September 9, 2010
Re: File Number SR-FINRA-2010-039.
I support the proposed adoption of FINRA Rules 2090 and 2111 for the most part but have the following suggestions for improvements.
First, federal securities laws generally do not cover recommendations to hold a security, but the common law does allow customers to bring claims for wrongful recommendations to retain a security. See, e.g., Ward v. Atlantic Sec. Bank, 777 So.2d 1144 (Fla. Dist. Ct. App. 2001) (allowing common law and state securities law claims for advice to keep a security, unlike federal law). An explicit recognition in Rule 2090 or 2111 or their supplementary materials that the suitability obligation extends to advice to retain a security would be an important improvement in these rules. It would foreclose the industrys current reliance on federal securities laws to avoid responsibility for advice of this sort.
Second, the Rules remove important language from NYSE Rule 472.40(1) that defines what a recommendation is. Brokers commonly do not understand the scope of their obligations when they bring a security to an investors attention. Language similar to Rule 472.40(a) should be included in the new rules.
Third, the new rules do not expressly address the significance of recommendations that result in overconcentration or lack of diversification. Rule 211(a) does require brokers to consider the investors other investments when determining whether to recommend an investment. This reference is oblique, however, and explicit supplemental material on this issue would be helpful, given its importance.
A fundamental duty of any stockbroker and the brokers firm is to avoid over-concentration of customers portfolios in a single security or a single group of securities. Courts routinely impose liability when brokers or investment managers fail adequately to diversify their customers portfolios. See GIW Indus., Inc. v. Trevor, Stewart, Burton Jacobsen, Inc., 895 F.2d 729, 733 (11th Cir. 1990) (The district court thus correctly concluded that appellant failed to diversify, as was required of a prudent investment manager.) Meinhardt v. Unisys Corp. (In re Unisys Savings Plan Litig.), 74 F.3d 420, 438 (3d Cir. 1996) (Ordinarily the fiduciary should not invest the whole or an unduly large proportion of the trust property in one type of security or in various types of securities dependent upon the success of one enterprise or upon conditions in one locality, since the effect is to increase the risk of large losses (quoting H. R. Conf. Rep. No. 1280, 93d Cong., 2d Sess. (1974)).
The Commission has likewise frequently found that stockbrokers and their firms violate a fundamental duty when they over-concentrate their customers portfolios. See, e.g., Stephen T. Rangen, Exchange Act Release No. 38,486 (April 8, 1997) (By concentrating so much of their equity in particular securities, the broker increased the risk of loss for these individuals beyond what is consistent with the objective of safe, non-speculative investing.) PaineWebber Inc., Exchange Act Release No. 36,724 (January 17, 1996) (PaineWebber sold direct investments . . . to numerous investors . . . in concentrations too high given the investors age, financial condition, sophistication and investment objectives.).
Supplemental Material 2111.03(c) requires a member or associated person who has actual or de facto control over a customer account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, are not excessive and unsuitable for the customer when taken together in light of the customers investment profile, as delineated in Rule 2111(a). This supplemental explanation only applies when the broker has control over the account. The duty to avoid unnecessary overconcentration, however, applies regardless of whether the broker has control. Indeed, an industry party might incorrectly argue, absent further clarification, based on 2111.03(c), that the duty to avoid overconcentration only applies when control exists. To avoid such an argument, FINRA should further clarify the duty to avoid overconcentration.
Thank you for considering these comments.
Stephen Krosschell, Esq.
Goodman Nekvasil, P.A.
14020 Roosevelt Blvd., Suite 808
Clearwater, FL 33762