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October 16, 2019


Regulatory Obligations

Currently, FINRA’s suitability rule establishes obligations that are central to promoting ethical sales practices and high standards of professional conduct.2 FINRA Rule 2111 (Suitability) establishes three primary obligations for firms and their associated persons: (1) reasonable-basis suitability, (2) customer-specific suitability and (3) quantitative suitability.3

Noteworthy Examination Findings

Some firms did not have adequate systems of supervision to review that recommendations were suitable in light of a customer’s individual financial situation and needs, investment experience, risk tolerance, time horizon, investment objectives, liquidity needs and other investment profile factors. This report shares some new suitability-related findings, as well as additional nuances on prior years’ findings.

  • Inadequate Supervision of Product Exchanges – Some firms did not maintain a supervisory system reasonably designed to assess the suitability of recommendations that customers exchange certain products, such as mutual funds, variable annuities or unit investment trusts (UITs). In particular, some firms did not maintain blotters or other processes to identify patterns of unsuitable recommendations of exchanges involving long-term products.4 Additionally, some firms did not reasonably supervise exchanges because they could not verify the information provided by registered representatives in their rationales to justify a recommended exchange, such as inaccurate descriptions of product fees, costs and existing product values. In other instances, firm supervision did not detect that the source of funds for a purchase was misrepresented (i.e., as “new” money), when other account information revealed another likely source of funds (e.g., funds from a liquidation of another financial product at the firm).
  • Limited Supervision to Identify “Red Flags” for Suitability – Some firms’ supervisory systems were not reasonably designed or used to detect red flags of possible unsuitable transactions. For example, some firms did not identify or question patterns of similar recommendations by representatives or branch offices across many customers with different risk profiles, time horizons and investment objectives. In some instances, several customers of a representative or branch office appeared to have made “unsolicited” transactions in identical securities, which could raise questions around whether the transactions were actually “unsolicited.”
  • Inadequate Supervision of Changes to Customer Account Information – As discussed further in the Supervision section of this report, FINRA noted instances where registered representatives unilaterally changed account information, such as customers’ income, net worth or account objectives. In many instances, the changes preceded or were contemporaneous with one or more transactions that, but for the account change, would have been subject to heightened supervisory scrutiny, raised suitability concerns or would not have been approved.
  • Limited Supervision of Trading Activity for Excessive Trading or Churning – FINRA identified a variety of situations where supervisors failed to recognize when a pattern of transactions rendered the series of recommendations unsuitable. FINRA also noted that some firms did not adequately train supervisors how to use exception reports to identify red flags indicative of excessive trading. In other cases, some firms did not appropriately respond to and address red flags indicating excessive trading identified through their exception reports.5
  • Unsuitable Options Strategy Recommendations – FINRA identified registered representatives recommending complex options strategies to customers who did not have the sophistication to understand the features of an option or the associated strategy, or without adequately considering the customers’ individual financial situations and needs, as well as other investment profile factors. Further, some firms did not implement trade limits and controls to identify and prevent options trading that exceeded customer pre-approved investment levels.

Additional Resources


2 On June 5, 2019, the SEC voted to adopt a package of rulemakings and guidance, including Regulation Best Interest (Reg BI). This section is intended to provide firms with findings solely related to compliance with existing FINRA suitability and related supervisory obligations and does not address Reg BI. For additional information, please see FINRA’s Topic Page on SEC Regulation Best Interest (Reg BI).

3 In addition to the items discussed in this document, FINRA reminds firms to consider the findings FINRA shared previously regarding overconcentration in illiquid securities, reasonable due diligence for private placements and certain variable annuity exchanges.

4 See FINRA Rule 2330(d) (Members’ Responsibilities Regarding Deferred Variable Annuities).

5 FINRA continued to note many of the challenges we discussed in the Abuse of Authority section of the 2018 Report, including registered representatives engaging in discretionary trading without written authorization.