Customer Account Supervision

Suitability and Regulation Best Interest

One of the principal's most important supervisory responsibilities is ensuring that recommendations made by the firm's registered representatives are appropriate for each customer. The regulatory framework for this obligation has evolved significantly, with Regulation Best Interest (Reg BI) establishing a heightened standard for broker-dealer recommendations that went into effect on June 30, 2020. Reg BI supplements, but does not entirely replace, the traditional FINRA suitability rules.

Under Reg BI, when a broker-dealer or its associated persons make a recommendation to a retail customer regarding any securities transaction or investment strategy involving securities, the broker-dealer must act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer or associated person ahead of the interest of the customer. Reg BI has four component obligations:

1. Disclosure Obligation: The firm must provide a Form CRS (Customer Relationship Summary) to retail customers before or at the earliest of making a recommendation, placing an order, or opening an account. Form CRS must describe the type of services offered, fees and costs, conflicts of interest, disciplinary history, and how to obtain additional information.
2. Care Obligation: The firm must exercise reasonable diligence, care, and skill when making recommendations. This includes understanding the potential risks, rewards, and costs of the recommendation; having a reasonable basis to believe the recommendation is in the customer's best interest based on the customer's investment profile; and considering reasonably available alternatives.
3. Conflict of Interest Obligation: The firm must establish, maintain, and enforce written policies and procedures to identify and address conflicts of interest. Certain conflicts, such as sales contests based on the sale of specific securities, must be eliminated entirely.
4. Compliance Obligation: The firm must establish, maintain, and enforce policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.

FINRA Suitability (Rule 2111)

FINRA Rule 2111 requires that a member or associated person have a reasonable basis to believe a recommended transaction or investment strategy is suitable for the customer based on the customer's investment profile. The three suitability obligations are:

• Reasonable-basis suitability: The representative must have a reasonable basis to believe the recommendation is suitable for at least some investors based on reasonable diligence
• Customer-specific suitability: The recommendation must be suitable for the particular customer based on their investment profile (age, financial situation, objectives, risk tolerance, etc.)
• Quantitative suitability: The overall level of trading activity in a customer's account must not be excessive given the customer's profile (anti-churning provision)

Margin Account Supervision

Margin accounts allow customers to borrow money from the broker-dealer to purchase securities, using the securities in the account as collateral. While margin can amplify returns, it also amplifies losses and creates significant risks for both the customer and the firm. Principals must supervise margin accounts closely to ensure compliance with Regulation T, FINRA margin rules, and the firm's own house margin requirements.

Key Margin Requirements

• Regulation T (initial margin): The Federal Reserve requires customers to deposit at least 50% of the purchase price of marginable securities (the current Reg T initial margin requirement)
• FINRA minimum maintenance: Customer equity must not fall below 25% of the market value of the long securities in the account. Most firms impose higher house maintenance requirements (typically 30-35%)
• Margin calls: When equity falls below the maintenance requirement, the firm issues a margin call requiring the customer to deposit additional funds or securities. If the customer fails to meet the call, the firm may liquidate positions to restore the required equity
• Day trading accounts: Pattern day traders (4 or more day trades in 5 business days) must maintain minimum equity of $25,000 and are subject to special margin requirements

Customer Complaints Handling

FINRA Rule 4530 requires member firms to report certain events to FINRA, including customer complaints that allege theft, misappropriation, forgery, fraud, or unauthorized trading. Proper handling of customer complaints is essential for investor protection and regulatory compliance. Principals must establish comprehensive complaint-handling procedures and ensure that all complaints are documented, investigated, and resolved appropriately.

Complaint Handling Process

1. Receipt and logging: All customer complaints, whether written, verbal, or electronic, must be promptly logged in the firm's complaint tracking system with the date received, customer name, registered representative involved, and nature of the complaint
2. Acknowledgment: The firm should promptly acknowledge receipt of the complaint to the customer
3. Investigation: A principal must investigate the complaint, which may include reviewing account records, trade confirmations, correspondence, recorded phone calls, and interviewing the registered representative and customer
4. Resolution: Based on the investigation, the firm must determine an appropriate resolution, which may include corrective action, compensation, or a determination that the complaint is unfounded
5. Response: The firm must respond to the customer in writing, explaining the findings and any action taken
6. Reporting: Certain complaints trigger reporting obligations under FINRA Rule 4530 (quarterly statistical reports and event-driven filings)

Senior Investor Protections

FINRA Rules 2165 and 4512 address the protection of senior and vulnerable adult investors. These rules were adopted in recognition of the growing risk of financial exploitation targeting older adults. As a principal, you must ensure your firm has procedures in place to detect potential exploitation, a process for placing temporary holds on disbursements when exploitation is suspected, and protocols for communicating with trusted contacts.

Trusted Contact Person (Rule 4512)

FINRA Rule 4512 requires firms to make reasonable efforts to obtain the name and contact information of a trusted contact person for each customer's account. The trusted contact is someone the firm can reach out to if it has concerns about the customer's health, welfare, or potential exploitation. The firm must disclose to the customer that the trusted contact may be contacted to address possible financial exploitation, to confirm the customer's current contact information, or to confirm the customer's health status or identity of any legal guardian, executor, or holder of a power of attorney.

Temporary Holds on Disbursements (Rule 2165)

FINRA Rule 2165 permits (but does not require) firms to place a temporary hold on disbursements of funds or securities from the account of a specified adult (age 65+) or a person age 18+ whom the firm reasonably believes has a mental or physical impairment that renders them unable to protect their own interests. The hold can last for 15 business days, with the possibility of an extension of up to 10 additional business days if the firm has reported the matter to a state regulator or agency and the investigation is ongoing.