FREQUENTLY ASKED QUESTIONS RE: ADDITIONAL CLIENT DATA REQUIREMENTS

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1 New FINRA Rules 2090 and Know Your Customer ( KYC ) and Suitability FREQUENTLY ASKED QUESTIONS RE: ADDITIONAL CLIENT DATA REQUIREMENTS You may choose to simply page down through all of the Questions and Answers in this document, or you may wish to use the navigation links below to go directly to a specific topic. Navigation links Additional Client Data required by these new FINRA Rules Gathering this Additional Client Data and Entering it into BranchNet Client Communications Client Liquidity Needs Advisor recommended investment techniques/strategies Other Assets Owned by the Client OSJ and Advisor Use of Additional Data when making Client Suitability Determinations Effective Date of new FINRA Rules and Account Restrictions Other requirements of these new FINRA KYC/Suitability rules Additional Client Data that is Required by these new FINRA Rules Q1. I understand that advisors are required by these new rules to gather additional data from clients. What additional data needs to be gathered? A1. The new FINRA rules require that an advisor have the essential facts necessary to form a reasonable basis for believing that a recommended transaction or investment strategy for a client is suitable. Therefore, advisors must now gather some additional client information: the client s investment time horizon for the account document (by percentage) how each client s total assets are distributed among asset categories (equities, mutual funds, real estate, checking/savings accounts, etc.) including assets held with LPL Financial and assets held outside of LPL Financial if the client has any liquidity needs that an account is expected to meet (for example: a client may have the intention of using funds from a specific account to pay for their child s education or to buy a vacation home). And if the client does indeed have a liquidity need for an account, it is then necessary to document when the funds are needed (0-3 years or more than 3 years) and approximately what the dollar amount of that liquidity need is Additionally, in cases where an advisor has specifically recommended and discussed an investment technique/strategy with a client regarding a BROKERAGE or DIRECT BUSINESS account, then that needs to be evidenced. Please note that the requirement to record advisor recommended investment techniques/strategies is not applicable to advisory accounts. Page 1 of 11 2/21/2012

2 Since it is quite possible that the advisor has NOT recommended and discussed an investment technique/strategy with a client regarding a BROKERAGE or DIRECT BUSINESS account, LPL Financial will be NOT be coding this field as a required field in BranchNet it will be completely the advisor s responsibility to determine whether or not this data field is applicable for each client BROKERAGE or DIRECT BUSINESS account. Q2. A number of my client accounts are 401k plans. I assume that the additional information I am required to gather is in regards to the company and not the individual participants, correct? A2. If the account is opened at the plan level, then the advisor only needs to collect the information for the plan. If the account is opened at the participant level, then the advisor will need to collect the data for the participant. Please note that this additional data is NOT required for RPCP, F1Plan and F1PlanAB accounts and these accounts will NOT be restricted as on July 9. Q3. In regards to 529 plan accounts where a minor is the named beneficial owner of the account - since the purpose of the account is to fund a child s education, it is pretty easy to determine the time horizon for the account, liquidity needs, when the liquidity need will occur and how much money is needed to fund that liquidity need. But in regards to Other Assets, are the assets of the account sponsor taken into consideration? A3. For suitability purposes, both the financials of the Sponsor and the child must be considered. Therefore, assets of the Sponsor and the child (outside of this 529 plan account) should be included in Other Assets. Q4. What will happen if the advisor does not already have or is unable to collect this information from every client and have the data updated in BranchNet before the new FINRA regulations are effective on July 9? A4. As of July 9, accounts that do not have the additional data in BranchNet (with the exception of RPCP, F1Plan and F1PlanAB accounts) will be restricted to closing transactions only, and will remain restricted until the additional data is entered into BranchNet. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. Q5. I will certainly be reaching out to most of my clients to gather this additional information, but I already know this data for some clients from previous discussions we ve had (particularly those clients that I ve had for years and years). Am I required to contact all of my clients to discuss these new FINRA rules? A5. In cases where advisors already know this additional KYC/Suitability information about some of their clients, there is no need to ask those clients to again provide this data (though it is recommended that advisors remind clients so they won t be surprised - that they will be receiving a notification from LPL Financial confirming the accuracy of this additional data after it is entered into BranchNet). Page 2 of 11 2/21/2012

