What are a Brokerage Firm’s Obligations to Recommend Only Suitable Investments?
Making suitable investment recommendations is the cornerstone of proper investment advice. All brokerage firms and financial advisors have a duty to recommend suitable investments that are consistent with the needs and objectives of the investor. Brokerage firms and financial advisors must learn all material facts about an investor before making any recommendations and must match all investments with a customer’s stated investment profile. Failure to recommend suitable investments may result in a claim to recover attenuating investment losses.
What is the Legal Standard for Suitability?
The Financial Industry Regulatory Authority (FINRA) has defined the standards in which investment recommendations made by brokerage firms and registered financial advisors are evaluated. The FINRA suitability rule focuses on three fundamental concepts: (1) reasonable basis suitability, (2) quantitative suitability, and (3) customer-specific suitability.
Reasonable basis suitability requires that a recommended investment or investment strategy be suitable or appropriate for at least some investors. Reasonable basis suitability requires an advisor to conduct adequate due diligence so that he or she can determine the risks and rewards of the investment or investment strategy.
Quantitative suitability requires a brokerage firm or financial advisor with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions – even if suitable when viewed in isolation – is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. 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.
Customer-specific suitability 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. Among the criteria that a financial advisor must evaluate to satisfy his or her customer-specific suitability obligations include the investor’s:
- Other investments
- Financial situation and needs
- Tax status
- Investment objectives
- Time horizon
- Liquidity needs
- Risk tolerance
- Any other information disclosed by the customer
What are Common Examples of Unsuitable Investments?
Whether an investment is unsuitable is a fact-specific inquiry. In other words, it is a question of whether the investment was suitable for you. A recommendation may be suitable for one investor but not for another. Accordingly, there is no one-size-fits-all description of an unsuitable investment. However, some classic examples of unsuitable investments include:
- The recommended investment carried a higher degree of risk than the investor understood (or would have been willing to assume).
- The financial advisor or brokerage firm failed to recommend adequate diversification.
- The firm or advisor recommended that the client borrow money against the value of the client’s securities (either in the form of margin or a line of credit) without adequately disclosing the risks.
Talk to an Attorney Who Specializes in Litigation of Claims Involving Unsuitable Investments
Suitability claims are perhaps the most common type of cause of action brought in investment recovery cases. The contours of the claim are complex and nuanced. The Wolper Law Firm has extensive experience handling suitability claims. If you have experienced losses in your investments and believe that they are the result of unsuitable investment recommendations, please contact the Wolper Law Firm for a free consultation and case evaluation
Call (954)-406-1231 as soon as possible