Thus, the stage is set for today's BrokeAndBroker.com Blog consideration of FINRA's "Suitability Rule":

FINRA Rule 2111: Suitability

(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer's investment profile. A customer's investment profile includes, but is not limited to, the customer's age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.

(b) A member or associated person fulfills the customer-specific suitability obligation for an institutional account, as defined in Rule 4512(c), if (1) the member or associated person has a reasonable basis to believe that the institutional customer is capable of evaluating investment risks independently, both in general and with regard to particular transactions and investment strategies involving a security or securities and (2) the institutional customer affirmatively indicates that it is exercising independent judgment in evaluating the member's or associated person's recommendations. Where an institutional customer has delegated decisionmaking authority to an agent, such as an investment adviser or a bank trust department, these factors shall be applied to the agent.

Supplementary Material:

.01 General Principles. Implicit in all member and associated person relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of FINRA rules, with particular emphasis on the requirement to deal fairly with the public. The suitability rule is fundamental to fair dealing and is intended to promote ethical sales practices and high standards of professional conduct.

.02 Disclaimers. A member or associated person cannot disclaim any responsibilities under the suitability rule.

.03 Recommended Strategies. The phrase "investment strategy involving a security or securities" used in this Rule is to be interpreted broadly and would include, among other things, an explicit recommendation to hold a security or securities. However, the following communications are excluded from the coverage of Rule 2111 as long as they do not include (standing alone or in combination with other communications) a recommendation of a particular security or securities:

(a) General financial and investment information, including (i) basic investment concepts, such as risk and return, diversification, dollar cost averaging, compounded return, and tax deferred investment, (ii) historic differences in the return of asset classes (e.g., equities, bonds, or cash) based on standard market indices, (iii) effects of inflation, (iv) estimates of future retirement income needs, and (v) assessment of a customer's investment profile;

(b) Descriptive information about an employer-sponsored retirement or benefit plan, participation in the plan, the benefits of plan participation, and the investment options available under the plan;

(c) Asset allocation models that are (i) based on generally accepted investment theory, (ii) accompanied by disclosures of all material facts and assumptions that may affect a reasonable investor's assessment of the asset allocation model or any report generated by such model, and (iii) in compliance with Rule 2214 (Requirements for the Use of Investment Analysis Tools) if the asset allocation model is an "investment analysis tool" covered by Rule 2214; and

(d) Interactive investment materials that incorporate the above.

.04 Customer's Investment Profile. A member or associated person shall make a recommendation covered by this Rule only if, among other things, the member or associated person has sufficient information about the customer to have a reasonable basis to believe that the recommendation is suitable for that customer. The factors delineated in Rule 2111(a) regarding a customer's investment profile generally are relevant to a determination regarding whether a recommendation is suitable for a particular customer, although the level of importance of each factor may vary depending on the facts and circumstances of the particular case. A member or associated person shall use reasonable diligence to obtain and analyze all of the factors delineated in Rule 2111(a) unless the member or associated person has a reasonable basis to believe, documented with specificity, that one or more of the factors are not relevant components of a customer's investment profile in light of the facts and circumstances of the particular case.

.05 Components of Suitability Obligations. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability.

(a) The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors. In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the member's or associated person's familiarity with the security or investment strategy. A member's or associated person's reasonable diligence must provide the member or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy. The lack of such an understanding when recommending a security or strategy violates the suitability rule.

(b) The customer-specific obligation requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer's investment profile, as delineated in Rule 2111(a).

(c) Quantitative suitability 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 customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

.06 Customer's Financial Ability. Rule 2111 prohibits a member or associated person from recommending a transaction or investment strategy involving a security or securities or the continuing purchase of a security or securities or use of an investment strategy involving a security or securities unless the member or associated person has a reasonable basis to believe that the customer has the financial ability to meet such a commitment.

.07 Institutional Investor Exemption. Rule 2111(b) provides an exemption to customer-specific suitability regarding institutional investors if the conditions delineated in that paragraph are satisfied. With respect to having to indicate affirmatively that it is exercising independent judgment in evaluating the member's or associated person's recommendations, an institutional customer may indicate that it is exercising independent judgment on a trade-by-trade basis, on an asset-class-by-asset-class basis, or in terms of all potential transactions for its account.

