ALI-ABA Conference on Life Insurance Company Products November 3-4, 2011 Washington, D.C.

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1 775 ALI-ABA Conference on Life Insurance Company Products November 3-4, 2011 Washington, D.C. Redefining the Retail Relationship: The Emerging Regulatory Framework Governing Suitability, the Standard of Care and Disclosure By Clifford E. Kirsch Sutherland Asbill & Brennan LLP New York, New York 2011 Sutherland Asbill & Brennan LLP. All Rights Reserved.

2 776 I. Introduction...4 II. FINRA s New Suitability and Know Y our Customer Rules...4 A. The Current and Emerging Framework NASD Conduct Rule 2310 Effective Through July 12, The New Framework: FINRA Rule 2111 (Suitability) and Rule 2090 (Know Y our Customer) Effective July 12, III. Suitability Developments Concerning Specific Products...10 A. Variable Annuity Suitability Background FINRA Notice to Members Notice to Members 04 45; Rule 2821; Regulatory Notice FINRA Rule 2330 (Formerly Known as NASD Rule 2821) State Insurance Suitability Requirements Recent FINRA Enforcement and Examination Variable Annuity Focus...20 B. Specialized Products Notice to Members FINRA Recommends Best Practices for Reviewing New Products Notice to Member FINRA Provides Guidance Concerning the Sale of Structured Products FINRA Regulatory Notice FINRA Reminds Forms of Their Sales Practice Obligations with Regard to the Sale of Securities in a High Y ield Environment FINRA Regulatory Notice Leveraged and Inverse Exchange Traded Funds FINRA Regulatory Notice Principal Protected Notes ( PPN ) Sutherland Asbill & Brennan LLP SUTHERLAND ASBILL & BRENNAN LLP

3 FINRA Regulatory Notice Commodity Futures Linked Securities Reverse Convertibles FINRA Regulatory Notice Regulation D Unregistered Offerings...30 IV. The Uniform Standard of Care...30 V. Chronology Regulatory Response to Convergence of Broker Dealer and Investment Advisory Services...30 VI. VII. Standard of Care Imposed Under the Current Regulatory Structure...32 Treatment of Broker Dealers Under the Advisers Act...33 A. Generally...33 B. RAND Report...34 VIII. Harmonizing the Broker Dealer and Investment Advisor Standard of Care...35 A. Legislative Proposals Investor Protection Act of House Proposal Senate Banking Committee Proposal...37 B. Dodd Frank Wall Street Reform and Consumer Protection Act of C. The SEC Study Review of Comments Submitted SEC Report...40 D. Financial Planner Study...43 E. Practical Implications to Consider Potential Harmonized Standard of Care...45 IX. Disclosure Developments...46 A. The New Adviser Disclosure Regime The Form ADV Part

4 Part 2B The Brochure Supplement Delivery and Updating Requirements...51 B. FINRA s Concept Release

5 779 I. Introduction The regulatory framework governing the retail relationship is being redefined. First, during the past five years there have been significant changes to both the general suitability rules applicable to broker dealers and the guidance and rules concerning specific products. More specifically, in 2010, the SEC approved an overhaul of FINRA s suitability and know yourcustomer rules. 1 That overhaul followed the implementation of FINRA s new variable annuity suitability rule and a spate of guidance issued with respect to specific products, such as structured products and Regulation D offerings. At the same time, the standard of care to which a broker dealer and its registered representatives should be subject is under intense regulatory scrutiny. The SEC is reportedly closer to rulemaking in this area, following a Dodd Frank mandate that the SEC consider whether rules are needed in this area. Further, the framework applying to disclosure of conflicts and compensation incentives is being revamped. The SEC has advanced new requirements for advisers and FINRA is considering a similar disclosure regime for broker dealers and their registered representatives. We review these developments in this outline. II. FINRA s New Suitability and Know Your C ustomer Rules A. The C urrent and Emerging Framework 1. NASD C onduct Rule 2310 Effective Through J uly 12, 2012 As of the date of the writing of this outline, FINRA s suitability requirements continue to be governed by NASD Conduct Rule 2310, which provides that a broker dealer must meet the requirement of customer specific suitability. C ustomer specific suitability refers to a brokerdealer s obligation to tailor a recommendation to a customer s financial profile and investment objectives. Thus, under the rule, a broker dealer could not recommend a security unless it believed that the security was appropriate for the customer based upon the information that the broker dealer had obtained from the customer. FINRA staff has maintained that the rule also includes the concept of reasonable basis suitability, that is, the broker dealer s obligation to have an adequate and reasonable basis for a recommendation, regardless of the customer to whom the recommendation was made. 1 See Exchange Act Rel. No (Nov. 17, 2010), 75 Fed. Reg (Nov. 23, 2010). 4 SUTHERLAND ASBILL & BRENNAN LLP

The Financial Services Regulatory Revolution: Navigating the New World of Broker-Dealer and Investment Adviser Regulation

81 ALI-ABA Course of Study The Financial Services Regulatory Revolution: Navigating the New World of Broker-Dealer and Investment Adviser Regulation October 8-9, 2009 New York, New York Suitability-Recent