Yield of Dreams

Rhoades: FINRA’s New Suitability Rule Crosses the Line

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Ron Rhoades, the newly-elected chairman of the National Association of Personal Financial Advisors (NAPFA), has been on a mission lately to express his displeasure at the possibility of FINRA overseeing registered investment advisors. But now he’s taking issue with FINRA’s new suitability rule, saying that the investment strategy provision too closely resembles the way RIAs are regulated under the Investment Advisers Act.

“If you’re going to apply suitability doctrine and say, ‘You have to have an investment strategy in place and you have to document that if you do provide that service,’ I think that really crosses the line and becomes an investment advisory activity and you become a fiduciary in regard to that,” Rhoades said, during a recent webinar sponsored by fi360.

While historically brokers have only had a suitability obligation when recommending securities transactions, the new rule expands that obligation to cover investment strategy recommendations, including purchase of a non-security with proceeds of a security sale, investment in a bond ladder, and use of margin, day trading, or ‘liquefied home equity.’ It also applies to recommendations to ‘hold’ a security or securities. But it may apply to other kinds of strategy recommendations, as well. FINRA has said, “the term ‘investment strategy’ is to be interpreted ‘broadly.’” 

If you’re interpreting it broadly, Rhoades believes you’re also talking about strategies such as strategic asset allocation, momentum effect, stock picking, timing the market, and tactical asset allocation. “If you’re doing that type of service for your clients, that sounds like an advisory service that might fit within the Investment Advisers Act.”

There have been questions raised over whether the new suitability rule imposes a fiduciary standard on brokers, but not for the reason Rhoades brings up. The rule points out that recommendations must be “consistent with the customer’s best interests,” language that is very similar to the fiduciary standard. FINRA said this language has been used in case law.

But Rhoades argues that the “customer’s best interest” provision is only one element of the duty of loyalty, not the duty of loyalty in its entirety.

“So I don’t think the best interest standard imposes a broad fiduciary obligation to all registered representatives,” Rhoades said. “Did FINRA mean to move in that direction? Possibly. Certainly they’re aware of potential for fiduciary rulemaking, and they’ve embraced some type of fiduciary concept for registered representatives.”

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Casting a gimlet-eye on asset management issues.

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