these commenters 

stated that, if FINRA includes the term 

in the final proposal, FINRA should 

except from the rule’s coverage any 

information determined to be 

‘‘investment education’’ under the 

Employee Retirement Income Security 

Act (‘‘ERISA’’).69

• FINRA’s Response: 

FINRA agrees that the term ‘‘strategy’’ 

should be included in the rule language 

and that, in general, it should be 

interpreted broadly. For instance, 

FINRA rejects the contention that the 

rule should only cover a recommended 

strategy if it results in a transaction. As 

with the current suitability rule, 

application of the proposed rule would 

be triggered when the broker-dealer or 

associated person recommends the 

security or strategy regardless of 

whether the recommendation results in 

a transaction.70 The term ‘‘strategy,’’ 

moreover, would cover explicit 

recommendations to hold a security or 

securities. The rule recognizes that 

customers may rely on members’ and 

associated persons’ investment expertise 

and knowledge, and it is thus 

appropriate to hold members and 

associated persons responsible for the 

recommendations that they make to 

customers, regardless of whether those 

recommendations result in transactions 

or generate transaction-based 

compensation. 

In regard to the comment concerning 

implicit recommendations on portfolios 

transferred to a firm, FINRA notes that 

nothing in the current rule proposal is 

intended to change the longstanding 

application of the suitability rule on a 

recommendation-by-recommendation 

basis. In limited circumstances, FINRA 

and the SEC have recognized that 

implicit recommendations can trigger 

suitability obligations. For example, 

FINRA and the SEC have held that 

associated persons who effect 

transactions on a customer’s behalf 

without informing the customer have 

implicitly recommended those 

transactions, thereby triggering 

application of the suitability rule.71 The 

rule proposal is not intended to broaden 

the scope of implicit recommendations. 

As discussed in Item 3 of this rule 

filing, FINRA also proposes to explicitly 

exempt from the rule’s coverage certain 

categories of educational material as 

long as they do not include (standing 

alone or in combination with other 

communications) a recommendation of 

a particular security or securities. 

FINRA believes that it is important to 

encourage broker-dealers and associated 

persons to freely provide educational 

material and services to customers. As 

one commenter explained, the U.S. 

Department of Labor provided a similar 

exemption from some requirements 

under ERISA.72

Scope of the Suitability Rule/NonSecurities Products 

The current suitability rule and the 

proposed new suitability rule cover 

recommendations involving securities. 

In the Notice seeking comment, 

however, FINRA asked whether the 

suitability rule should cover 

recommendations of non-securities 

products made in connection with the 

firm’s business. This issue generated the 

greatest number of comments, most of 

which were against extending the rule’s 

reach. 

• Comments: 

Some commenters favored broadening 

the suitability rule so that it covers nonsecurities products.73 One commenter 

stated that the expansion was needed 

because broker-dealers market more 

than just securities and oftentimes 

customers do not understand that they 

may be afforded less protection when 

purchasing non-securities products.74

Another commenter stated that it would 

be unreasonable for a firm to allow a 

non-securities recommendation that was 

inconsistent with a customer’s 

suitability profile.75 Yet another 

commenter believed that broker-dealers 

implicitly already have similar 

obligations but favored explicitly 

applying the suitability rule to nonsecurities products.76 According to this 

commenter, broker-dealers fail to 

observe the high standards of 

commercial honor and just and 

equitable principles of trade required by 

FINRA Rule 2010 if they recommend 

any unsuitable financial product, 

service, or strategy to their customers.77

This commenter argued that the 

proposal was not an expansion of 

broker-dealer obligations; rather the 

proposal would make explicit what 

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78See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61. 79See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61. 

80See, e.g., Michael Berenson, Morgan, Lewis & 

Bockius LLP on behalf of American Equity Life 

Insurance Company, June 23, 2009 (‘‘AELIC Letter’’); 

Charles Schwab Letter, supra note 35; Committee of 

Annuity Insurers Letter, supra note 43; John M. 

Damgard, President of the Futures Industry 

Association, June 29, 2009 (‘‘FIA Letter’’); Form 

Letter Type A, supra note 52; Form Letter Type B, 

supra note 52; Hancock, MetLife and Prudential 

Letter, supra note 44; James L. Harding, James L. 

Harding & Associates, Inc., July 1, 2009 (‘‘Harding 

Letter’’); FOLIOfn Letter, supra note 35; Wells Fargo 

Letter, supra note 35; LPL Letter, supra note 66; TD 

Ameritrade Letter, supra note 35; NSCP Letter, 

supra note 35; NAIBD Letter, supra note 35; 

Thomas W. Sexton, Senior Vice President & General 

Counsel for the National Futures Association, June 

29, 2009 (‘‘NFA Letter’’), SIFMA Letter, supra note 

35; T.RowePrice Letter, supra note 35; Robert R 

Carter and David A Stertzer, Association for 

Advanced Life Underwriting, June 29, 2009 (‘‘AALU 

Letter’’); Alan J Cyr, Cyr & Cyr Insurance Services, 

June 26, 2009 (‘‘Cyr & Cyr Insurance Services 

Letter’’); F. John Millette, IMG Financial Group, 

June 23, 2009 (‘‘IMG Financial Group Letter’’); Neal 

Nakagiri, NPB Financial Group, LLC, June 2, 2009 

(‘‘NPB Financial Group Letter’’); Richard C. Orvis, 

Principal Life Insurance Co., June 23, 2009 

(‘‘Principal Life Insurance Co. Letter’’). 

81See, e.g., Committee of Annuity Insurers Letter, 

supra note 43; FOLIOfn Letter, supra note 35; Form 

Letter Type A, supra note 52; Form Letter Type B, 

supra note 52; Hancock, MetLife and Prudential 

Letter, supra note 44; LPL Letter, supra note 66; 

NSCP Letter, supra note 35; T.RowePrice Letter, 

supra note 35. 

