Sales Activities - FINRA Conduct Rule 2310, 2330 and 2510
NASD (now known as FINRA) Conduct Rule 2310
Suitability of Recommendations
Rule 2310 requires registered representatives to take the following into account before recommending investments to individual (non-institutional) investors:
The customer's financial status, tax status, investment objectives and such other information used or considered to be reasonable in making recommendations to the customer.
Rule 2310 requires the representative to only make suitable recommendations and to deal fairly with customers. The following practices are examples of violations of the suitability rules:
- Recommending speculative low-priced securities without attempting to obtain information about the client's financial situation, needs and other assets
- Borrowing or using customer's funds or securities
- Failing to describe important facts and risks about the security to each client
- Making trades of excessive size in a client's account
- Excessive short-term trading of mutual fund shares - churning for the purpose of generating commissions
- Fraudulent activity - making unauthorized transactions in a customers account or setting up fictitious accounts to disguise prohibited activities
- Recommending trades that are too expensive, too risky or beyond the client's financial ability
Fair Dealing with Customers
IM-2310-2 states that:
- Implicit in all member and registered representative relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of the Association's rules, with particular emphasis on the requirement to deal fairly with the public.
- This does not mean that legitimate sales efforts in the securities business are to be discouraged by requirements that do not take into account the variety of circumstances that can enter into the member-customer relationship. It does mean, however, that sales efforts must be judged on the basis of whether they can be reasonably said to represent fair treatment for the persons to whom the sales efforts are directed, rather than on the argument that they result in profits to customers.
Suitability Obligations to Institutional Customers
IM-2310-3 states that in recommending any purchase, sale or exchange of a security, a member must have reasonable grounds for believing that the recommendation is suitable for the customer based on the facts disclosed by the customer as to financial situation, needs and other security holdings.
The two most important considerations in determining the scope of a member's suitability obligations in making recommendations to an institutional customer are the customer's capability to evaluate investment risk independently and the extent to which the customer is exercising independent judgment in evaluating a member's recommendation. A member must determine, based on the information available, the customer's capability to evaluate investment risk. In 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. This is more likely to arise with relatively new types of instruments, or those with significantly different risk or volatility characteristics than other investments generally made by the institution. If 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. On the other hand, 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 investment decision.
Other FINRA rules
Conduct Rule 2330 - Customer Securities and Funds
This rule details improper uses of customer funds, including performance guarantees and sharing in investment performance. The only exceptions apply to accounts owned by members of the representative's family or to registered investment advisers who receive written authorization from an advisory client. However, the member may only share in the profits or losses of an advisory client's account in direct proportion to the financial contributions made to the account.
Conduct Rule 2510 - Discretionary Accounts
Excessive trades are not permitted in discretionary accounts. Excessive trades include any transactions of purchase or sale that are excessive in size or frequency in view of the financial resources and character of such account.
The member or the person duly designated shall approve promptly in writing each discretionary order entered and shall review all discretionary accounts at frequent intervals in order to detect and prevent transactions that are excessive in size or frequency in view of the financial resources and character of the account.
This rule does not apply to:
Bulk exchanges at net asset value of money market funds using negative response letters.
Discretion as to the price at which, or the time when, an order given by a customer for the purchase or sale of a definite amount of a specified security shall be executed, except that the authority to exercise time and price discretion will be considered to be in effect only until the end of the business day on which the customer granted such discretion, absent a specific, written contrary indication signed and dated by the customer.