12.2 Suitability Requirements

FINRA Rule 2111 — The Three Suitability Duties

Before a registered representative recommends a security or strategy, FINRA Rule 2111 requires a reasonable basis for believing it suits the customer. The rule breaks into three components, and the exam tests each separately.

Reasonable-basis comes first and is product-level: the rep must perform due diligence and understand the security's risks and rewards before recommending it to a single person. Customer-specific suitability then applies that product to one investor's profile.

The Customer Investment Profile

Rule 2111 lists the factors a rep must collect and weigh. Memorize them — the exam loves a "which is NOT a profile factor" question (credit score and FICO are not on the list).

• Age and time horizon
• Other investments and overall portfolio
• Financial situation: income, net worth, liquid net worth
• Tax status
• Investment objectives (growth, income, preservation, speculation)
• Investment experience
• Liquidity needs
• Risk tolerance (ability and willingness)

Quantitative Suitability and Churning

Even if every single trade is individually appropriate, the aggregate activity can be unsuitable. Examiners look at the turnover ratio (annualized purchases ÷ average equity) and the cost-to-equity ratio (the break-even percentage the account must earn just to cover costs). A cost-to-equity ratio above roughly 20% is a strong red flag. Excessive trading for commissions is churning — a violation of both Rule 2111 and the catch-all ethics rule.

Regulation Best Interest (Reg BI)

Effective June 30, 2020, Reg BI (SEC Rule 15l-1) requires broker-dealers to act in the best interest of a retail customer at the time of a recommendation, without placing the firm's interest ahead of the customer's. "Best interest" is a higher bar than mere suitability. Reg BI has four obligations:

Key enhancement: unlike Rule 2111, the Care Obligation explicitly requires the rep to consider cost and reasonably available alternatives. A more expensive product that is otherwise identical generally fails Reg BI.

Form CRS and Scope

Form CRS (Customer Relationship Summary) is a plain-English document, maximum two pages for a standalone broker-dealer, delivered at or before the recommendation. It summarizes services, fees, conflicts, standard of conduct, and disciplinary history. Reg BI and Form CRS apply only to retail customers; Rule 2111 applies to all customers. Compliance with Reg BI satisfies Rule 2111, but the reverse is not true.

Know Your Customer — Rule 2090

FINRA Rule 2090 requires firms to use reasonable diligence to know the essential facts about every customer and the authority of anyone acting on the account (for example, a power of attorney). KYC supports both suitability and anti-money-laundering identity verification. "Essential facts" are those needed to service the account, comply with special handling instructions, understand who has trading authority, and meet other regulatory duties.

A Worked Suitability Scenario

A 78-year-old widow has $90,000 of total net worth, $20,000 of which is liquid, an income objective, and low risk tolerance. A rep recommends placing $40,000 into a non-traded, illiquid REIT with a seven-year hold and a 7% up-front load. Walk the three duties: reasonable-basis may be met (the product suits some investors), but customer-specific suitability fails — the holding is illiquid relative to her liquidity needs, the time horizon ignores her age, and the high cost is hard to justify.

Under Reg BI, the Care Obligation independently fails because a cheaper, more liquid income vehicle (e.g., a short-duration bond fund) was a reasonably available alternative the rep did not weigh. This single fact pattern can be tested as a suitability question or a Reg BI question.

Special Suitability Situations

Some products carry heightened suitability scrutiny beyond Rule 2111:

Institutional Suitability

For an institutional account, Rule 2111 customer-specific suitability is modified: if the institutional customer affirmatively states it is exercising independent judgment in evaluating recommendations and the firm reasonably believes the customer can do so, the rep's customer-specific obligation is satisfied. Reasonable-basis suitability still applies — the rep must always understand the product. Documentation supporting recommendations and the customer profile is typically retained for six years.

On the Exam

Distinguish the three suitability duties, identify non-profile factors (credit score), name Reg BI's four obligations, and remember the scope split: Reg BI = retail best interest with cost analysis; Rule 2111 = all customers, suitability. Records supporting recommendations are typically retained for six years.