By Cynthia Jeffries
The historic market turmoil of the last 12 months has led to more service requests, lower revenue streams and busier calendars. Unfortunately, another consequence of the upheaval has been an increase in the number of customer claims, as clients question why the investments you recommended fell far short of achieving their historical rates of return. In fact, FINRA reported in October a 49-percent increase year-over-year. The No. 1 product subject to client disputes was mutual funds, with derivative investments (e.g., options, futures) coming in a close second.
But there's a silver lining to this cloud, as the increase in claims has given you a golden opportunity to increase your number of contacts with clients and to take a concentrated look at their entire investment pictures.
FINRA'S SUITABILITY RECOMMENDATIONS
When determining investment suitability, FINRA's Rule 2310, Recommendations to Customers (Suitability), provides guidelines for the information you must obtain and the circumstances you must be aware of before recommending any security to any client. These criteria, along with ongoing client communication, can be a significant help when you and your clients sit down together to create an appropriate pathway for achieving their financial goals.
Here's what you need to know:
- Financial status of your client. This includes a client's net worth, annual income, liquid assets and other investments. Additional information, including financial responsibilities and a foreseen change in lifestyle, could also provide insight.
- Tax status of your client. This includes a client's current tax bracket, as well as changes to his or her status. For example, maybe your client has elected to begin taking distributions and this action will put him or her in a lower tax bracket. Or, perhaps your client holds assets outside of your practice and the activity of these investments may contribute to a change in tax status. Knowing this may have a big effect on the recommendation you might make.
- Investment objective. This includes, but is not limited to, knowing each client's reasons for investing, at what point the investment will be needed, whether the client has investment preferences (e.g., not investing in foreign stocks, wanting to invest in an environmentally conscious company), and the risk level the client is willing to take.
- Other information that may provide a reasonable basis for a recommendation. A client's age, changes in employment or future funding needs (e.g., college, sale or purchase of property, a need for liquidity) are examples of information that can help you and your client in making a wise investment decision.
After obtaining and considering this information, you should have a reasonable basis for your recommendations, regardless of transaction type.
FINRA GUIDANCE APPLIES TO CASH ALTERNATIVES, TOO
Guidance from FINRA for obtaining this information is not limited to recommendations of mutual funds, bonds, variable products or alternative investments. A recent regulatory notice, Notice to Members 08-82, reminds us of our obligations when recommending cash alternatives to a client. This would include, but is not limited to, fixed income securities, bank CDs, Treasury bills, ultra-short bond mutual funds and exchange-traded funds. While these products are well-known, a customer's understanding of the product and an examination of whether a client is specifically suitable are key. Changes in the market can affect these products, and this should be clearly communicated to the client.
FINRA offers many product-specific online learning opportunities that address how to determine investment suitability. Visit www.finra.org, click on "Industry Professionals," and then click on "Education." You'll find E-Learning courses covering the following topics and more:
- Senior investor suitability considerations
- Fixed income suitability: Retail sales practices
- Suitability issues: Considerations for product exchanges
- Variable Annuities: Sales practice issues for 1035 Exchanges
- Variable annuities: Suitability and disclosure for new purchases
Cynthia Jeffries is a compliance advisor at Commonwealth Financial Network, member FINRA/SIPC, and a registered investment adviser, in Waltham, Mass. She can be reached at cjeffries@commonwealth.com.