3 In cases where advisors do not already know this additional information, then the clients must be contacted. In rare circumstances, it is possible that advisors may be unable to reach a particular client prior the July 9 effective date of the new FINRA rules - yet have sufficient knowledge of a long term client s entire situation in order to reasonably estimate the additional KYC/Suitability data that is now required. To be very clear about this: making estimates about this additional KYC/Suitability information should ONLY be done when the advisor has sufficient knowledge about the client s financial situation to make a reasonable estimate. It would be a clear violation of industry regulations as well as a violation of LPL Financial policy - for an advisor to provide information that the advisor does not know to be true or does not have a reasonable basis for believing that the information is correct. Additionally, recognize that notifications will be sent out by LPL Financial confirming this information with clients and depending on the client, entry of estimated information by the advisor without the client s explicit approval may cause the client to make a formal complaint about the advisor s actions to LPL Financial or possibly a regulatory body. Q6. What if one of my clients refuses to provide the additional data that the new FINRA rules require? A6. As of July 9, accounts that do not have the additional data in BranchNet (with the exception of RPCP, F1Plan and F1PlanAB accounts) will be restricted to closing transactions only, and will remain restricted until the additional data is entered into BranchNet. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. It should also be noted that in every successful client relationship, there must be a certain level of trust and understanding between the advisor and the client. If a client is unwilling to provide sufficient information to the advisor so that suitable and appropriate investment recommendations can be made, then it may well be best for the advisor to not continue the relationship. Before making such a decision, of course, it is important to help the client understand: This information is required by federal regulators and ALL financial institutions are now required to obtain it; Beyond a rough estimate of how these other assets are distributed (by percentage) among asset categories, nothing else needs to be disclosed about the client s other assets (such as the dollar value or where the assets are located); and This information is used for the sole purpose of allowing the advisor to better understand the client s financial situation and to ensure that investment recommendations are appropriate and suitable for the client. Page 3 of 11 2/21/2012

4 Gathering this Additional Client Data and entering it into BranchNet Q7. Are advisors required to use a particular form when gathering this additional information? Does this form need to be sent to LPL? A7. LPL Financial recommends that advisors utilize a spreadsheet to capture the additional data for all of your clients in one place (please see the template on the BranchNet Resource Center (BranchNet Resource Center I Regulatory and Advocacy I FINRA Know Your Customer and Suitability Requirements). Another option that advisors may wish to consider is using the AS document that was part of the February 21 Advisor Alert. This is an OPTIONAL document advisors are NOT required to use this form and clients do NOT need to sign this form. This form is meant for internal branch office use only to assist you in gathering additional client KYC/Suitability data. Please do not send this form to LPL Financial as it will not be processed and will be returned to the advisor. Advisors can access the February 21 Advisor Alert through the online Resource Center. Please note that since the AS document is only an OPTIONAL worksheet for internal use within the branch office, it is not included in the listing of Account Forms on BranchNet. The AS document is part of the February 21 Advisor Alert and all Advisors Alerts can be accessed in the Advisor Alert Archive (the link to the Advisor Alert Archive is under the Highlights section of the Resource Center home page). Q8. Is there a specific form that my clients need to sign regarding this additional information that I am gathering? A8. Existing clients do NOT need to sign anything regarding this additional information that advisors are gathering. Right now, advisors simply need to gather this additional information so it is available for entry into the new data fields when available in BranchNet (which we expect will be in mid-may). When opening a new account prior to the new data fields being added to the LPL Financial New Account forms, an advisor should take the opportunity to gather this additional data from clients, using the same spreadsheet or form that the advisor is using to record the additional data for existing clients. Clients opening a new account currently do not need to sign any document that is used to gather this additional data. Once the new data fields are added to the New Account forms, advisors will no longer need a separate process to capture this additional information when opening a new account. These new fields will be added to the New Accounts forms at the same time as the fields are added to BranchNet (which we expect will be in mid-may). Once the new fields are available in BranchNet (which we expect will be in mid-may), please note that when an existing account is updated with the additional data, clients will receive a Page 4 of 11 2/21/2012

