5.2 Know Your Customer, FINRA Suitability, and Institutional Accounts

Rule 2090: Know Your Customer

FINRA Rule 2090 requires a member to use reasonable diligence, when an account is opened and as it is maintained, to know and retain the essential facts about every customer. Essential facts are those needed to service the account effectively, follow special handling instructions, act for the customer, and comply with law. The rule applies to retail and institutional accounts and does not depend on a recommendation.

A principal should be able to answer:

• Who owns the account, and who has authority to act?
• What restrictions, powers of attorney or fiduciary duties govern it?
• Are standing instructions, trusted-contact information and tax status current?
• Do changes in address, bank instructions or ownership create fraud or capacity concerns?

KYC is not the same as the Customer Identification Program. Rule 2090 focuses on facts needed to service and supervise the relationship; CIP focuses on forming a reasonable belief that the firm knows the customer's true identity (Section 8.2).

Where Rule 2111 Still Matters

For recommendations to retail customers, Reg BI generally supersedes Rule 2111. Rule 2111 still applies where Reg BI does not, including recommendations to an entity or another customer that is not a Reg BI retail customer, and it remains useful vocabulary for the Series 26 outline. Product-specific rules, especially deferred-variable-annuity Rule 2330, continue to apply in addition to Reg BI.

Rule 2111 covers a recommendation of a security or an investment strategy involving a security, including an explicit recommendation to hold. Whether a communication is a recommendation depends on its content, context and presentation. A personalized call urging a customer to keep an expensive fund is more likely a recommendation than general educational material explaining fund expenses.

The Three Suitability Components

The Rule 2111 investment profile includes age, other investments, financial situation and needs, tax status, objectives, experience, time horizon, liquidity needs, risk tolerance and other disclosed information. A principal should investigate inconsistencies rather than accept an implausible profile—for example, an 82-year-old customer marked both “capital preservation” and “aggressive growth” immediately before a high-cost exchange.

Quantitative suitability no longer depends on control. Before June 30, 2020, FINRA had to show that the representative had actual or de facto control of the account. FINRA removed that element so Rule 2111 would match Reg BI's Care Obligation, which never required control. Today the question is whether the recommended series was excessive in light of the customer's profile. Rule 2111.05(c) says no single test defines excessive activity; the turnover rate, the cost-equity ratio and in-and-out trading are the usual indicators. In packaged products, the pattern usually appears as repeated fund switches or annuity exchanges rather than rapid stock trading.

Two other supplementary provisions matter to a principal. Rule 2111.02 says a member or associated person cannot disclaim suitability responsibilities, so a customer acknowledgment does not cure an unsuitable recommendation. Rule 2111.06 bars recommending a transaction, or a continuing purchase such as a periodic investment plan, unless there is a reasonable basis to believe the customer has the financial ability to meet the commitment.

Institutional Accounts and Rule 2111(b)

An institutional account for Rule 4512(c) purposes includes banks, insurance companies, registered investment companies and advisers, and persons with total assets of at least $50 million. Under Rule 2111(b), a member fulfills customer-specific suitability for an institutional account if:

1. it has a reasonable basis to believe the institutional customer is capable of evaluating investment risks independently, both generally and for the particular transactions or strategies; and
2. the customer affirmatively indicates that it is exercising independent judgment.

The indication may be broad or transaction-specific and may be given by the customer or an authorized agent. The firm still owes reasonable-basis suitability, and the exemption does not eliminate KYC, antifraud, Reg BI (if a natural-person retail customer is involved), or product-specific obligations.

Recommendations to Hold and Monitoring

Rule 2111 covers an explicit hold recommendation. Reg BI also covers explicit holds and can cover an implicit hold when the firm has agreed to monitor periodically. The principal should distinguish education from advice, document the scope of any monitoring promise, and review recurring “do nothing” recommendations involving high ongoing costs.

Supervisory Tests

Exception reports should compare recommendations with age, time horizon, liquidity, concentration, product costs and prior activity. Institutional-account reviews should preserve the customer's independent-judgment affirmation. A product committee's approval is only reasonable-basis groundwork; each representative and supervisor must still evaluate the actual customer.

Fair Prices, Service Charges, and Fiduciary Information

Task 2.3 of the outline also lists three pricing and information rules:

• Rule 2121 (Fair Prices and Commissions) requires a member acting as principal to buy from or sell to a customer at a fair price, and a member acting as agent to charge no more than a fair commission, considering market conditions, expense and the value of its services. Its supplementary material sets out FINRA's long-standing 5% Policy as a guide for mark-ups, not a safe harbor; a pattern of mark-ups of 5% or less can still be unfair. The policy does not apply to securities sold under a prospectus or offering circular at the specific public offering price, so a mutual fund load is tested under Rule 2341's sales-charge limits instead (Section 2.3).
• Rule 2122 (Charges for Services Performed) requires charges for services such as collecting dividends or interest, transferring securities, appraisals, safekeeping and custody to be reasonable and not unfairly discriminatory among customers. Account-closing, transfer and custodial fees on fund accounts fall here.
• Rule 2060 (Use of Information Obtained in a Fiduciary Capacity) bars a member acting as paying agent, transfer agent, trustee or in a similar capacity from using ownership information it receives in that role to solicit purchases, sales or exchanges, except at the issuer's request and on its behalf. A distributor affiliated with a fund's transfer agent may not mine the shareholder list to pitch competing products.