Communications and the Standard of Care

The three categories of communication

FINRA Rule 2210 classifies communications by the size of the audience, measured over a thirty-day window.

Correspondence is any written communication, including electronic, distributed or made available to 25 or fewer retail investors within any 30 calendar-day period.

A retail communication reaches more than 25 retail investors within any 30 calendar-day period.

An institutional communication is distributed only to institutional investors, and does not include a firm's internal communications.

The boundary is exactly 25. An email to 25 retail investors is correspondence; to 26 it is a retail communication with a different approval regime. A retail investor is anyone other than an institutional investor, including a prospect with no account.

Approval: correspondence requires supervision and review but not pre-approval. Retail communications must be approved by a registered principal before the earlier of use or filing, with limited exceptions. Institutional communications require written review procedures.

Filing: some retail communications are filed at least 10 business days before first use — a new member's communications during its first year, security futures communications, and certain investment company rankings. Others are filed within 10 business days of first use — communications concerning registered investment companies, direct participation programs, collateralized mortgage obligations and derivative products. Correspondence and institutional communications are not filed.

Records of communications are retained under SEC Rule 17a-4.

Content standards

The general standard is that communications must be fair and balanced, provide a sound basis for evaluating the facts, and omit no material fact whose omission would mislead.

Prohibited: false, exaggerated, unwarranted, promissory or misleading claims; predictions or projections of investment performance outside narrow exceptions; performance claims without the period, assumptions and fees a reader needs; comparisons that omit material differences; and any statement implying that FINRA or the SEC endorses a member, a communication or a security.

Testimonials must disclose whether the person was paid and that their experience may not be representative of others'. Communications must prominently disclose the member's name.

Product-specific rules layer on top: options communications must be preceded or accompanied by the options disclosure document and approved by a Registered Options Principal; communications about collateralized mortgage obligations may never compare them to other investment vehicles such as certificates of deposit; and communications about variable contracts, investment company rankings and bond fund volatility ratings each have their own rule.

The standard is fair and balanced, not merely accurate. A communication of entirely true statements can violate the rule by omission — presenting a yield without its risk, or a tax exemption without the alternative minimum tax consequence.

Social media used to discuss the firm's business is a communication subject to these rules and to the firm's retention obligations. It is not a private matter.

Regulation Best Interest and suitability

Regulation Best Interest, SEC Rule 15l-1, requires a broker-dealer or associated person making a recommendation of a securities transaction or investment strategy to a retail customer to act in that customer's best interest at the time the recommendation is made, without placing the firm's or the representative's interest ahead of the customer's.

It is satisfied through four component obligations:

Disclosure — full and fair written disclosure of the scope and terms of the relationship and of material conflicts, delivered in practice through Form CRS, the customer relationship summary.

Care — reasonable diligence, care and skill to understand the recommendation's risks, rewards and costs; a reasonable basis to believe it is in the customer's best interest given their investment profile; and a reasonable basis to believe a series of recommendations is not excessive.

Conflict of interest — written policies to identify and at a minimum disclose or eliminate conflicts, with a specific requirement to eliminate sales contests, quotas, bonuses and non-cash compensation based on the sale of specific securities within a limited period.

Compliance — written policies reasonably designed to achieve compliance overall.

FINRA Rule 2111, the suitability rule, sets out three obligations: reasonable-basis suitability, that the product is suitable for at least some investors; customer-specific suitability, that it suits this customer's profile; and quantitative suitability, that a series of transactions is not excessive even where each one alone would be suitable. Rule 2111 continues to apply where Regulation Best Interest does not — notably to institutional customers.

The relationship, stated plainly: for a retail customer Reg BI governs, and it is stricter, because it requires consideration of cost and forbids putting the firm's interest first. A recommendation that is merely suitable is not necessarily in the customer's best interest.

The customer investment profile that both rules refer to includes age, other investments, financial situation and needs, tax status, investment objectives, investment experience, time horizon, liquidity needs and risk tolerance.

FINRA Rule 2090, Know Your Customer, sits underneath both: a member must use reasonable diligence to know the essential facts about every customer and the authority of each person acting on their behalf. It attaches to the account rather than to a recommendation, so it applies even where nothing is recommended.