5 notification letter from LPL Financial confirming that data; and when a new account is established, clients will receive a Welcome Letter just as they do today (and the Welcome Letter will be updated to include this additional data). Q9. When will these new data fields be integrated into LPL Financial New Account forms and BranchNet? A9. We expect that the new data fields will be available starting in mid-may. Q10. I have a good sized book of business and a pretty large number of client accounts. Should I prioritize which accounts I should reach out to first to gather this data? A10. Advisors may choose to gather the additional client data in any manner that they feel is best for their practice, but it is recommended that advisors first gather this information for accounts that are the mostly actively traded, as well as larger valued accounts. This will help minimize the chance that the additional KYC/Suitability information will not be in BranchNet for such accounts when the new FINRA regulations are effective on July 9. As of July 9, accounts without the additional data (with the exception of RPCP, F1Plan and F1PlanAB accounts) will be restricted to closing transactions only, and will remain restricted until the additional data is entered into BranchNet. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. Q11. Can advisors get a listing of their client accounts that are missing this additional client data? A11. Yes. Once the new data fields are accessible in BranchNet (which we expect will be in mid-may), advisors can see a list of accounts that are missing this additional client data by using the Account Browse function. On the Account Browse screen, in the Sort Results by These Criteria section, in the Then By criteria selection, LPL will be adding Suit (short for Suitability ) as a search criteria. Search results will then show a listing of client accounts, and under the Suit column will be listed either REQ (meaning that additional data is still required to be entered for the account) or COMP (meaning that entry of the additional data has been completed). Please note that since it is quite possible that the advisor has NOT recommended and discussed an investment technique/strategy with a client regarding a BROKERAGE or DIRECT BUSINESS account, LPL Financial will be NOT be coding this field as a required field in BranchNet it will be completely the advisor s responsibility to determine whether or not this particular data field is applicable for each BROKERAGE and DIRECT BUSINESS account. Q12. What will happen if I am unable to collect this information for all my client accounts before the new FINRA regulations are effective on July 9? Page 5 of 11 2/21/2012

6 A12. As of July 9, accounts that do not have the additional data in BranchNet (with the exception of RPCP, F1Plan and F1PlanAB accounts) will be restricted to closing transactions only, and will remain restricted until the additional data is entered into BranchNet. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. Client Communications Q13. Is there a pre-approved communication that advisors can use to let clients know about these new regulatory requirements? A13. Yes. The communication is available on the Resource Center in the same section where this FAQ is located (access the Regulatory & Advocacy section, then click on FINRA Know Your Customer and Suitability Requirements ). This is an OPTIONAL communication that advisors may choose to send to clients if they wish to (it is NOT required). Q14. Will my existing clients receive a communication confirming the validity of the additional information after the data is entered into BranchNet? A14. Yes. When an existing account is updated with the additional data required by the new FINRA rules, the client will receive a letter confirming that data. This communication will be similar to the Books & Records confirmation letter that LPL already sends out periodically as required by industry regulations. Client Liquidity Needs Q15. Regarding the idea of liquidity need; what if the client has a general expectation of using the money from an account to some day fund their retirement is that considered a liquidity need? A15. Yes, a general expectation of using funds from an account to meet living expenses in retirement (no matter if retirement is only a few years away or many years in the future) is considered a liquidity need. It is extremely important, however, for advisors to clearly ask clients to identify any specific expenditure that a client expects to use funds from an account for such as paying for a world cruise in 5 years, or funding a charitable gift in 10 years. Q16. Is it possible for a client to have no liquidity needs for an account? A16. Yes. It is certainly possible that a client may have an investment account with the expectation of growing the value of the account over time, but if they expect their financial needs to be met through other accounts or other means they may very well have no real expectation of how they will eventually use the funds in this particular account. In such cases, the client has no liquidity needs for this particular account. Advisor recommended investment techniques and strategies Q17. What is an advisor recommended investment technique/strategy? Page 6 of 11 2/21/2012

