Suitability & Recommendations - Series 6 Exam

Customer Profiling

The foundation of making suitable recommendations is understanding your customer. Before recommending any investment product, a registered representative must gather comprehensive information about the customer's financial situation, needs, and goals. This process is sometimes called "Know Your Customer" (KYC) and is both a regulatory requirement and a professional obligation.

Essential Customer Information

The following information should be collected during the customer profiling process:

Age and life stage: A 25-year-old with decades until retirement has different needs than a 65-year-old approaching retirement. Age affects time horizon, risk tolerance, and product suitability.
Marital status and dependents: Family obligations affect insurance needs, liquidity requirements, and investment objectives.
Annual income and employment status: Current and expected future income determines the ability to invest and the need for liquidity.
Net worth and liquid net worth: Total net worth provides context for the recommendation, while liquid net worth indicates how much the customer can afford to invest in potentially illiquid products like variable annuities.
Tax status and bracket: Tax considerations affect whether tax-deferred products provide meaningful benefits. A customer in a low tax bracket may not benefit enough from tax deferral to justify the higher costs of a variable annuity.
Investment objectives: Growth, income, capital preservation, speculation, or a combination. The customer's stated objectives must align with the recommended product.
Risk tolerance: The customer's willingness and ability to accept fluctuations in the value of their investments. This is both a psychological factor (willingness) and a financial factor (ability to absorb losses).
Time horizon: How long the customer plans to keep the investment before needing access to the funds. Longer time horizons generally support more aggressive investments and products with surrender charge periods.
Investment experience: A customer's familiarity with financial products affects how well they can evaluate risks and make informed decisions.
Existing investments and insurance: Understanding what the customer already owns prevents duplication and helps ensure the overall portfolio is balanced.
Liquidity needs: The customer's need for readily accessible cash. Products with surrender charges or long-term commitment requirements are unsuitable for customers who may need their money soon.

Series 6 exam questions about suitability typically present a customer scenario with specific financial details and ask which product or share class is most suitable. Focus on the customer's age, time horizon, investment amount, liquidity needs, risk tolerance, and tax status. These are the key factors that drive suitability determinations for mutual funds, variable annuities, and variable life insurance.

Regulation Best Interest (Reg BI)

Regulation Best Interest (Reg BI) is an SEC rule that became effective on June 30, 2020. It establishes a standard of conduct for broker-dealers and their associated persons when making recommendations to retail customers. Reg BI enhances the previous suitability standard by requiring that recommendations be in the customer's "best interest" rather than merely suitable.

The Four Component Obligations

Reg BI imposes four specific obligations on broker-dealers:

Disclosure Obligation: Before or at the time of a recommendation, the broker-dealer must provide the retail customer with a Form CRS (Customer Relationship Summary). This document must disclose:
- The types of services offered
- Fees and costs the customer will pay
- Conflicts of interest
- Whether the firm and its associated persons have disciplinary history
- How to access additional information
Care Obligation: The broker-dealer must exercise reasonable diligence, care, and skill when making a recommendation. This means:
- 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 their investment profile
- Having a reasonable basis to believe that a series of recommended transactions is not excessive or harmful (quantitative suitability)
Conflict of Interest Obligation: The broker-dealer must establish, maintain, and enforce written policies and procedures to identify, disclose, and mitigate or eliminate conflicts of interest. This includes addressing material limitations on the products that can be recommended and addressing compensation structures that could incentivize inappropriate recommendations.
Compliance Obligation: The broker-dealer must establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI as a whole.

Retail Customer: Under Reg BI, a retail customer is a natural person (or their legal representative) who uses the recommendation primarily for personal, family, or household purposes. The protections of Reg BI apply specifically to these individuals, not to institutional investors.

FINRA Suitability Obligations

FINRA Rule 2111 (Suitability) requires that a broker-dealer or associated person have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer, based on information obtained through reasonable diligence. FINRA Rule 2111 works alongside Reg BI and establishes three types of suitability obligations:

Three Types of Suitability

Reasonable-Basis Suitability: The representative must have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. This requires the representative to understand the product being recommended, including its features, risks, costs, and how it works. A representative who does not understand a product cannot have a reasonable basis for recommending it.
Customer-Specific Suitability: The representative must have a reasonable basis to believe that the recommendation is suitable for the specific customer based on that customer's investment profile. This is where the customer profiling information described above becomes critical. A product that is suitable for some investors may not be suitable for a particular customer.
Quantitative Suitability: A representative who has actual or de facto control over a customer's account must have a reasonable basis to believe that a series of recommended transactions, even if each individual transaction is suitable, is not excessive when taken together. This addresses the issue of "churning" (excessive trading to generate commissions).

