Updated: October 2023
Duty to Supervise- FINRA Rule 3010
Per FINRA:
“Supervision
This rule requires NASD-registered firms to establish and maintain a system to supervise the activities of their registered representatives, registered principals, and other associated persons expected to comply with applicable securities laws, regulations, and NASD rules. These supervisory systems must include written procedures that designate a registered representative or principal with supervisory responsibilities. They must also include an annual discussion about relevant compliance matters with registered representatives and registered principals. Final responsibility for proper supervision rests with the firm.”
Brokerage firms are required to prescreen potential new brokers and review any prior customer complaints. Their supervisory procedures must be designed to:
- Monitor performance of customer accounts
- Monitor account activity to prevent and detect excessive trading (churning), unsuitable recommendations, recommendation of non firm approved products (selling away) and other sales practice abuses
- Monitor account opening procedures (overstating liquid net worth, annual income and investment experience are common abuses)
- Monitor communications between brokers and their clients
- Monitor broker advertising
The Financial Industry Regulatory Authority (FINRA) is the agency that licenses and regulates stockbrokers and brokerage firms. FINRA requires brokers and brokerage firms to report customer complaints and disputes as well as regulatory sanctions. In addition brokers are required to disclose certain financial matters such as personal bankruptcies, judgments and liens.
Duty to Supervise- FINRA Rule 2090 – Know Your Customer
Per FINRA-“ Every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer.”
Often referred to as the Suitability Rule, this rule mandates that a broker take into account the customer’s age, health, financial resources and level of financial sophistication when making investment recommendations. There is a duty to only make recommendations that are ‘suitable’ for that customer.
An Extreme Example of Suitability: What is suitable for 50 year old executive with a finance background is not suitable for the 83 year old widow with no financial experience, limited net worth and living on social security.
The SEC Regulation Best Interest Rule
Per the U.S. Securities and Exchange Commission, the Best Interest Rule applies when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.
The Best Interest Rule requires “When making such a recommendation to a retail customer, you must act in the best interest of the retail customer at the time the recommendation is made, without placing your financial or other interest ahead of the retail customer’s interests.”
- This obligation requires four specified component obligations, one of which is compliance and mandates the broker dealer to establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.
Failure to Supervise Results in Losses in Customer Accounts & An Example of Suitability
FINRA requires Broker-Dealers to establish reasonable written procedures to supervise the activities of its financial advisors (registered representatives), designed to achieve compliance with securities laws and regulations.
The broker who trades excessively (churning) in order to generate commissions can lead to a failure to supervise claim against the broker-dealer since they apparently did not monitor the amount of trading the broker was doing and compare it to the risk tolerance and investment objectives of the customer. An effective supervisory system will have thresholds which are triggered to send a red flag warning should established parameters be violated. This will then trigger a review of the account by compliance to compare the broker’s trading to the investment objectives and suitability standards for that particular customer. Unfortunately, there are broker-dealers who are either negligent and failed to follow up on these red flags, or purposely ignoring the red flags in order to generate revenue.
This same lack of follow through can result in accounts being overly concentrated with a single stock or too large of percentage of the account invested in Alternative Investments. The latter, over concentrating an account with alternative investments (ie: real estate investment trusts (REITS) , oil and gas partnerships, and private placements is a common and popular abuse.
Alternative Investments: These are assets that are not stocks, bonds or cash. Alternative investments generally fall within five categories: hedge funds, private capital, natural resources (oil and gas, energy), real estate (REITs) and infrastructure. They are typically less liquid that conventional investments, less regulated with higher fees and generally higher risk.
Recover Your Investment Losses Now With Rex Securities Law
If you have suffered investment losses in an account handled by a financial advisor contact us for a complimentary consultation with an experienced securities lawyer to learn how you may be able to recover damages through FINRA arbitration.
With offices in Boca Raton, FL and Austin, TX, stockbroker fraud attorney Bob Rex provides representation to investors nationwide who are seeking recovery of investment losses due to the negligence or fraud of stockbrokers, financial advisors, and broker dealers.
If you have questions about how your account has been handled, call (877) 224-3199 to speak with an experienced securities attorney at no cost to you.
Most cases are handled on a contingent fee basis meaning that you do not pay legal fees unless we are successful.