82See, e.g., AALU Letter, supra note 80; AELIC 

Letter, supra note 80; Cyr & Cyr Insurance Services 

Letter, supra note 80; Principal Life Insurance Co. 

Letter, supra note 80. 

83See, e.g., AELIC Letter, supra note 80; 

Committee of Annuity Insurers Letter, supra note 

43; FIA Letter, supra note 80; Form Letter Type A, 

supra note 52; Form Letter Type B, supra note 52; 

Hancock, MetLife and Prudential Letter, supra note 

44; Michael T. McRaith, Illinois Department of 

Insurance Letter, June 29, 2009; NAIBD Letter, 

supra note 35; NFA Letter, supra note 80; NSCP 

Letter, supra note 35; SIFMA Letter, supra note 35. 

84See, e.g., AALU Letter, supra note 80; 

Committee of Annuity Insurers Letter, supra note 

43; Wells Fargo Letter, supra note 35. 

85See, e.g., AELIC Letter, supra note 80. 

86See Barry D. Estell, Attorney at Law, June 24, 

2009 (‘‘Estell Letter’’); FOLIOfn Letter, supra note 

35; Mougey and Kraszewski Letter, supra note 61. 

87See FOLIOfn Letter, supra note 35. 

88See FOLIOfn Letter, supra note 35. 

89See FOLIOfn Letter, supra note 35. 

90TD Ameritrade Letter, supra note 35. 

91See Estell Letter, supra note 86; Mougey and 

Kraszewski Letter, supra note 61. 

92FINRA has stated that ‘‘defining the term 

‘recommendation’ is unnecessary and would raise 

many complex issues in the absence of specific 

facts of a particular case.’’ Securities Exchange Act 

Release No. 37588, 1996 SEC LEXIS 2285, at *29 

(Aug. 20, 1996), 61 FR. 44100, 44107 (Aug. 27, 

1996) (Notice of Filing and Order Granting 

Accelerated Approval of NASD’s Interpretation of 

its Suitability Rule). 

93 In the same vein, it is important to note that 

a customer’s acquiescence or desire to engage in a 

transaction does not relieve a broker-dealer or 

associated person of the responsibility to make only 

suitable recommendations. See, e.g., Clinton H. 

Holland, Jr., 52 S.E.C. 562, 566 (1995) (‘‘Even if we 

conclude that Bradley understood Holland’s 

Continued 

FINRA’s rules have consistently 

required from broker-dealers and 

associated persons.78 The commenter 

supported a revision of proposed Rule 

2111 to incorporate an explicit 

suitability obligation that is not limited 

to securities.79

The vast majority of commenters, 

however, were against applying the 

suitability rule to non-securities 

products.80 Some argued that FINRA 

did not have jurisdiction over nonsecurities products.81 Some argued 

against the expansion because they 

claimed there is no evidence of abuse 

resulting from recommendations 

involving non-securities products.82

Some commenters stated that such 

action is unnecessary because the states 

and Federal regulators, and in some 

instances other self-regulatory 

organizations, already regulate many 

non-securities products and services 

(e.g., insurance, real estate, investment 

advisers, futures products, etc.).83

Others claimed that FINRA was illsuited to regulate non-securities 

products because it has no expertise 

outside securities issues.84 A few argued 

that adoption of an enhanced suitability 

rule would create confusion regarding 

whether a recommendation is made ‘‘in 

connection with a firm’s business.’’ 85

• FINRA’s Response: 

With the possible exception of 

potentially duplicative regulation, 

which FINRA believes could be 

addressed in any further expansion of 

the reach of the rule, FINRA does not 

agree with the commenters’ reasoning 

against extending the scope of the 

suitability rule. 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. 

Scope of the Suitability Rule/ 

Clarification of the Term 

‘‘Recommendation’’ 

Consistent with the current suitability 

rule, the proposed new rule does not 

define the term ‘‘recommendation.’’ 

FINRA received a number of comments 

regarding the term. 

• Comments: 

Some commenters asked FINRA to 

define the term ‘‘recommendation.’’ 86

One commenter believed that FINRA’s 

failure to define ‘‘recommended 

transaction’’ will make it difficult for 

firms to distinguish recommended 

transactions from ‘‘discussed’’ and/or 

‘‘reviewed’’ transactions.87 This 

commenter stated that the ‘‘current 

compliance rule of thumb matches 

customer action within a measured 

period of time after information is 

provided to a customer as a test of 

whether any resulting transaction was 

‘recommended.’ ’’ 88 The commenter 

believes that ‘‘the discussion in NTM 

01–23 provides a good foundation upon 

which FINRA can base the 

definition.’’ 89 Another commenter asked 

that FINRA reaffirm the principles 

discussed in NTM 01–23 regarding the 

term ‘‘recommendation.’’ 90 Other 

commenters argued that the term should 

be defined to include recommendations 

to hold securities.91

• FINRA’s Response: 

The determination of the existence of 

a recommendation has always been 

based on the facts and circumstances of 

the particular case and, therefore, the 

fact of such action having taken place is 

not susceptible to a bright line 

definition.92 As two commenters noted, 

however, FINRA announced several 

guiding principles in NTM 01–23 

regarding whether a communication 

constitutes a recommendation. In 

general, those guiding principles remain 

relevant. 

For instance, FINRA stated that a 

communication’s content, context, and 

presentation are important aspects of 

the inquiry. In addition, the more 

individually tailored the 

communication is to a particular 

customer or customers about a specific 

security or strategy, the more likely the 

communication will be viewed as a 

recommendation. FINRA also explained 

that a series of actions that may not 

constitute recommendations when 

viewed individually may amount to a 

recommendation when considered in 

the aggregate. FINRA stated, moreover, 

that it makes no difference whether the 

communication was initiated by a 

person or a computer software program. 

