Finra files rule clarifying where Reg BI supersedes suitability standard

Broker-dealer regulator says Reg BI will clamp down on sales contests

Finra has proposed a rule that would clarify when the current suitability standard for brokers will be superseded by a new broker advice rule set to be implemented this summer.

On Thursday, the Financial Industry Regulatory Authority Inc. filed with the Securities and Exchange Commission a proposal to amend the suitability rule as well as rules governing non-cash compensation for brokers.

The changes would make clear that the SEC’s Regulation Best Interest for brokers will apply to broker recommendations for retail customers. But brokers would continue to adhere to suitability for transactions with institutional investors and in other circumstances.

“Finra does not propose to eliminate the suitability rule because it applies broadly to all recommendations to customers whereas Reg BI applies only to recommendations to ‘retail customers,’” the rule proposal states. “Thus, FINRA’s suitability rule is still needed for entities and institutions (e.g., pension funds), and natural persons who will not use recommendations primarily for personal, family, or household purposes (e.g., small business owners and charitable trusts).”

The SEC approved Reg BI, as it’s known, last summer as part of a regulatory package designed to strengthen investment-advice rules. It must be implemented by firms by June 30.

Finra sent the rule proposal to amend suitability straight to the SEC without a comment period. If the SEC approves the rule, Finra said it will publish a regulatory notice within 60 days of the SEC decision. The rule would go into effect on the Reg BI implementation date.

Finra is trying to preserve certain aspects of the suitability rule instead of scrapping the standard, said Kurt Wolfe, a securities attorney at Troutman Sanders.

“They’re almost trying to thread a needle,” Mr. Wolfe said. “What they’re saying is where Reg BI applies, it’s the law of the land. For anything around the periphery, Finra rules still apply.”

The SEC and investor advocates have engaged in a long debate about whether Reg BI raises the broker standard above suitability to address conflicts of interest. In its rule proposal, Finra asserted that it does.

“Two key enhancements are that Reg BI explicitly imposes a best interest standard and explicitly requires a consideration of costs,” the Finra rule proposal states. “In addition, Reg BI places greater emphasis than the suitability rule on consideration of reasonably available alternatives. Moreover, Reg BI explicitly applies to recommendations of types of accounts (e.g., broker-dealer or investment adviser, or among broker-dealer accounts, including recommendations of IRA rollovers).”

The Finra rule proposal says Reg BI goes farther than suitability in curbing programs within firms designed to stoke sales of certain investment products.

“[F]irms generally would no longer be permitted to sponsor or maintain internal sales contests based on sales of securities within a product category within a limited time, even if they are based on total production and equal weighting,” the Finra rule proposal states.

The new rules could mean the days of pushing products to win a trip to a Caribbean island may be ending.

“It’s going to be really difficult for brokers to participate in sales contests,” Mr. Wolfe said. “There’s almost an inherent conflict of interest there.”