NEW YORK (Reuters) - Some securities brokerages are struggling with an industry rule requiring, among other things, policies to make sure that recommendations to hold securities are appropriate for their investors, according to findings this week by Wall Street’s industry-funded watchdog.
The Financial Industry Regulatory Authority (FINRA) rule, which took effect in July 2012, required that investments recommended by brokerage firms be suitable for investors at all times, and not just when investors buy them. In the past, brokers mainly had to worry only that their “buy” and “sell” recommendations were suitable at the time of sale.
Last year’s rule was a significant change because it meant that brokerages now have to also make sure, on an ongoing basis, that their clients should still be “holding” a specific security.
Now, FINRA is finding that some brokerages are not doing a good job of meeting the new requirement. The regulator’s findings were released late on Wednesday.
The most common problem: failing to put adequate procedures in place to ensure that “hold” recommendations remain suitable long past the moment when a firm’s broker and customer speak. The firms did not adequately document the recommendation or have procedures for supervising such recommendations, FINRA said.
The self-regulator reviewed practices at 200 firms to gauge Wall Street’s efforts to comply with the 15-month-old rule, which was itself an attempt to enhance and clarify the so-called suitability standard that brokers face. The rule now requires that brokers’ recommendations be suitable for investors at all times, based on factors such as their age and risk tolerance.
To be sure, FINRA found problems in only a “small percentage” of the firms it had examined. A FINRA spokeswoman declined to comment on the number that had problems. Most firms, however, had updated their policies and trained staff to comply with the new suitability rule, FINRA said.
Nonetheless, failing to have adequate policies to comply with the “hold” strategy requirement is still a significant gap for the firms involved and their customers, say compliance professionals. Changing market conditions can unexpectedly transform some “hold” recommendations from suitable and safe, to risky. Losses to investors that stem from not following industry rules can leave firms vulnerable to arbitration cases and regulatory actions, they say.
Developing policies to ensure that “hold” recommendations are suitable has been a big adjustment for the securities industry because brokerage firms previously did not have a way to document that advice, said Francois Cooke, a managing director with ACA Compliance Group, a Washington-area firm that provides compliance consulting services to broker-dealers.
A “hold” recommendation is unlike advising a client to buy or sell securities, which brokers document on order tickets, Cooke said. It is something brokerages must now monitor on an ongoing basis, to insure that a security previously purchased still is suitable for their clients.
Many firms have met the challenge by developing various ways to document the recommendation, including paperwork similar to order tickets, FINRA said. Some small brokerages are using technology from the firms that clear their transactions to type in notes about their recommendations, FINRA said.
Firms that did not have adequate procedures for complying with the new rule received letters of caution, FINRA said.
Editing by Linda Stern and Matthew Lewis