Finally, FINRA noted the relevance of 

determining whether a reasonable 

person would view the communication 

as a recommendation. Thus, for 

example, FINRA explained that a broker 

could not avoid suitability obligations 

through a disclaimer where—given its 

content, context, and presentation—the 

particular communication reasonably 

would be viewed as a 

recommendation.93

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recommendations and decided to follow them, that 

does not relieve Holland of his obligation to make 

reasonable recommendations.’’), aff’d, 105 F.3d 665 

(9th Cir. 1997) (table format); John M. Reynolds, 50 

S.E.C. 805, 809 (1991) (regardless of whether 

customer wanted to engage in aggressive and 

speculative trading, representative was obligated to 

abstain from making recommendations that were 

inconsistent with the customer’s financial 

condition); Eugene J. Erdos, 47 S.E.C. 985, 989 

(1983) (‘‘[W]hether [the customer] considered the 

transactions * * * suitable is not the test for 

determining the propriety of [the registered 

representative’s] conduct.’’), aff’d, 742 F.2d 507 (9th 

Cir. 1984); Dep’t of Enforcement v. Bendetsen, No. 

C01020025, 2004 NASD Discip. LEXIS 13, at *12 

(NAC Aug. 9, 2004) (‘‘[A] broker’s recommendations 

must serve his client’s best interests and that the 

test for whether a broker’s recommendation is 

suitable is not whether the client acquiesced in 

them, but whether the broker’s recommendations 

were consistent with the client’s financial situation 

and needs.’’). 

94To the extent that past Notices to Members, 

Regulatory Notices, case law, etc., do not conflict 

with proposed new rule requirements or 

interpretations thereof, they remain potentially 

applicable, depending on the facts and 

circumstances of the particular case. 

95See Nickles, 1992 NASD Discip. LEXIS 28, at 

*18. 

96See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61; St. John’s Letter, supra 

note 61; Taurus Letter, supra note 61. 

97See Charles Schwab Letter, supra note 35; 

Committee of Annuity Insurers Letter, supra note 

43; FOLIOfn Letter, supra note 35; LPL Letter, supra 

note 66; NSCP Letter, supra note 35; SIFMA Letter, 

supra note 35; TD Ameritrade Letter, supra note 35. 

98See Charles Schwab Letter, supra note 35; 

FOLIOfn Letter, supra note 35; NSCP Letter, supra 

note 35; SIFMA Letter, supra note 35; TD 

Ameritrade Letter, supra note 35. 

99See Charles Schwab Letter, supra note 35; 

SIFMA Letter, supra note 35. 

100See Committee of Annuity Insurers Letter, 

supra note 43; National Planning Holdings Letter, 

supra note 66. 

101See Committee of Annuity Insurers Letter, 

supra note 43; National Planning Holdings Letter, 

supra note 66. 

102See LPL Letter, supra note 66; SIFMA Letter, 

supra note 35. 

These guiding principles, together 

with numerous litigated decisions and 

the facts and circumstances of any 

particular case, inform the 

determination of whether the 

communication is a recommendation for 

purposes of FINRA’s suitability rule.94

FINRA believes that this guidance and 

these precedents allow broker-dealers to 

fundamentally understand what 

communications likely do or do not 

constitute recommendations. 

It also is important to emphasize that 

both the current and proposed 

suitability rules require that a 

recommendation be suitable when 

made. Firms may have different 

methods of tracking recommendations 

for a variety of reasons, but the main 

suitability obligation is not dependent 

on whether and, if so, where and how, 

a transaction occurs.95

Finally, as noted above, the proposed 

rule would capture explicit 

recommendations to hold securities as a 

result of FINRA’s elimination of the 

‘‘purchase, sale or exchange’’ language 

and the addition of the term ‘‘strategy.’’ 

Accordingly, there is no reason to define 

‘‘recommendation’’ to include 

recommendations to hold securities. 

Information Gathering 

The proposal discussed in the Notice 

seeking comment made two changes to 

the type of information that firms and 

associated persons had to attempt to 

gather and analyze as part of their 

suitability obligation. First, the proposal 

would have required the firm and 

associated person to consider 

information known by the firm or 

associated person. Second, the proposal 

included an expanded list of 

information that members and 

associated persons would have to 

attempt to gather and analyze when 

making recommendations. 

Information Gathering/Information 

Known By the Firm 

The proposal discussed in the Notice 

would have required members and 

associated persons to consider all 

information about the customer that was 

‘‘known by the member or associated 

person.’’ 

• Comments: 

Some commenters supported 

requiring firms and brokers to analyze 

information known by the firm 

regardless of how the firm learned of the 

information.96 However, other 

commenters were opposed to this 

requirement.97 Some were opposed 

because of the difficulty they believed it 

would cause for firms with multiple 

business lines.98 According to these 

commenters, customers may provide 

information for a variety of different 

purposes (e.g., banking, insurance, or 

securities transactions) to different 

employees working in different 

departments and recording the 

information on separate systems, and a 

single broker may not have access to all 

of that information.99

Other commenters opposed the 

language on the basis that it might 

require associated persons to capture 

and consider personal information that 

may not be relevant to investment 

decisions and that clients may not want 

captured in a system or shared with a 

broader audience (especially when the 

associated person has intimate 

knowledge of a client through a family 

relationship or friendship).100

According to the commenters, examples 

may include a diagnosed illness, 

pending divorce or separation, pending 

legal action, or other personal 

problems.101 Finally, some commenters 

believed that such a requirement could 

be unfair to associated persons in 

situations where firms are aware of 

information about customers but do not 

pass it along to the associated 

persons.102

• FINRA’s Response: 

FINRA has modified the proposal and 

no longer refers to facts ‘‘known by the 

member or associated person.’’ The 

current proposal requires the member or 

associated person to have reasonable 

grounds to believe the recommendation 

is suitable based on ‘‘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.’’ 

‘‘Reasonable diligence’’ is that level of 

effort that, based on the facts and 

circumstances of the particular case, 

provides the member or associated 

person with sufficient information about 

the customer to have reasonable 

grounds to believe that the 

recommended security or strategy is 

suitable. The level of importance of each 

category of customer information may 

vary depending on the facts and 

circumstances of the particular case. 