16 Paragraphs

My oh my . . . imagine that you're a stockbroker and thinking about recommending an investment to a customer and you want to make sure that you're following the rules. Why it's such a simple proposition. You just read FINRA Rule 2111: Suitability. I mean, geez, the title of the Rule has only one word: "Suitability."  Despite the one-word title, the Rule comprises two lettered paragraphs followed by seven enumerated Supplementary Material paragraphs, of which the latter grouping includes a total of seven lettered subparagraphs. Sixteen total paragraphs to define one word! Astounding!!

Thou Shalt Be Reasonable

As you read through the FINRA Suitability Rule, you sort of sense that the all-important obligation is to be "reasonable." What's reasonable? Oh, don't worry, no matter what you do, someone will accuse you of not being that. Worse, the essence of the Suitability Rule is that a stockbroker's recommendation will " judged as being within the ethical standards of FINRA rules, with particular emphasis on the requirement to deal fairly with the public." Ethical standards on Wall Street? Really?? And how do you know if you're dealing "fairly with the public?" Why that's simple; just use reasonableness and ethics when trying to answer that question about fairness! 

Quantitative Suitability

FINRA provides stockbrokers with simple, intelligible guidance on what's "suitable." Just look at the "Supplementary Material" portion of the Rule and consider this:

.05 Components of Suitability Obligations. Rule 2111 is composed of three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. . .

. . .

(c) Quantitative suitability 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 customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer's account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

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 customer's investment profile, as delineated in Rule 2111(a). No single test defines excessive activity, . . .

The AWC alleges that between January 1, 2014 and December 31, 2015, Cotter exercised de facto control over an IRA account and a second account of a customer referenced only as "LC." The AWC asserts that LC was in her sixties, expressed a desire to earn income for retirement, had $60,000, and had a conservative risk tolerance. 

In finding the existence of de facto control by Cotter over LC's two accounts, FINRA asserted that:

• Cotter solicited all the transactions in the accounts;
• LC routinely accepted his recommendations; and
• LC was an unsophisticated investor. 

The AWC alleges that Cotter used his de facto control to excessively trade the two accounts in a manner that was inconsistent with LC's investment objectives, financial situation, and needs.

Damning Data 

In trying to put Cotter's alleged misconduct into some numeric setting, the AWC calculates that during the relevant period from January 1, 2014 and December 31, 2015, Cotter's cited trading resulted in net commissions of $100,549.42, losses of $391,893, and in the:

IRA Account

• turnover rate of 9.84; and
• a cost-to-equity ratio of 23.2%

Second Account

• turnover rate of 5.3; and
• a cost-to-equity ratio of 20.02% 

The AWC concluded that given the cost-to-equity ratios noted above, the IRA account needed a 23.2% return and the second account needed a 20.02% return just to break-even/avoid loss. The AWC asserts that:

Given the customer's age and her conservative risk tolerance, requiring a minimum return of 20 to 23% was unsuitable for these accounts.

In accordance with the terms fo the AWC, FINRA imposed upon Cotter a $15,000 fine; a nine-month suspension from association in any and all capacities with any FINRA member; and disgorgement of commissions to be paid to FINRA of $100,549.42, plus interest.

Bill Singer's Comment

In my law practice, I represent both industry and public customers, and I am a former Series 7/63. Let me clearly underscore that suitability is a fundamental aspect of any stockbroker's investment recommendations. Without question, when a stockbroker engages in control over an account, de facto or otherwise, concerns about suitability are wholly appropriate. The Cotter AWC makes a persuasive case given the cost-to-equity ratios, losses, and the customer's purported financial profile. Notwithstanding the clumsiness of its Suitability Rule, I compliment FINRA on this excellent AWC, which is replete with content and context, and walks readers through a thoughtful analysis. 

There is no reference in the AWC as to whether LC complained about the activity in her accounts. I would have included such a statement -- one way or the other. 

Another omission in the AWC pertains to whether the statistical analysis set forth in the settlement was also calculated by member firm NEXT on an ongoing basis. There is no reference in the AWC as to whether the member firm generated an exception report and disclosed the statistics to Cotter. Given that FINRA describes LC as an "unsophisticated investor," doesn't that circumstance impose an obligation on a member firm to monitor any trading in such an account where break-even requires at least a 20% return and the customer has sustained nearly $400,000 in losses over a two-year period? 

