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Compliance Concepts

Suitability for Retail Customers (FINRA Exam Findings - Part 2)

December 12, 2018

by Howard Haykin


“The devil is in the details” when it comes to effective compliance and supervision - and this is especially true when dealing with ‘customer suitability’. In Part 2 of  our coverage on FINRA's Annual Report on Examination Findings, we offer an overview of FINRA’s recent findings, assessments and recommendations, while recommending that you click the embedded links for the 'all-important details'.  To access related posts, click on:


FINRA’s Annual Report on Examination Findings, released Friday, December 7th, was fairly predictable in reporting that Suitability for Retail Customers is the regulator’s Number One Highlighted Observation.


Time and again, FINRA observed firms and their associated persons operating in violation of FINRA Rule 2111, Suitability. And in those instances where registered reps repeatedly engaged in unsuitable recommendations, FINRA goes so far as to suggest that firms consider subjecting such reps to special supervisory procedures – i.e., heightened supervision plans – as detailed in FINRA Regulatory Notice 18-15.


SELECTED EXAMINATION FINDINGS.    FINRA addressed product suitability in its 2017 Report on Examination Findings

and it supplements those observations with the following insights from recent FINRA examinations, as well as from its 2018 targeted examination (sweep) of volatility-linked products.


  • Overconcentration.   Once again, some customer accounts were concentrated in complex structured notes or sector-specific investments, as well as illiquid securities, such as non-traded real estate investment trusts (REITs). These positions are not only unsuitable for unsophisticated customers, but they result in significant customer losses. In some instances, firms lacked procedures or systems reasonably designed to identify and supervise the concentration of such products in customers’ accounts.


  • Excessive Trading.   Some firms failed to establish and enforce an adequate supervisory system reasonably designed to identify and prevent potentially excessive trading in customer accounts. And even where firms employ an “active account” letter (or “activity letter”) process, such efforts were doomed by inadequate supervision or overly general and ineffectual letters.


  • Unsuitable Variable Annuity Recommendations – Some firms failed to establish, maintain and enforce supervisory systems and WSPs reasonably designed to ensure that reps’ recommendations of variable annuities complied with suitability obligations. Rep-driven recommendations to retail customers to exchange one annuity product for another are often costly, unsuitable and largely unsupervised. In some cases, registered reps and their supervisors lacked adequate training in these products.


TAKING A CUE FROM SOUND SUPERVISORY PRACTICES.    Firms with sound supervisory practices for suitability generally identified risks, developed policies, and implemented controls tailored to the specific features of the products they offered and their customer base. These controls included:


  • restricting or prohibiting recommendations of products for certain investors, as well as establishing systems-based controls (or “hard blocks”) for recommendations of certain products to retail investors to ensure that registered reps adhered to those restrictions or prohibitions.
  • verifying the source of funds for variable annuity transactions.
  • requiring training on specific complex or high-risk products before reps may recommend them and before principals may supervise such sales by reps.
  • Recognizing instances where a firm or its associated persons has “actual or de facto control” over a customer’s account.