The following are examples of suitability violations that appear frequently on the Series 6 exam:

Recommending Class B shares when the customer qualifies for Class A breakpoints (breakpoint sale)
Recommending a variable annuity to a customer who needs short-term liquidity
Replacing an existing annuity with a new annuity that triggers new surrender charges without clear benefit
Recommending aggressive growth funds to a retiree who needs income and capital preservation
Recommending a variable annuity inside a qualified plan (like an IRA) without justifying the additional insurance features, since the IRA already provides tax deferral

Documentation Requirements

Proper documentation is essential for demonstrating that suitability analysis was performed and that the recommendation was appropriate. Documentation protects both the customer and the representative.

What Must Be Documented

Customer investment profile: All information gathered during the KYC process, including financial data, investment objectives, risk tolerance, time horizon, and experience.
Rationale for recommendation: The reasons why the specific product was recommended based on the customer's profile. This should clearly connect the product's features to the customer's needs.
Alternatives considered: Under Reg BI, documentation should reflect that the representative considered reasonably available alternatives and selected the recommendation that was in the customer's best interest.
Disclosures provided: Evidence that the customer received all required disclosures, including the prospectus (for securities products), Form CRS, and any product-specific disclosures.
Customer acknowledgment: Records showing the customer understood and agreed to the recommendation. While not always a signed document, evidence of communication and consent is important.

Principal Review

FINRA rules require that certain transactions be reviewed and approved by a registered principal before being executed. Variable annuity transactions must receive principal review under FINRA Rule 2330. The principal must review the suitability analysis and determine that the recommendation is consistent with the customer's stated needs and objectives. This supervisory review adds an additional layer of protection for the customer.

Deep Dive Reg BI vs. Fiduciary Standard

There is an important distinction between the Reg BI standard that applies to broker-dealers and the fiduciary standard that applies to investment advisers under the Investment Advisers Act of 1940.

Reg BI (Broker-Dealers): Requires recommendations to be in the "best interest" of the retail customer. However, this standard applies only at the time of the recommendation. The broker-dealer does not have an ongoing duty to monitor the investment or update the recommendation as circumstances change. The standard is disclosure-based: conflicts must be disclosed and mitigated but do not need to be eliminated entirely.

Fiduciary Standard (Investment Advisers): Imposes a continuous duty of loyalty and care. Investment advisers must act in their clients' best interests at all times, not just at the point of recommendation. They must avoid conflicts of interest or provide full disclosure and obtain informed consent. The fiduciary duty is broader and ongoing.

While Reg BI significantly enhanced the standard for broker-dealers beyond the previous suitability rule, it is generally considered to be a less stringent standard than the full fiduciary duty. The SEC has stated that Reg BI and the fiduciary standard are separate regulatory frameworks, and Reg BI does not create a fiduciary obligation for broker-dealers.

For Series 6 purposes, understand that registered representatives of broker-dealers must comply with both FINRA suitability rules AND Reg BI. When there is overlap, the higher standard applies.

Senior Investors

Working with senior investors requires special care and attention. FINRA has issued specific guidance and rules to protect older investors, who may be more vulnerable to unsuitable recommendations, financial exploitation, and cognitive decline. This is an increasingly tested topic on the Series 6 exam.

FINRA Rule 2165: Financial Exploitation of Specified Adults

FINRA Rule 2165 allows broker-dealer firms to place a temporary hold on disbursements of funds or securities from the account of a "specified adult" when there is a reasonable belief that financial exploitation has occurred, is occurring, or has been attempted. Key provisions:

Specified adults: Includes individuals aged 65 and older AND individuals aged 18 or older who the firm reasonably believes have a mental or physical impairment that renders them unable to protect their own interests.
Temporary hold: A firm may place a temporary hold on a disbursement for up to 15 business days while it investigates the suspected exploitation. The hold may be extended for an additional 10 business days with principal approval.
Trusted contact person: Firms are required to make reasonable efforts to obtain the name and contact information of a trusted contact person for each customer's account. This person can be contacted if the firm suspects financial exploitation, to confirm the customer's health status, or to verify contact information.
Notification requirements: The firm must promptly notify the trusted contact person and all parties authorized to transact on the account of any temporary hold placed.

