Brokers back regulator's tough stance on suitability

Knowing what is suitable is not always black and white, but brokers agree a crackdown will elevate the industry

May 15, 2015 @ 10:10 am

By Mark Schoeff Jr.

Brokers endorsed a move by their regulator this week to toughen sanctions for violations of the suitability rule even as they acknowledged the standard leaves room for interpretation.

The Financial Industry Regulatory Authority Inc. on Tuesday revised its Sanctions Guidelines, which included raising its suggested suspensions to two years from one for brokers making unsuitable recommendations. It also strongly advises possible barring of brokers and expulsion of firms for fraudulent activity.

Cracking down on suitability violations will help clients, said Jeremy Gottlieb, owner of Gottlieb Wealth Management. In reviewing investments of clients transferring to his firm, he often sees evidence that their portfolios were built on the basis of product sales rather than what is in their best interest.

“Categorically, I think it's good,” he said of Finra's guideline changes. “Overall, it's going to elevate the industry.”

Philip Swotkewicz, a senior vice president at Merrill Lynch, said Finra should get even tougher on brokers who put their clients in unsuitable investments. He likened the situation to finding out that a doctor was engaging in malpractice.

“I would never want to go to that doctor again,” Mr. Swotkewicz said. “It was a good move. I think they should go further.”

Enforcing the suitability rule, however, is not necessarily straightforward, because its application depends on the situation.


The rule says that recommendations to buy or hold securities must be aligned with a customer's investment profile and take into consideration the client's age, financial situation, investment objectives, tax status, investment experience, time horizon, liquidity and risk tolerance.

The standard allows brokers to sell products with high fees that benefit the broker as long as they also fit a client's needs. The fiduciary standard that governs investment advisers requires them to act in their clients' best interest.

Although Finra enforces the less-strict suitability rule, in its examination priorities over the last few years, it has been pushing brokers to act in the best interest of their clients. The regulator has targeted complex and risky products, such as variable annuities, alternative mutual funds, nontraded real estate investment trusts and structured notes.

Whether these vehicles are good for a customer — or even suitable — often lies in the eye of the beholder.

“Every case is unique,” Mr. Gottlieb said. “The suitability for each client can be different.”

Paul Tolley, chief compliance officer at Commonwealth Financial Network, agrees there's no suitability formula.

“It's always facts and circumstances,” Mr. Tolley said. “Suitability is subjective in many respects.”

But Mr. Gottlieb is growing wary of putting some products in client portfolios, even when they fit the client's needs.

“Some of the investments I might recommend, I'm rethinking because there's so much push back,” he said. “They're penalizing all of us who do it right as well as those who don't do it right.”

And the debate about what products are suitable is a heated one.

“Putting an annuity inside an IRA is not suitable, yet we see it all the time,” said John Nowicki, present of LCM Capital Management.

But meeting the suitability standard should not be difficult if robo-advisers can be programmed to do so, said Benjamin Edwards, director of the Investor Advocacy Clinic at the Michigan State University College of Law.


The trick is to find a way to make a profit and adhere to suitable advice.

“It's quite difficult to both maximize your commissions and stay within the suitability guidelines,” Mr. Edwards said.

Some say Finra is not looking to go after middle-of-the-road brokers. In its suitability crackdown, Finra likely will focus on cases in which aggravating factors, such as a broker with a prior disciplinary history, a broker who is deliberately trying to hurt customers or a situation where there is significant customer harm, are at play, said Emily Gordy, a former Finra senior vice president for enforcement.

“It will be clear there is a violation,” said Ms. Gordy, a partner at Shulman Rogers. “You won't see the higher sanctions in the cases that might be in the gray area.”

The strengthened sanctions reflect Finra's goal of eradicating rogue brokers, Mr. Tolley said.

“It is reinforcing Finra's fundamental message that egregious violations and recidivism must be addressed appropriately,” he said.

Another motivation for Finra's action came from Securities and Exchange Commissioner Kara Stein, who last year called for the self-regulator to update its sanctions.

“She was the catalyst,” Ms. Gordy said.

But some say the guideline changes are not enough and others warn of unintended consequences.

Ross Gerber, chief executive of Gerber Kawaski Wealth and Investment Management, said Finra should take a more muscular approach.

“The fact that they're adding a year suspension [for suitability violations] is just a band-aid for a bigger issue.”

The sanctions revisions may actually result in some negative consequences, said Bill Singer, an attorney who focuses on cases within the financial services industry.

“Individuals facing two-year sentences will be more apt to fight cases than settle,” he said. “If you face a two-year suspension, you may be more apt to cover up misconduct and to try to engage in under-the-counter settlements.”

But in the end, the tougher sanctions will stop much wrongdoing, Mr. Edwards said.

“An increased penalty has an increased deterrent effect, even if Finra brings the same number of enforcement cases,” he said.

Alessandra Malito contributed to this story.


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