Communications, KYC, and Best Interest

A broker-dealer is regulated on two fronts: how it reaches people, and what it owes the people it advises. This lesson covers the four rules the exam groups together.

Sorting communications: correspondence, retail, institutional

FINRA Rule 2210 sorts every written communication into one of three categories, and written includes email, texts, and social media posts. The category depends on how many retail investors receive the piece.

A retail investor is anyone who is not an institutional investor. Institutional investors are:

• Banks, savings and loan associations, insurance companies, registered investment companies, and registered investment advisers.
• Government entities, and employee benefit plans with at least 100 participants.
• FINRA member firms, their registered people, and any entity with at least $50 million in assets.

The three categories:

• Correspondence goes to 25 or fewer retail investors in any 30 calendar-day period.
• A retail communication goes to more than 25 retail investors in any 30 calendar-day period.
• An institutional communication goes only to institutional investors.

Approval follows the category:

• A registered principal must approve each retail communication before the firm uses or files it, whichever comes first.
• Correspondence gets supervision and review under the firm's written procedures. No principal signs off in advance.
• Institutional communications need written review procedures, but no advance approval. If the firm expects the piece to reach retail investors, it becomes a retail communication.

Content standards cover all three categories. The communication must be fair and balanced, and it may not be false, exaggerated, misleading, or promissory. It must name the firm, give a sound basis for judging the facts, and never claim a FINRA or SEC endorsement.

The firm keeps every communication for three years from its last use.

Telemarketing and the do-not-call list

Before you make a cold call, check the clock and two lists. FINRA Rule 3230 and the FTC's Telemarketing Sales Rule set the limits.

You may call only between 8:00 a.m. and 9:00 p.m. in the time zone of the person you call, not your own. On the call, name yourself and your firm. Give a contact number or address, and say you are selling securities.

The FTC runs the National Do Not Call Registry, and your firm screens against it before calling. Your firm also keeps its own do-not-call list. When a person asks not to be called, you record the request and stop calling for five years.

Four exceptions let a call through:

• The person gave the firm prior express permission to call.
• The person did business with the firm in the last 18 months, which is an established business relationship.
• The person has a personal or family relationship with the caller.
• The call goes to a broker-dealer.

Know your customer

FINRA Rule 2090 tells your firm to use reasonable diligence to know the essential facts about every customer. It also covers the authority of anyone who gives orders on the account. The duty starts when the account opens and lasts as long as the account does.

Essential facts let the firm service the account, follow special handling instructions, know who may give orders, and comply with the rules. The duty holds whether or not anyone recommends anything.

Regulation Best Interest

Regulation Best Interest (SEC Rule 15l-1) applies when you recommend a security, an investment strategy, or an account type to a retail customer. It binds the firm and its registered people, and has been in force since June 30, 2020.

A retail customer is a natural person who gets a recommendation and uses it mainly for personal, family, or household purposes. It also covers that person's legal representative. No dollar cutoff exists. A wealthy individual investing her own savings counts; a pension fund does not.

You must act in the retail customer's best interest, and never put your own financial interest ahead of the customer's. Four obligations carry that duty:

• Disclosure. Before or when you recommend, put the relationship in writing: your capacity, your fees and costs, your services, any limits on what you sell, and every material conflict of interest. Form CRS, the customer relationship summary, carries much of this.
• Care. Understand the risks, rewards, and costs of what you recommend. Then have a reasonable basis to believe it fits this customer's investment profile: age, other investments, finances, tax status, objectives, experience, time horizon, liquidity needs, and risk tolerance.
• Conflict of interest. The firm writes procedures to find conflicts, then discloses, reduces, or removes them. Sales contests tied to one security within a limited time must be removed. Disclosing them is not enough.
• Compliance. The firm writes and enforces procedures designed to meet the whole rule.

FINRA Rule 2111, the suitability rule, still covers the recommendations Regulation Best Interest does not reach, such as those to institutional customers.

What counts as a recommendation

Every duty in the last two sections starts with a recommendation, so the exam tests what one is. A recommendation is a call to action. Read the content, the context, and the presentation. Then ask whether a reasonable person would take it as a suggestion to act.

The more a message is tailored to one customer, the more likely it is a recommendation. Telling a customer to hold is one. So is telling one to roll a 401(k) into an IRA, or to switch account types.

These are not recommendations:

• General market commentary and educational material.
• Purely factual information about a security.
• A list of securities the customer produced with an objective screening tool.
• An unsolicited order the customer thought of alone.

A disclaimer settles nothing. Calling a message "not a recommendation" does not stop it from being one.

How this gets tested

Most items give a fact pattern and ask which rule applies. Count the retail investors to pick the communication category, then apply its approval rule. Check the called party's local time before you judge a phone call.

For advice questions, ask first whether a recommendation happened. If one did, and the customer is a natural person investing for herself, Regulation Best Interest applies.