FINRA Series 7 Exam Horse (3)

Question of money

Question of money (Photo credit: Ano Lobb. @healthyrx)

By Kevin Leland

This post is taken entirely from the Securities Law Professor Site and talks about the new, (went into effect in July of 2012) but entirely based on the old –’Know Your Customer Rule.’ This is the point where the regulatory rubber meets the road. It’s mainly about training securities dealers to put their clients investment goals and best interest, before their own production and commision goals. It’s about being a true professional, and focusing on the investors’ needs, and letting the money you’re paid for your services follow.

The obligation to act in a customer’s best interests within the scope of the terms “recommendation,” “customer” and “investment strategy”; requires a registered representative to use a risk-based approach to documenting suitability, to document and meet information gathering requirements; reasonable-basis and quantitative suitability; and the institutional-customer exemption.

Q005) Are  securities firms and its employees, according to FINRA rule (2090) –Know Your Customer,  required to use reasonable diligence, and document that their recommendations are in line with a customer’s investment strategies, and follow any special handling instructions when opening and maintaining accounts?

A005) Yes. Registered representatives are also required to understand the authority of each person acting on behalf of the customer, and comply with applicable laws, regulations, and rules.

Q006) According to FINRA rule (2111) is  a firm or associated person, through reasonable diligence to ascertain their customers’ investment profiles, required to have a reasonable basis to believe that a recommended transaction or investment strategy involving securities are suitable for the individual customers or institutions?

A006) No. The suitability rule (2111) is only applicable to individual customers. Paragraph (b) of the Rule provides an exemption for institutional accounts.

The broad and subjective scope of this ‘Know Thy Customer’ FINRA commandment, made many members sphincter muscles spasm, and enacting this rule was actually delayed by almost a year. To calm their member’s anxiety, they made the following declaration (NTM 12-25):

FINRA reiterates, however, that many of the obligations under the new rule are the same as those under the predecessor rule and related case law. Existing guidance and interpretations regarding suitability obligations continue to apply to the extent that they are not inconsistent with the new rule. Furthermore, FINRA appreciates that no two firms are exactly alike. Firms have different business models; offer divergent services, products and investment strategies; and employ distinct approaches to complying with applicable regulatory requirements. FINRA’s guidance is not intended to influence any firm’s choice of a particular business model or reasonable approach to ensuring compliance with suitability or other regulatory requirements.

On top of making appropriate recommendations geared to the ascertained investment profiles of individual customers, there is also ‘Quantitative Suitability’ to be concerned with. Quantitive Suitability addresses excessive trading in a customer’s account (a.k.a. ‘Account Churning) and requires a firm or associated person who has actual or de facto control over the account to have a reasonable basis for believing that a series of 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.

The more they trade, the more you get paid…If you are on the rep/broker end of the transactions. However, even though jumping in and out of investments may pay a better ROI to the investor, than say, feeding cash-money to a slot machine –it’s usually not much better. But as anyone (like myself) who has ever participated, or still actively ‘day trades’ will tell you –It can be addictive, like any form of gambling, but it sure is a hellovalotta fun! But regardless, as a securities firm or associated member, don’t touch this investing behavior with a ten foot pole. It will be impossible to justify according to Quantitive Suitability, by your documentation, and will get you a pants-down spanking from FINRA.

Click here for the next post (4) in the series

This next post will discuss what other tests need to be completed to earn your living as a dealer in securities. It boils down and explains the differences between the Series 63, Series 65, and Series 66 Exams.


2 responses to “FINRA Series 7 Exam Horse (3)

  1. Pingback: FINRA General Securities Representative Exam (5) | Bangari Content Gallery

  2. Pingback: Free Series 7 Study Guide (2) | Bangari Content Gallery

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