However, members and associated 

persons must use reasonable diligence 

to gather and analyze the customer 

information and may only make a 

recommendation if they have reasonable 

grounds to believe the recommendation 

is suitable. In this regard, failing to use 

reasonable diligence to gather the 

information or basing a 

recommendation on inadequate 

information would violate customerspecific suitability, which requires a 

broker-dealer to have a reasonable basis 

to believe a recommendation is suitable 

for the particular investor at issue. 

Apart from the new ‘‘reasonable 

diligence’’ language, the modified 

proposal also alters the wording at the 

end of paragraph (a) of the proposed 

rule. Instead of requiring members and 

associated persons to consider ‘‘any 

other information the member or 

associated person considers to be 

reasonable,’’ the modified proposal 

requires them to consider ‘‘any other 

information the customer may disclose 

to the member or associated person in 

connection with’’ the recommendation. 

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103See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61; Mougey and 

Kraszewski Letter, supra note 61; St. John’s Letter, 

supra note 61; T.RowePrice Letter, supra note 35. 

104See St. John’s Letter, supra note 61; Mougey 

and Kraszewski Letter, supra note 61. 

105See Charles Schwab Letter, supra note 35; 

SIFMA Letter, supra note 35; TD Ameritrade Letter, 

supra note 35; Wells Fargo Letter, supra note 35. 

106See Charles Schwab Letter, supra note 35; 

SIFMA Letter, supra note 35; TD Ameritrade Letter, 

supra note 35; Wells Fargo Letter, supra note 35. 

107See Charles Schwab Letter, supra note 35; 

SIFMA Letter, supra note 35; TD Ameritrade Letter, 

supra note 35; Wells Fargo Letter, supra note 35. 

108See Charles Schwab Letter, supra note 35; LPL 

Letter, supra note 66; SIFMA Letter, supra note 35; 

Wells Fargo Letter, supra note 35. 

109See FOLIOfn Letter, supra note 35. 

110See LPL Letter, supra note 66. 

111See LPL Letter, supra note 66. 

112See LPL Letter, supra note 66. 

113See FOLIOfn Letter, supra note 35. 

114See FOLIOfn Letter, supra note 35. 

115See FOLIOfn Letter, supra note 35. 

116See FOLIOfn Letter, supra note 35. 

117See National Planning Holdings Letter, supra 

note 66. 

118See National Planning Holdings Letter, supra 

note 66. 

119See National Planning Holdings Letter, supra 

note 66. 

120See Tamara K. Salmon, Senior Associate 

Counsel for the Investment Company Institute, June 

29, 2009 (‘‘ICI Letter’’). 

121See ICI Letter, supra note 120. 

In light of some of the comments noted 

above, FINRA believes it is important to 

tie this customer information to possible 

investment decisions. 

Information Gathering/Additional 

Information 

The proposal expands the explicit list 

of types of information that brokerdealers and associated persons have to 

attempt to gather and analyze. At 

present, the suitability rule requires that 

broker-dealers and associated persons 

attempt to gather information about and 

analyze the customer’s other security 

holdings, financial situation and needs, 

financial status, tax status, investment 

objectives, and such other information 

used or considered to be reasonable by 

such member or associated person in 

making recommendations to the 

customer. FINRA expanded that list to 

include the customer’s age, investment 

experience, investment time horizon, 

liquidity needs, and risk tolerance. 

• Comments: 

Some commenters applauded FINRA 

for placing a clear affirmative duty on 

firms to make reasonable efforts to 

gather a more comprehensive and 

specific list of facts about the customer 

prior to making a recommendation.103

These commenters believed that the 

investing public will benefit because 

broker-dealers will consider a larger 

number of consistent criteria.104

A few other commenters, while 

agreeing that such information is 

relevant in some situations, stated that 

obtaining each specified category of 

information may not be warranted on 

every occasion.105 These commenters 

requested that FINRA build flexibility 

into the rule and not mandate that the 

member seek to obtain these new 

categories of information for every 

recommended transaction.106 According 

to these commenters, broker-dealers 

should have discretion to determine 

what customer information is relevant 

to the suitability determination 

associated with each recommended 

transaction.107 If FINRA does require 

firms to obtain and capture this 

information, these commenters also 

asked FINRA to establish an effective 

date for the new rule that recognizes the 

difficulty associated with developing, 

modifying, and implementing forms and 

systems to request and capture the 

proposed new categories of 

information.108

Other commenters more strongly 

objected to the proposed expansion of 

the list of items that broker-dealers must 

attempt to gather and analyze.109 One 

commenter argued that factors such as 

a customer’s investment experience, 

time horizon, and risk tolerance are 

ones to be considered when reviewing 

a customer’s portfolio as a whole, not 

individual trades.110 According to this 

commenter, requiring consideration of 

such factors on a trade-by-trade basis 

will prevent customers from creating a 

diverse portfolio made up of securities 

with different levels of liquidity, risk, 

and time horizons.111 This commenter 

also stated that requiring firms to 

attempt to gather information about a 

customer’s ‘‘other investments’’ would 

be difficult because it would require an 

associated person to have a complete 

view of a customer’s entire portfolio.112

Another commenter went further and 

stated that the current list of items in 

Rule 2310 should be abolished.113 The 

commenter stated that ‘‘FINRA should 

adopt a rule that states that broker 

dealers should collect sufficient data 

and perform the analysis that it, in its 

professional judgment, deems 

reasonably necessary to provide the 

services it offers and advertises to 

consumers.’’ 114 If that cannot be 

achieved, the commenter recommends 

limiting the information to that 

discussed in SEA Rule 17a–3.115 This 

commenter also argued that FINRA 

should detail exactly how firms are 

required to use each piece of 

information that FINRA requires firms 

to gather.116

Another commenter stated that 

FINRA should maintain a standard 

approach to the terminology used in 

relation to this aspect of the rule.117 As 

an example, the commenter noted that 

the rule proposal uses the term ‘‘other 

investments,’’ while FINRA Rule 2330 

covering deferred variable annuities 

uses ‘‘existing assets (including 

investment and life insurance 

holdings).’’ 118 The commenter believed 

that ‘‘other investments’’ is overly broad 

and that FINRA should use the term 

currently used in Rule 2330.119

Finally, one commenter argued that 

money market mutual funds be 

exempted from all or some of the 

requirements to gather information 

when making recommendations.120

According to the commenter, a current 

exemption from some information 

gathering for transactions in money 

market mutual funds should continue or 

be expanded in the proposed rule.121

• FINRA’s Response: 