Finally, the AWC should have indicated the point on the two-year continuum cited in the AWC when Cotter's recommendations transitioned from "suitable" on an "isolaged" basis to "unsuitable" when taken together.

Anti-Fraud Fund

One aspect of this settlement that annoys me is the disclosure that the commission disgorgement is payable to FINRA. I infer from that fact (and I can't underscore enough that I am merely engaging in speculation here), that LC was compensated by Cotter and/or the brokerage firm for her losses and commissions. Otherwise, I would have expected that the disgorgement would be ordered paid to LC. That being said, FINRA should establish an Anti-Fraud Fund by which public customers would be paid for any compensatory damages awarded to them but not paid by FINRA member firms or associated persons, and said Fund should be funded, in part, by ordered disgorgements. I have long advocated that FINRA fully fund an Anti-Fraud Fund for the benefit of public customers and I reiterate that call here.

BrokerCheck Disclosures 

Online FINRA BrokerCheck records as of October 23, 2017, disclose that Cotter has "32 Years of Experience" and was associated with eight firms. 

Customer Disputes

Under the BrokerCheck heading "Customer Dispute - Settled," are two matters.

The earliest disclosure involves a 1986 customer complaint seeking $27,000 in damages that Dean Witter settled for $20,000, of which Cotter contributed $10,000. Dean Witter characterized the matter as follows:

PRIOR TO MR. COTTER'S DEPARTURE, THE FIRM SETTLED ONE CUSTOMER PROBLEM CONCERNING CLIENTS [CUSTOMERS'. THESE CLIENTS WERE ACTIVELY INVESTING IN AND HAD LOST MONEY IN INDEX OPTIONS. ALTHOUGH THEES CLIENTS WERE ELDERLY, ONE IS A C.P.A. WITH AN ACTIVE PRACTICE AND A HISTORY OF SPECULATIVE INVESTING. MR. COTTER DISPUTED THE COMPAINT BUT IN THE INTEREST OF GOOD CUSTOMER RELATIONS AGREED TO A SETTLEMENT AND THE FIRM CONCURRED. A SETTLEMENT OF $20,000 WAS REACHED WITH THE CLIENTS AND PAID BY THE FIRM. MR. COTTER AGREED TO PAY $10,000 OF THIS SETTLEMMENT [sic] AND OWED THE FIRM APPROXIMATELY $1,700 OF THIS $10,000 WHEN HE LEFT. MR. COTTER INFORMED THE FIRM THAT HE INTENDS TO PAY THE FIRM THE REMAINING SUM. BECAUSE OF HIS PROBLEM, HE ALSO COMPLETED A SUSPENSION OF TWO WEEKS AND HIS OPTIONS RECOMMENDATIONS WERE RESTRICTED TO COVERED OPTIONS FOR ONE YEAR. AT THE TIME HE LEFT THE FIRM, THERE WERE NO OTHER CUSTOMER PROBLEMS OF WHICH THE FIRM IS AWARE. 

In response to his firm's 1986 disclosure, Cotter submitted this statement:

DEAN WITTER DEMANDED THAT I PAY THE FIRM $10,000. CLIENT WAS AND STILL IS A C.P.A. ALL TRADES WERE APPROPRIATE. I HAVE KNOWN THE CLIENT FOR 30 YRS. I WAS NOT CONSULTED BY DW REGARDING SETTLEMENT OF THIS CLAIM 

A second BrokerCheck disclosure was submitted by NEXT and reported its receipt of a customer complaint on May 18, 2016, seeking $625,000 in damages and  alleging:

Customer alleges registered representative mismanaged funds in her brokerage accounts from 2013-2016. 

NEXT settled the matter on January 23, 2017, for $326,646 to which Cotter is indicated as not having contributed.

Employment Separations 

Under the BrokerCheck heading "Employment Separation After Allegations," Cotter is indicated as having voluntarily resigned from Petersen Investments, Inc. on May 1, 2017, after the firm was advised that FINRA was referring a matter to its Enforcement Division. 

On March 18, 2016, NEXT "discharged" Cotter based upon allegations that:

The firm conducted an internal review of the trading activity in a customer's accounts and found the level of trading activity to be excessive in light of the customer's profile and the character of the account.