Suitability obligations are essential for ensuring investor protection and promoting fair dealings with customers and ethical sales practices. FINRA Rule 2111, titled “Suitability,” governs general suitability obligations.
As regulatory scrutiny intensifies, suitability compliance remains a top priority for broker-dealers and financial firms. FINRA Rule 2111 outlines the standard for making investment recommendations that are in your clients' best interests — and the consequences for getting it wrong can be steep.
Below is everything you need to understand about FINRA Rule 2111, your obligations, and how to avoid common pitfalls.
What is FINRA Rule 2111 (Suitability Rule)?
FINRA Rule 2111 outlines the suitability obligations for FINRA member firms. The rule requires that firms or associated persons have a “reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on information obtained through reasonable diligence of the firm or associated person to ascertain the customer’s investment profile.”
According to FINRA, a customer’s investment profile generally includes — but is not limited to — the following factors:
- Age
- Other investments
- Financial situation and needs
- Tax status
- Investment objectives
- Investment experience
- Investment time horizon
- Liquidity needs
- Risk tolerance
Rule 2111 is triggered by a broker’s recommendation, including suggestions to buy, sell, or even hold a security. The determination of whether a recommendation has been made is based on the facts and circumstances of each individual case.
Bottom line: To comply with FINRA Rule 2111, brokers must demonstrate a firm understanding of both the investment product and the customer.
Who must comply with FINRA Rule 2111?
FINRA 2111 applies to all FINRA member firms, including broker-dealers and their associated persons, who make recommendations to customers regarding securities or investment strategies involving securities.
What are the three suitability obligations of FINRA 2111?
Rule 2111 provides for three suitability obligations for firms and associated persons that help inform best practices:
Reasonable basis suitability
Requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. Reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards of the recommended security or strategy.
Customer-specific suitability
Requires that a broker, based on a particular customer’s investment profile, has a reasonable basis to believe that the recommendation is suitable for that customer. The broker must attempt to obtain and analyze a broad array of customer-specific factors to support this determination.
Quantitative suitability
Requires a broker with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.
Best practices for complying with FINRA Rule 2111
When recommending private placements to non-retail customers, as covered by FINRA Rule 2111, both FINRA Regulatory Notice 10-22 and Regulatory Notice 23-08 provide broker-dealers with guidance that addresses how to conduct an investigation to fulfill FINRA’s “reasonable basis” obligations.
FINRA Notice 10-22: How to meet reasonable basis obligations
According to Notice 10-22, a broker-dealer or associated person must conduct a reasonable investigation into any security or investment strategy they recommend.
While what qualifies as “reasonable” may vary based on the facts and circumstances, the investigation should address, at a minimum:
- The issuer and its management
- The issuer’s business prospects
- Assets held or to be acquired
- The claims being made about the investment
- The intended use of the offering proceeds
FINRA Notice 23-08: Additional Guidance for Private Placements
Notice 23-08 adds further guidance by identifying four key areas that firms should evaluate when investigating a private placement:
- Regulatory and litigation history: Review the background of the issuer, its management, and any material affiliates, including any criminal, disciplinary, or regulatory actions. Check compliance with the bad actor disqualification provisions under Rule 506(d)-(e).
- Material developments: Stay alert to new or ongoing developments, such as legal proceedings or regulatory inquiries, that occur during the offering period and could affect suitability.
- Use of proceeds: Examine transactions or payments between the issuer and its affiliates to ensure offering proceeds are used appropriately and transparently.
- Performance representations: Scrutinize how past performance is presented. Watch for misleading claims, cherry-picked results, or unbalanced marketing materials that could misinform investors.
Keep in mind: Independent verification is key
While FINRA acknowledges that member firms are not expected to have the same knowledge as an issuer, Notice 23-08 emphasizes the importance of independently verifying material claims, especially:
- When affiliated with the issuer
- When red flags or concerns are present
How to demonstrate a reasonable investigation
To show compliance with the reasonable basis obligation, FINRA advises firms to:
- Document the inquiries, research, and analysis conducted
- Request and review primary documents directly from the issuer
- Critically evaluate third-party due diligence reports — don’t rely on them blindly
By taking these steps, firms help ensure their recommendations are well-founded and aligned with Rule 2111’s suitability standards.
Penalties for FINRA 2111 violations
Under FINRA’s 2024 Sanctions Guidelines, a violation of FINRA 2111 can result in serious consequences, including significant monetary sanctions that vary in amount, depending on the size of the firm and the type of violation. Suspension or expulsion of firms or individuals may also result.
How Smarsh can help you meet FINRA Rule 2111
Smarsh offers an end-to-end platform of AI-powered compliance solutions designed to streamline your compliance processes, reduce manual workloads and ensure adherence to regulatory requirements. With Smarsh, you can:
- Capture every conversation. Archive communications across all your most important communications channels (email, messaging, voice, social, mobile) for complete visibility and compliance.
- Detect more real risk with AI. Use machine learning and customizable risk scenarios to surface suitability concerns, reduce false positives and flag misconduct faster.
- Customize and test supervision models. Build and refine risk detection logic with no-code tools like Scenario Builder and Scenario Evaluator.
- Scale with confidence. Trusted by global financial firms, Smarsh helps you meet regulatory expectations while managing growing communication volumes.
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