On behalf of Mihalek Law posted in Securities Law on Monday, November 24, 2014.
FINRA (Financial Industry Regulatory Authority) has adopted rules geared to protect retail investors, such as the Suitability Rule (FINRA Rule 2111). The Suitability Rule provides that a firm or its registered representatives must have a reasonable basis to believe that a recommended transaction or investment strategy is suited to the customer based on that customer’s investment profile. A customer’s investment profile includes such factors as the customer’s age, other investments, financial situation and needs, investment objectives and risk tolerance.
The second section of Rule 2111 deals with institutional accounts. FINRA Rule 4512(c) defines an Institutional Account as the account of: 1) a bank, savings and loan association, insurance company or registered investment company; 2) a state or SEC registered investment adviser; or 3) any other person (whether a natural person, corporation, partnership, trust or otherwise) with total assets of at least $50 million.
Rule 2111(b) provides that the broker-dealer or its agents fulfills the suitability obligation for an institutional account if: 1) the firm or agent has 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 involving a security or securities; and 2) said customer affirmatively indicates that it is exercising independent judgment in evaluating a member’s recommendations. If 1 and 2 exist, then the firm is deemed to have fulfilled its suitability obligations to the institutional customer.
Oftentimes, institutional investors, like community banks, are not exercising independent judgment over their investment portfolio. Rather, like most retail clients, these institutional customers routinely rely on and trust their investment advisers and accept their recommendations. If the institutional investor does not possess a Bloomberg terminal and subscribe to investment services, it may not have access to all available information. Even where access to information is available, institutional investors may not have personnel with the expertise and training to evaluate the risks of particular trading strategies or esoteric debt instruments, like inverse floaters, collateralized debt obligations (CDO’s), asset backed securities (ABS) and other forms of complicated structured finance investments.
Community banks and other institutional investors should not indicate that they are exercising their independent judgment on investment decisions unless they actually are. Too often, brokerage firms have customers sign what appear to be routine forms which may come back to haunt the customer in the event of a dispute with the firm. An investor does not become capable of independently evaluating complex securities or trading strategies by virtue of being a bank, a savings and loan association or wealthy. It takes knowledge and understanding of the recommended investments and strategies.