Under the current suitability rule, 

broker-dealers must attempt to gather 

information on and analyze the 

customer’s other holdings, financial 

situation and needs, financial status, tax 

status, investment objectives, and such 

other information used or considered to 

be reasonable by the firm or associated 

person in making recommendations to 

the customer. The expanded 

information in the proposed rule 

includes the customer’s age, investment 

experience, investment time horizon, 

liquidity needs, and risk tolerance. 

FINRA cannot dictate exactly how firms 

should use each piece of information. 

As discussed above, the level of 

importance of each category of customer 

information (not only those in the 

expanded list) may vary depending on 

the facts and circumstances of the 

particular case. However, failing to use 

reasonable diligence to gather the 

information or basing a 

recommendation on inadequate 

information would violate customerspecific suitability. 

FINRA declines one commenter’s 

request to exempt money market mutual 

funds from all or some of the 

requirements to gather information 

when making recommendations. By way 

of background, the original suitability 

rule (currently paragraph (a) of NASD 

Rule 2310) required firms and brokers to 

have reasonable grounds to believe that 

the recommendation to purchase, sell, 

or exchange any security is suitable 

based upon the facts, if any, disclosed 

by the customer as to ‘‘his other security 

holdings and as to his financial 

situation and needs.’’ In 1990, the SEC 

approved amendments that created a 

second information-gathering 

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122See Securities Exchange Act Release No. 

27982, 1990 SEC LEXIS 795 (May 2, 1990) (Order 

Approving Rule Change to Obtain Information 

Pertinent to Customer Account). 

123As the SEC explained, ‘‘On Sept. 15, 2008, the 

Reserve Primary Fund, which held $785 million in 

Lehman-issued securities, became illiquid when the 

fund was unable to meet investor requests for 

redemptions. The following day, the Reserve Fund 

declared it had ‘broken the buck’ because its net 

asset value had fallen below $1 per share.’’ 

http://www.sec.gov/news/press/2010/2010–16.htm. 

124See Hancock, MetLife and Prudential Letter, 

supra note 44; NAIBD Letter, supra note 35; NSCP 

Letter, supra note 35; SIFMA Letter, supra note 35; 

Wells Fargo Letter, supra note 35. 

125See NAIBD Letter, supra note 35; SIFMA 

Letter, supra note 35; Wells Fargo Letter, supra note 

35. 

126See Hancock, MetLife and Prudential Letter, 

supra note 44; NAIBD Letter, supra note 35; NSCP 

Letter, supra note 35; SIFMA Letter, supra note 35; 

Wells Fargo Letter, supra note 35. 

127See SIFMA Letter, supra note 35; Wells Fargo 

Letter, supra note 35. 

128See SIFMA Letter, supra note 35. 

129See Hancock, MetLife and Prudential Letter, 

supra note 44; NAIBD Letter, supra note 35; NSCP 

Letter, supra note 35. 

130See NAIBD Letter, supra note 35. 

131See Hancock, MetLife and Prudential Letter, 

supra note 44. 

132See Hancock, MetLife and Prudential Letter, 

supra note 44. In addition, one commenter stated 

that the exemption should apply to all suitability 

obligations and should not, as previously had been 

the case, be limited to customer-specific suitability. 

See SIFMA Letter, supra note 35. FINRA believes 

that the exemption should remain focused on 

customer-specific suitability. For instance, it 

remains important that brokers understand the 

securities they recommend and that those securities 

are appropriate for at least some investors. 

133See Mougey and Kraszewski Letter, supra note 

61. 

requirement (currently paragraph (b) of 

NASD Rule 2310).122 The new 

paragraph added in 1990 required firms 

to make reasonable efforts to also obtain 

the customer’s financial status, tax 

status, investment objectives, and such 

other information used or considered to 

be reasonable by such member or 

associated person in making 

recommendations to the customer. 

Transactions involving money market 

mutual funds were exempted from the 

requirement under the new paragraph. 

However, transactions involving money 

market mutual funds were not exempted 

from the original suitability 

requirements under paragraph (a). 

FINRA believes that recommended 

money market mutual funds should be 

subject to the same informationgathering requirements as other 

recommended securities. That is 

especially true in light of the problems 

experienced by the Reserve Primary 

Fund in late 2008.123

Institutional Customer 

At present, IM–2310–3 provides a 

limited exemption from the customerspecific obligation when dealing with 

institutional customers in certain 

situations. The proposal continues to 

provide an exemption, but it adds a 

requirement that institutional customers 

provide affirmative acknowledgement of 

certain aspects of their relationship with 

the broker-dealer and modifies the 

definition of institutional customer. 

Institutional Customer/Affirmative 

Acknowledgement Regarding 

Surrendering Rights 

As with the current suitability rule, 

the proposal provides an exemption 

from customer-specific suitability 

regarding institutional customers if the 

broker-dealer or associated person has a 

reasonable basis to believe that the 

institutional customer is capable of 

evaluating investment risks 

independently and is exercising 

independent judgment in evaluating the 

member’s or associated person’s 

recommendations. However, the 

proposal discussed in the Notice 

seeking comment added as a third 

requirement that the institutional 

customer must affirmatively indicate 

that it is willing to forgo the protection 

of the customer-specific obligation of 

the suitability rule. 