7 A17. An advisor recommended investment technique/strategy is the overall game plan that an advisor has recommended and discussed with the client regarding a particular BROKERAGE or DIRECT BUSINESS account. It can also be described as the way the advisor is seeking to meet the client s investment objective. For example, an advisor may believe that a strategy of Buy and Hold is appropriate for a client in order to achieve the client s personal goals in regards to a particular account. The client may have need for a particular account to generate investment income, and as a result, the advisor recommends specific stocks that reliably pay solid dividends. The advisor also recommends to the client that they should adopt a general Buy and Hold strategy for this account, and that generally they should not be concerned by short term price fluctuations. Q18. Depending on the particular client and their situation, I may not have an overall strategy that I feel comfortable recommending to them. Is it required to select an advisor recommended strategy/technique for EACH account? A18. Absolutely not. The requirement to record advisor recommended investment techniques/strategies is ONLY applicable in cases where the advisor has recommended and discussed an investment strategy with a client regarding a BROKERAGE or DIRECT BUSINESS account. For brokerage or direct business accounts where such a recommendation and discussion did not occur, there is no requirement to select and record an advisor recommended investment technique/strategy. Please also note that the requirement to record advisor recommended investment techniques/strategies is not applicable to advisory accounts. Q19. Why isn t the requirement to record advisor recommended investment techniques/strategies applicable to advisory accounts? A19. Since investment strategies are implemented for each advisory account and can be determined by the account type, selection and recording of the advisor s recommended investment techniques/strategies is not applicable for advisory accounts. Q20. My client has chosen to make investment purchases on margin. I certainly did not recommend this technique/strategy but I am making recommendations about which securities my client should consider buying, and facilitating my client s instructions. For this account, should I enter Trading on Margin as the advisor recommended investment technique and strategy? A20. No, since you did not make the recommendation for the client to pursue the technique/strategy to trade on margin in this account. Q21. I recommended that my client adopt an investment technique/strategy of asset allocation for her account. She appreciated my ideas but has decided not to adopt my recommendation. I have made some recommendations about some specific stocks and bonds she should buy, and generally she agrees with those recommendations, but we are not following an investment technique/strategy of asset allocation. Should I enter asset allocation as the advisor Page 7 of 11 2/21/2012

8 recommended technique/strategy, even though my client has chosen not to follow my recommendation? A21. The KYC/Suitability information that will be entered into BranchNet will be used by LPL Financial as well as the advisor s OSJ to ensure that investments are suitable and appropriate for the client. Therefore, if an advisor recommended investment technique/strategy for an account was NOT accepted for by the client, then that recommendation should NOT be entered into BranchNet. But the FINRA KYC/Suitability rules make it clear that if an advisor does recommend an investment technique/strategy to a client, then a record of that recommendation must be made. Therefore, if an advisor recommended technique/strategy is made- but NOT adopted by the client for use in an account - the advisor must make a record of the recommendation and the client s rejection of the recommendation in the client s file. Additionally, it is strongly recommended that advisors make a point of escalating such matters to their OSJ since while it Is certainly possible to maintain a relationship with a client who rejects an advisor s recommended investment technique/strategy, it could be indicative of a significant disconnect between the client s approach to investing and the advisor s which, unless well discussed and documented, could led to unfortunate misunderstandings, disputes and possible litigation. Other Assets Owned by the Client Q22. Regarding the breakdown (in percentages) of other assets that each of my clients own. I have a particular client who has transferred two of her three investment accounts to LPL Financial (her IRA account and her individual account both of which are fully invested in mutual funds). The client has told me that she also owns an annuity, checking and savings accounts, and some rental property. Roughly speaking, all of her assets (including those at LPL Financial and those held away) are distributed 40% in mutual funds, 10% in the annuity, 20% in checking and savings, and 30% in real estate. Is the client required to disclose any of the specific details about the assets held outside of LPL Financial such as the name of the annuity, the name of bank where she has her checking and savings account, and the address of her rental property? A22. No, the new FINRA rules do not require the client to disclose any specific information about assets held away from LPL Financial. All that is required is an estimate (by percentage) of how the client s total assets are distributed among asset categories (real estate, bonds, equities, alternative investments, etc.). Q23. Should the client s primary residence be included in the estimate of other assets? A23. No. Using this Additional Data when making Client Suitability Determinations Page 8 of 11 2/21/2012

