FINRA Assessment and Evaluation 3 — Questions and Answers
Question 1: Under Regulation Best Interest (Reg BI), how does the standard for broker-dealers differ from the traditional FINRA suitability standard?
- Reg BI requires only that recommendations be suitable, not necessarily in the customer's best interest
- Reg BI imposes a 'best interest' standard that is higher than mere suitability (Correct answer)
- Reg BI applies only to institutional investors, not retail customers
- Reg BI eliminates the need for customer profile information
Correct answer: Reg BI imposes a 'best interest' standard that is higher than mere suitability
Reg BI requires broker-dealers to act in the retail customer's best interest and not place their own financial interests ahead of the customer's, exceeding the older suitability standard.
Question 2: When assessing a complex product's suitability, what is a 'reasonable basis' determination?
- The broker believes the product could possibly benefit some investors
- The broker has conducted reasonable diligence to understand the product's risks and rewards before recommending it (Correct answer)
- The product has been approved by FINRA for sale to retail customers
- The product has outperformed benchmarks in at least three of the past five years
Correct answer: The broker has conducted reasonable diligence to understand the product's risks and rewards before recommending it
Reasonable basis suitability requires the registered representative to understand the product well enough to determine that it could be suitable for at least some investors before recommending it.
Question 3: A firm's supervisory review of a registered representative's recommendations reveals a pattern of recommending highly illiquid private placements to customers with stated short-term liquidity needs. This most directly violates which FINRA obligation?
- Books and records requirements
- Customer-specific suitability under Rule 2111 (Correct answer)
- Anti-money laundering program requirements
- Registration requirements under Rule 1210
Correct answer: Customer-specific suitability under Rule 2111
Recommending illiquid products to customers with documented short-term liquidity needs violates customer-specific suitability under FINRA Rule 2111.
Question 4: What is the primary purpose of collecting a customer's 'investment objectives' during account opening?
- To determine the minimum account balance required
- To tailor investment recommendations to align with what the customer is trying to achieve financially (Correct answer)
- To identify customers who may be subject to pattern day trader rules
- To comply with FINRA's continuing education requirements
Correct answer: To tailor investment recommendations to align with what the customer is trying to achieve financially
Investment objectives such as growth, income, or capital preservation guide brokers in making recommendations that align with a customer's financial goals.
Question 5: A registered representative recommends a municipal bond to a customer in the 10% marginal tax bracket. What evaluation concern does this raise?
- Municipal bonds are not approved for retail investors
- Municipal bonds' tax advantage may provide little benefit to low-bracket taxpayers, making taxable alternatives potentially more suitable (Correct answer)
- Municipal bonds are too risky for any individual investor
- The recommendation violates MSRB rules on fair pricing
Correct answer: Municipal bonds' tax advantage may provide little benefit to low-bracket taxpayers, making taxable alternatives potentially more suitable
The tax-exempt benefit of municipal bonds primarily benefits high-bracket investors; for low-bracket customers, taxable securities may offer better after-tax yields.
Question 6: Under FINRA rules, which of the following customers is presumed NOT to need basic suitability protections when receiving institutional recommendations?
- A high-net-worth individual with a $2 million brokerage account
- An institutional investor with $50 million in assets that has an independent investment adviser (Correct answer)
- A non-profit foundation with $15 million in assets managed in-house
- A foreign bank operating in the United States
Correct answer: An institutional investor with $50 million in assets that has an independent investment adviser
FINRA Rule 2111 allows firms to limit customer-specific suitability obligations for institutional customers with $50M+ in assets who use independent investment advisers.
Question 7: When evaluating whether leveraged ETFs are suitable for a buy-and-hold retail investor, which characteristic is most critical to disclose?
- Leveraged ETFs have higher expense ratios than index funds
- Leveraged ETFs are designed for short-term trading and experience decay over time due to daily rebalancing (Correct answer)
- Leveraged ETFs are not registered under the Securities Act of 1933
- Leveraged ETFs can only be purchased through institutional brokers
Correct answer: Leveraged ETFs are designed for short-term trading and experience decay over time due to daily rebalancing
Daily rebalancing causes leveraged ETFs to experience compounding decay in volatile markets, making them unsuitable for long-term buy-and-hold strategies.
FINRA Assessment and Evaluation 3
Under Regulation Best Interest (Reg BI), how does the standard for broker-dealers differ from the traditional FINRA suitability standard?