• Comments: 

A number of commenters stated that 

requiring institutional customers to 

affirmatively acknowledge that they are 

giving up rights is impractical and will 

render the institutional exemption 

ineffective.124 According to these 

commenters, this requirement is 

unnecessary in light of the other two 

conditions (that the customer be capable 

of evaluating risks and is exercising 

independent judgment).125 The 

commenters also stated that, because 

institutional clients are highly unlikely 

to affirmatively forego suitability 

protections for commercial reasons, this 

new requirement will have the practical 

effect of negating the exemption.126

• FINRA’s Response: 

FINRA has modified the proposed 

exemption in a way that should 

alleviate commenters’ concerns while 

providing the necessary protection to 

institutional customers. The revised 

exemption eliminates the requirement 

that institutional customers 

affirmatively indicate that they are 

giving up suitability protections and 

focuses on the two main conditions 

discussed in the current exemption. The 

revised exemption, however, does 

require institutional customers to 

affirmatively indicate that they are 

exercising independent judgment. 

Institutional Customer/Change in 

Definition 

The proposal harmonizes the 

definition of ‘‘institutional customer’’ in 

the suitability rule with the more 

common definition of ‘‘institutional 

account’’ in NASD Rule 3110(c)(4) 

[proposed FINRA Rule 4512(c)]. As a 

result, the monetary threshold for an 

institutional customer would increase 

from the current $10 million invested in 

securities and/or under management to 

$50 million in assets. In addition, unlike 

the current exemption, a natural person 

could qualify as an institutional 

customer under the proposal. 

• Comments: 

Some commenters supported the 

change in definition.127 One commenter 

stated further that consistent standards 

produce more efficient, effective, and 

clear regulation that is beneficial to 

investors, regulators, and market 

participants alike.128 Other commenters, 

however, disagreed, arguing that the 

definition of $10 million invested in 

securities and/or under management in 

current IM–2310–3 is a more 

appropriate standard for purposes of the 

institutional account suitability 

exemption and should be retained in the 

new rule rather than referencing the 

Rule 3110(c)(4) standard of at least $50 

million in total assets.129 According to 

one commenter, many highly 

sophisticated institutional brokerage 

customers would not satisfy the $50 

million dollar asset threshold but would 

not need the protection of the suitability 

rule.130

Another commenter who favored 

keeping the current standard stated that, 

if FINRA believes a different standard 

should be used for uniformity, FINRA 

should use the definition in NASD Rule 

2211(a)(3) (Communications with the 

Public) rather than the one in NASD 

Rule 3110(c)(4).131 Under NASD Rule 

2211, institutional sales material may be 

distributed only to ‘‘institutional 

investors,’’ defined to include several 

categories of persons, including those 

identified in NASD Rule 3110(c)(4). It 

also adds the following entities: 

Employee benefit plans meeting the 

requirements of Section 403(b) or 

Section 457 of the Internal Revenue 

Code with at least 100 participants, 

qualified plans with at least 100 

participants, and governmental entities 

or subdivisions thereof. This commenter 

also suggested that FINRA should make 

the standard a rebuttable presumption 

against determining that an entity that is 

outside the list of plans identified above 

is an institutional customer.132

Finally, one commenter argued that 

there should not be any exemption for 

institutional customers.133 According to 

this commenter, many institutional 

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134See Mougey and Kraszewski Letter, supra note 

61. 

135See NASAA Letter, supra note 47. 

136See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61; Taurus Letter, supra 

note 61; T.RowePrice Letter, supra note 35. 

137See NASAA Letter, supra note 47. 

138See NASAA Letter, supra note 47. 

139See NASAA Letter, supra note 47. 

140See Cornell Letter, supra note 34; Estell Letter, 

supra note 86. 

141See FOLIOfn Letter, supra note 35. 

142See, e.g., IM–2310–2(b)(2) (discussing 

quantitative suitability, also called excessive 

trading); IM–2310–3 (discussing reasonable-basis 

and customer-specific suitability). 

143See, e.g., James B. Chase, Securities Exchange 

Act Release No. 47476, 2003 SEC LEXIS 566, at *17 

(Mar. 10, 2003) (involving customer-specific 

suitability); Harry Gliksman, 54 S.E.C. 471, 474–75 

(1999) (discussing excessive trading); Rafael 

Pinchas, 54 S.E.C. 331 (1999) (discussing excessive 

trading and customer-specific suitability); F.J. 

Kaufman & Co., 50 S.E.C. 164, 168–69 (1989) 

(discussing both reasonable-basis and customerspecific suitability); Patrick G. Keel, 51 S.E.C. 282, 

284–87 (1993) (upholding violation of customerspecific suitability); Dep’t of Enforcement v. 

Medeck, No. E9B2003033701, 2009 FINRA Discip. 

LEXIS 7, at *31 (NAC July 30, 2009) (discussing 

excessive trading); Dep’t of Enforcement v. Siegel, 

No. C05020055, 2007 NASD Discip. LEXIS 20, at 

*36–40 (NAC May 11, 2007) (discussing reasonablebasis suitability and due-diligence requirement 

thereunder), aff’d, Securities Exchange Act Release 

No. 58737, 2008 SEC LEXIS 2459 (Oct. 6, 2008), 

aff’d in relevant part, 592 F.3d 147 (D.C. Cir. Jan. 