Suitability Considerations for Seniors

When recommending products to senior investors, representatives should pay particular attention to:

Time horizon: Seniors typically have shorter time horizons, which may make long-term products with surrender charges (like variable annuities) unsuitable.
Liquidity needs: Seniors may need access to funds for healthcare expenses, living expenses, or emergencies. Products that restrict access to funds may be inappropriate.
Risk tolerance: Many seniors have a lower risk tolerance and greater need for capital preservation and income.
Mental capacity: Representatives should be alert to signs of diminished capacity and should not take advantage of a customer who may not fully understand the recommendation.
Existing products: Replacing existing annuities or insurance policies with new ones (which trigger new surrender charge periods) is scrutinized closely for senior investors.

The financial industry has heightened obligations when working with senior investors. FINRA Rule 2165 provides a mechanism to protect seniors from financial exploitation, while the trusted contact person requirement helps firms identify potential issues early. Series 6 representatives should be especially cautious about recommending products with long surrender periods, high fees, or complex features to older clients.

Product-Specific Suitability Considerations

Mutual Fund Share Class Suitability

Selecting the right share class is a core suitability obligation for Series 6 representatives. The decision depends primarily on the investment amount, time horizon, and whether breakpoints apply:

Class A: Most suitable for larger investments ($25,000+) held long-term, where breakpoint discounts and lower ongoing expenses provide the best value.
Class B: Rarely suitable today due to higher ongoing costs and FINRA scrutiny. May only be appropriate for smaller investments by long-term investors who cannot afford the front-end load, though many firms no longer offer them.
Class C: Most suitable for shorter holding periods (1-3 years) where avoiding a front-end load outweighs the higher annual expenses.

Variable Annuity Suitability

As discussed in Chapter 3, variable annuities are complex products with high fees. They are most suitable for investors who have maximized contributions to other tax-advantaged accounts, have a long time horizon, benefit from tax deferral, and value the insurance features (death benefit, guaranteed income options).

529 Plan Suitability

529 plans are generally suitable for any family saving for education expenses, but representatives should consider the investor's state of residence (for state tax benefits), the beneficiary's age (which affects the appropriate investment risk level), and whether the family has other education savings vehicles in place.

Customer Profile	Suitable Products	Generally Unsuitable
Young, high risk tolerance, long horizon	Growth funds (Class A), aggressive subaccounts	Money market funds, fixed annuities
Retiree, income need, low risk tolerance	Income funds, bond funds, balanced funds	Variable annuities with long surrender periods, aggressive growth funds
High income, maxed out 401(k)/IRA	Variable annuity (if long horizon), municipal bond fund	Low-cost index fund in taxable account (may be better)
Parent saving for child's college	529 plan, Coverdell ESA	Variable annuity (tax-deferral less relevant for education savings)

Check Your Understanding

Test your knowledge of suitability and recommendations. Select the best answer for each question.

1. Under Regulation Best Interest, the four component obligations are disclosure, care, conflict of interest, and:

2. Under FINRA Rule 2165, how long can a firm place an initial temporary hold on a disbursement from a specified adult's account?

3. A 70-year-old retired customer with moderate savings needs income and has low risk tolerance. Which recommendation is MOST suitable?

4. Which type of suitability requires a representative to understand the product being recommended?

5. A customer wants to invest $50,000 in a mutual fund and plans to hold for 10+ years. The representative recommends Class C shares. Is this suitable?

Class C shares are generally unsuitable for large, long-term investments. With $50,000, the investor would qualify for Class A breakpoint discounts, and the lower ongoing 12b-1 fees of Class A shares (typically 0.25% vs. 0.75-1.00%) would result in significantly lower total costs over 10+ years. Recommending Class C in this scenario could be considered a suitability violation.