The Financial Industry Regulatory Authority (FINRA) is the main independent regulator for all securities industry firms in the United States. FINRA membership is mandatory for most securities firms, including broker-dealers, investment advisers, and other financial services companies that engage in securities transactions.
FINRA member firms must comply with its rules and regulations, which are designed to promote fair and ethical practices in the financial industry. Two of FINRA’s numerous rules are particularly important for investor protection and anti-money laundering (AML) compliance: Rule 2090 and Rule 2111. These rules work in tandem to ensure that financial professionals truly understand their clients and make suitable investment strategy recommendations while safeguarding against financial risk.
In this guide, we’ll explore FINRA Rules 2090 and 2111, their requirements, how they relate to each other, and the critical role they play in safeguarding investors’ interests. For additional information on FINRA, view our blog overviewing FINRA compliance.
FINRA Rule 2090: Know Your Customer
FINRA Rule 2090, also known as the “Know Your Customer” (KYC) rule, requires FINRA member firms to use reasonable diligence to find out and retain essential facts about every customer. The rule helps firms understand their customers’ financial situations, investment objectives, and risk tolerances.
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
Under Rule 2090, firms are required to gather information about their customers at the beginning of the relationship and periodically update this information to reflect any significant changes.
The essential facts that must be collected include information needed to:
Effectively service the customer’s account,
Act in accordance with special handling instructions,
Comply with relevant laws, regulations, and rules—including the Bank Secrecy Act and anti-money laundering regulations, as required by Rule 3310.
FINRA Rule 2111: The Suitability Rule
FINRA Rule 2111, known as the “Suitability Rule,” requires that broker-dealer firms and associated persons have a reasonable basis for believing recommended transactions or investment strategies are suitable. Suitability assessments must be based on the customer’s investment profile, including age, other investments, financial situation, tax status, investment objectives, experience, time horizon, liquidity needs, and risk tolerance.
The rule imposes three main suitability obligations on firms and their associated persons:
Reasonable basis suitability obligation: Firms must conduct reasonable due diligence to ensure that a recommendation is appropriate for at least a subset of investors.
Customer-specific suitability obligation: Firms must have a reasonable basis to believe that a recommendation suits a customer’s specific investment profile.
Quantitative suitability obligation: When a firm controls a customer’s account, it must reasonably believe that a series of recommended transactions, while potentially suitable individually, are not excessive or inappropriate for the customer when considered collectively.
To comply with Rule 2111, firms must gather sufficient information about the customer’s financial situation, investment experience, and objectives. They must then carefully consider this information when making recommendations. They must also document and collect evidence regarding their compliance with the rule.
The Relationships Between FINRA Rule 2090 and 2111
FINRA Rule 2090 and Rule 2111 are closely related. They work together to protect investors and ensure that firms act in their customers’ best interests. Rule 2090’s KYC requirements provide the foundation for Rule 2111’s suitability assessments.
While Rule 2090 focuses on gathering and maintaining essential customer information, Rule 2111 uses that information to make suitable recommendations. Both rules apply throughout the customer relationship, from the initial account opening to ongoing interactions and recommendations.
Know Your Customer: Essential Compliance Steps
To comply with FINRA Rule 2090, firms must take several essential steps:
Gather and verify customer information: Collect essential facts about each customer, including their identity, financial situation, investment objectives, and risk tolerance.
Continuously monitor and update customer profiles: Implement systems to monitor and update customer information continuously. This includes regularly reviewing customer accounts, documenting any changes in the customer’s situation, and updating the customer’s profile.
Follow legal and regulatory standards: Firms must ensure that their KYC processes comply with all applicable laws and regulations, including FINRA rules, SEC regulations, and the Bank Secrecy Act’s Customer Identification Program (CIP) requirements.
Firms should leverage technology solutions, such as digital KYC and identity verification and transaction monitoring to streamline and automate their KYC processes.
Common Violations of Rules 2090 and 2111
Despite the critical importance of Rules 2090 and 2111, violations still occur.
Some common examples include:
Failing to gather sufficient customer information during the account opening process
Not updating customer profiles when there are significant changes in the customer’s situation
Making unsuitable recommendations that are inconsistent with the customer’s investment profile
Engaging in excessive trading or churning in a customer’s account
Recommending high-risk or complex investments without ensuring the customer understands the risks
Violations of FINRA rules can result in serious consequences for firms and individuals, including regulatory fines, disciplinary actions, and reputational damage. In some cases, firms may be required to pay restitution to customers harmed by unsuitable recommendations.
FINRA Rule Compliance With Alessa
Alessa’s modular anti-money laundering software and fraud management solutions help dealer brokers collect and verify essential customer information and assess customer risk. Our solutions include:
Real-time identity verification software for KYC compliance during onboarding,
Ongoing and periodic customer monitoring, including real-time transaction monitoring
Daily updates on client risk
A powerful and customizable risk-scoring solution
As an end-to-end AML solution, Alessa also provides enhanced due diligence; watchlist, sanctions, and PEP screening; and automated regulatory reporting.
Contact us today for a free demonstration of how Alessa can assist you with FINRA compliance.