12, 2010), cert. denied, 2010 U.S. LEXIS 4340 (May 

24, 2010); see also Regulatory Notice 10–22, 2010 

FINRA LEXIS 43, at *10–20 (April 2010) 

(discussing due diligence required for reasonablebasis suitability in context of recommended private 

offerings); Notice to Members 03–71, 2003 NASD 

LEXIS 81, *5–6 (Nov. 11, 2003) (discussing duediligence requirement for reasonable-basis 

suitability in context of recommendations of nonconventional investments). 

customers, even those with $50 million 

in assets, are not particularly 

sophisticated about complex securities 

and need the protections of the 

suitability rule.134

• FINRA’s Response: 

While any standard is imperfect, 

FINRA believes that it is important to 

use the definition in Rule 3110(c)(4) for 

consistency and because of its higher 

monetary threshold. FINRA does not 

believe that it is appropriate to use the 

much broader definition in NASD Rule 

2211(a)(3), which defines ‘‘institutional 

investor’’ for purposes of the rules 

governing communications with the 

public. Communications that are 

distributed or made available only to 

institutional investors qualify as 

institutional sales material, which is not 

subject to the same content, principal 

approval and filing requirements as 

communications that are distributed or 

made available to retail investors. The 

communication rules’ requirements, 

while important, serve a different 

purpose than the sales-practice 

protections that the suitability rule 

provides when a broker-dealer 

recommends a security to a customer. 

FINRA understands the concern that 

even some institutional customers with 

$50 million in assets might be 

unsophisticated about complex 

securities and need the protections of 

the suitability rule. However, the 

exemption would not apply in that 

circumstance. Again, the broker-dealer 

or associated person must have a 

reasonable basis to believe that the 

institutional customer is capable of 

evaluating investment risks 

independently and, under the modified 

proposal, the customer must 

affirmatively state that it is exercising 

independent judgment in evaluating the 

recommendations. 

Institutional Customer/Eliminating 

Detailed Discussion From IM–2310–3 

Although the focus is the same, the 

proposed institutional exemption is 

considerably shorter in length than the 

current one. Its brevity generated one 

comment. 

• Comments: 

One commenter viewed the new, 

abbreviated institutional investor 

discussion in the proposal as a ‘‘box 

check’’ waiver that provides less 

protection than the detailed discussion 

in IM–2310–3 of considerations for 

determining whether the exemption 

should apply.135

• FINRA’s Response: 

The proposed institutional investor 

discussion, while shorter than the 

current version in IM–2310–3, contains 

certain stricter standards. In addition to 

the two main considerations used in 

both versions, the proposal includes an 

increased monetary threshold that 

certain institutions must meet to qualify 

for the exemption and, even more 

important, a requirement that the 

institution affirmatively indicate that it 

is independently evaluating the firm’s 

recommendations. 

Supplementary Material 

The Consolidated FINRA Rulebook 

uses supplementary material to discuss 

certain aspects of a rule’s requirements 

in greater detail. However, a number of 

commenters raised issues regarding the 

supplementary material. 

• Comments: 

A number of commenters supported 

codifying various interpretations of the 

suitability rule.136 Some commenters, 

however, believed that FINRA should 

modify some of those interpretations. 

For instance, one commenter questioned 

the ‘‘three-pronged approach’’ to 

suitability discussed in Supplementary 

Material .02, which codifies discussions 

in IMs and case law about reasonablebasis suitability, customer-specific 

suitability, and quantitative suitability. 

This commenter suggested that the 

approach created new standards that 

provide less protection to customers.137

This commenter took particular issue 

with reasonable-basis suitability, which 

requires a broker-dealer to have a 

reasonable basis to believe, based on 

adequate due diligence, that the 

recommendation is suitable for at least 

some investors.138 The commenter 

believed that a member’s familiarity 

with a product should be presumed.139

Two other comments focused on 

quantitative suitability, which requires a 

broker-dealer that has actual or de facto 

control over an account to have a 

reasonable basis for believing that a 

series of recommended transactions, 

even if suitable when viewed in 

isolation, are not excessive and 

unsuitable for the customer when taken 

together in light of the customer’s 

investment profile. These commenters 

believed that FINRA should eliminate 

the requirement under quantitative 

suitability that a broker-dealer have 

‘‘control’’ over an account before the 

obligation applies.140 Yet another 

commenter stated that FINRA should 

eliminate supplementary material from 

all rules and limit rulemaking to rule 

text.141

• FINRA’s Response: 

FINRA believes that supplementary 

material is an important means of 

providing greater specificity to a rule’s 

overarching requirements. FINRA notes 

that supplementary material will be 

filed with the SEC and is enforceable to 

the same extent as the main rule text. 

With regard to the codification of the 

main suitability obligations, FINRA 

disagrees with the contention that the 

discussion creates new standards that 

provide less protection to customers. 

The discussion at issue codifies existing 

interpretations of suitability obligations, 

often directly from IMs following NASD 

Rule 2310 142 and case law.143 The 

commenter argued that presuming that 

firms and associated persons are 

familiar with the products they 

recommend would provide greater 

protection to customers. FINRA believes 

the opposite is true, and FINRA’s 

examination and enforcement 

experience belies the notion that firms 

and associated persons are always 

familiar with every recommended 

product or strategy. The existing duty to 

perform adequate due diligence to 

understand the products and strategies 

that firms and associated persons 

recommend is of critical importance to 

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52574 Federal Register / Vol. 75, No. 165 / Thursday, August 26, 2010 / Notices 

144See F.J. Kaufman & Co., 50 S.E.C. at 168–69 

(discussing both reasonable-basis and customerspecific suitability); Siegel, 2007 NASD Discip. 

LEXIS 20, at *36–40 (discussing reasonable-basis 

suitability and due-diligence requirement 

thereunder); see also Regulatory Notice 10–22, 2010 

FINRA LEXIS 43, at *10–20 (April 2010) 

(discussing due diligence required for reasonablebasis suitability in context of recommended private 

offerings); Notice to Members 03–71, 2003 NASD 

LEXIS 81, *5–6 (Nov. 11, 2003) (discussing due 

diligence requirement for reasonable-basis 

suitability in context of recommendations of nonconventional investments). 

145See Cornell Letter, supra note 34; Corporate 

Law Center & Investor Rights Clinic Letter, supra 

note 61; NASAA Letter, supra note 47. 

146See Cornell Letter, supra note 34; Corporate 

Law Center & Investor Rights Clinic Letter, supra 

note 61; NASAA Letter, supra note 47. 