9 Q24. How should advisors and branch managers integrate this additional client information into their determination about client suitability? A24. This additional KYC/Suitability information provides advisors, branch managers and LPL Financial with greater opportunity and responsibility to provide investment recommendations that can potentially better meet client needs. As an example, for clients with an investment strategy of capital preservation, it is not unusual to expose a small percentage of their portfolio to securities with growth potential (in order to preserve the client s buying power against inflation). However, in the case of a client who has a specific liquidity need that represents a fairly large percentage of their account value, it may be more appropriate to have an even smaller percentage of their portfolio invested in such securities. Q25. When a branch manager is reviewing the previous day s trades that were entered by advisors in the branch, and she wishes to look at a particular trade and compare it against the client s profile information including this additional KYC/Suitability data how can that be done? A25. From the Trade Blotter the OSJ can click on the client s name. This will take the OSJ to the Account Browse Profile tab which will show the client s profile data. After the new fields are available in BranchNet (which we expect will be in mid-may), they will be included in the client s profile data. The OSJ then uses the client profile information to determine if the investment is suitable. Q26. Must this additional KYC/Suitability information be considered during reviews of client suitability and account activity? A26. Yes. Just as is the case today, if a supervisor identifies a potential issue about whether a transaction (or transactions) is/are suitable for a client, the supervisor will contact the advisor to discuss. Effective Date of new FINRA Rules and Account Restrictions Q27. When are these new FINRA rules effective? A27. July 9, Q28. Why will accounts that have not been updated with this additional data by July 9 be restricted? A28. The new FINRA rules require that advisors and firms MUST start using the additional client data as part of determining the suitability of investments by July 9 -which means that if an account does not have this client data on file (with the exception of RPCP, F1Plan and F1PlanAB accounts) then a suitability determination cannot be made. Page 9 of 11 2/21/2012

10 As a result, accounts that do not have the additional client data required by the new FINRA rules in BranchNet prior to July 9 must be restricted to closing transactions only, until the additional data has been added. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. Q29. What are closing transactions? A29. Closing transactions are trades that close out all or part of an existing position. In other words, as of July 9, no trades to create a new security position (or add to an existing position) can be placed in accounts where the additional client data required by the FINRA rules has not been entered into BranchNet (with the exception of RPCP, F1Plan and F1PlanAB accounts). Nor can such trades be entered on the Branch Trade Report. This restriction will stay in place until the additional client data required by the new FINRA KYC/Suitability rules is added to the account. For example, as of July 9, if a client whose account has not been updated wishes to purchase and own shares of a company stock, the Buy order would not be able to be processed until after the advisor entered into BranchNet the additional data required by the new FINRA rules. If that same client wished to enter a sell order for some or all of the shares they already owned of a company stock, this is a closing transaction and we would be able to process that Sell order. If that same client wished to close some or all of an existing short position in their account, this is a closing transaction and we would be able to process that Buy to cover order. Q30. Will we still be able to process other types of client requests such as payout requests (including IRA distributions), journals, etc. even if accounts are restricted to closing transactions only? A30. Yes. Q31. Will the new FINRA rules impact open Good- Til-Canceled ( GTC ) orders that were placed prior to July 9? A31. No. A GTC order entered prior to the effective date of the new FINRA rules (July 9) will be executed if the limit on the order is hit or the stop price is triggered unless the order is cancelled or the order expires. Q32. Will the new FINRA rules impact options orders placed prior to July 9? A32. No. A GTC order entered prior to the effective date of the new FINRA rules (July 9) will be executed if the limit on the order is hit or the stop price is triggered unless the order is cancelled or the order expires. Page 10 of 11 2/21/2012

11 Q33. Will the new FINRA rules impact existing instructions for periodic investments placed prior to July 9 (such as a monthly investment of $1000 into ABC mutual fund)? A33. No. Instructions entered prior to the effective date of the new FINRA rules (July 9) to periodically invest additional client funds into an existing position will be unaffected by the new FINRA rules. Q34. What will happen if I am unable to collect this information for all of my clients before the new FINRA regulations are effective on July 9? Or what if one of my clients refuses to provide the additional data that the new FINRA rules require? A34. As of July 9, accounts that do not have the additional data in BranchNet (with the exception of RPCP, F1Plan and F1PlanAB accounts) will be restricted to closing transactions only, and will remain restricted until the additional data is entered into BranchNet. Additionally, advisors will be unable to report opening transactions (trades that create new positions or add to existing positions) for restricted accounts through the Branch Trade Report. Other requirements in these new FINRA KYC/Suitability rules Q35. Are there other requirements in these new FINRA KYC/Suitability rules? A35. Yes. Also effective July 9, advisors who make explicit hold recommendations to clients regarding a specific security will need to make a record of such recommendations. LPL Financial will be providing additional details about this new FINRA requirement as the July implementation date draws closer. Page 11 of 11 2/21/2012