147See Corporate Law Center & Investor Rights 

Clinic Letter, supra note 61. 

148 17 CFR 200.30–3(a)(12). 

1 15 U.S.C. 78s(b)(1). 

2 17 CFR 240.19b–4. 

the protection of investors.144 This is 

especially true in light of the increasing 

complexity of certain products and 

strategies. 

Elimination of Interpretive Material 

Following NASD Rule 2310 

In connection with the new suitability 

rule, FINRA proposes eliminating many 

and modifying some of the IMs that 

follow NASD Rule 2310. This aspect of 

the proposal also generated several 

comments. 

• Comments: 

A few commenters were concerned 

that the proposal did not include some 

of the current IMs, especially IM–2310– 

2.145 These commenters believe that it is 

important to maintain the statement in 

IM–2310–2 that brokers can be 

disciplined for excessive trading, 

unauthorized trading, and fraud.146 One 

commenter noted in particular that this 

IM was the only place in the entire 

NASD conduct rules explicitly 

prohibiting unauthorized trading.147

• FINRA’s Response: 

FINRA continues to believe that most 

of the current IMs following NASD Rule 

2310 should be eliminated or modified 

because they are no longer necessary. As 

discussed in detail in Item II.A. of this 

filing, some are duplicative of other 

rules and others would be rendered 

unnecessary by changes proposed in the 

new suitability rule. For example, as 

noted in Item II.A., it is well-settled that 

unauthorized trading violates just and 

equitable principles of trade under 

FINRA Rule 2010. Consequently, the 

elimination of the discussion of 

unauthorized trading in the IMs 

following the suitability rule in no way 

alters the longstanding view that 

unauthorized trading clearly violates 

FINRA’s rules. 

III. Date of Effectiveness of the 

Proposed Rule Change and Timing for 

Commission Action 

Within 45 days of the date of 

publication of this notice in the Federal 

Register or within such longer period (i) 

as the Commission may designate up to 

90 days of such date if it finds such 

longer period to be appropriate and 

publishes its reasons for so finding or 

(ii) as to which the self-regulatory 

organization consents, the Commission 

will: 

(A) By order approve or disapprove 

such proposed rule change, or 

(B) institute proceedings to determine 

whether the proposed rule change 

should be disapproved. 

IV. Solicitation of Comments 

Interested persons are invited to 

submit written data, views and 

arguments concerning the foregoing, 

including whether the proposed rule 

change is consistent with the Act. 

Comments may be submitted by any of 

the following methods: 

Electronic Comments: 

• Use the Commission’s Internet 

comment form (http://www.sec.gov/ 

rules/sro.shtml); or 

• Send an e-mail to rulecomments@sec.gov. Please include File 

Number SR–FINRA–2010–039 on the 

subject line. 

Paper Comments: 

• Send paper comments in triplicate 

to Elizabeth M. Murphy, Secretary, 

Securities and Exchange Commission, 

100 F Street, NE., Washington, DC 

20549–1090. 

All submissions should refer to File 

Number SR–FINRA–2010–039. This file 

number should be included on the 

subject line if e-mail is used. To help the 

Commission process and review your 

comments more efficiently, please use 

only one method. The Commission will 

post all comments on the Commission’s 

Internet Web site (http://www.sec.gov/ 

rules/sro.shtml). Copies of the 

submission, all subsequent 

amendments, all written statements 

with respect to the proposed rule 

change that are filed with the 

Commission, and all written 

communications relating to the 

proposed rule change between the 

Commission and any person, other than 

those that may be withheld from the 

public in accordance with the 

provisions of 5 U.S.C. 552, will be 

available for Web site viewing and 

printing in the Commission’s Public 

Reference Room, 100 F Street, NE., 

Washington, DC 20549, on official 

business days between the hours of 10 

a.m. and 3 p.m. Copies of such filing 

also will be available for inspection and 

copying at the principal office of 

FINRA. All comments received will be 

posted without change; the Commission 

does not edit personal identifying 

information from submissions. You 

should submit only information that 

you wish to make available publicly. All 

submissions should refer to File 

Number SR–FINRA–2010–039 and 

should be submitted on or before 

September 9, 2010. 

For the Commission, by the Division of 

Trading and Markets, pursuant to delegated 

authority.148

Florence E. Harmon, 

Deputy Secretary. 

[FR Doc. 2010–21228 Filed 8–25–10; 8:45 am] 

BILLING CODE 8010–01–P 

SECURITIES AND EXCHANGE 

COMMISSION 

[Release No. 34–62748; File No. SR–FINRA– 

2010–043] 

Self-Regulatory Organizations; 

Financial Industry Regulatory 

Authority, Inc.; Notice of Filing of 

Proposed Rule Change To Reinstitute 

Short Exempt Marking for Trade 

Reporting and OATS 

August 20, 2010. 

Pursuant to Section 19(b)(1) of the 

Securities Exchange Act of 1934 

(‘‘Act’’) 1 and Rule 19b–4 thereunder,2

notice is hereby given that on August 6, 

2010, Financial Industry Regulatory 

Authority, Inc. (‘‘FINRA’’) filed with the 

Securities and Exchange Commission 

(‘‘SEC’’ or ‘‘Commission’’) the proposed 

rule change as described in Items I and 

II below, which Items have been 

prepared by FINRA. The Commission is 

publishing this notice to solicit 

comments on the proposed rule change 

from interested persons. 

I. Self-Regulatory Organization’s 

Statement of the Terms of Substance of 

the Proposed Rule Change 

FINRA is proposing to amend 

FINRA’s trade reporting and Order 

Audit Trail System (‘‘OATS’’) rules, 

including changes relating to recent 

amendments to SEC Regulation SHO. 

The text of the proposed rule change 

is available on FINRA’s Web site at 

http://www.finra.org, at the principal 

office of FINRA and at the 

Commission’s Public Reference Room. 

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