Did your Broker recommend an Unsuitable Investment?
FINRA Rule 2111 requires that a firm or its representative have a reasonable basis to believe a recommended transaction or investment strategy involving a security is suitable for the customer. This is based on the information obtained through reasonable diligence of the firm or associated person to understand the customer’s investment profile.
The rule states that the 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 and risk tolerance,” among other information.
Brokers must have a firm understanding of both the product and the customer, according to Rule 2111. The lack of such an understanding itself violates the suitability rule.
Firms that fail to perform adequate due diligence, or that make unsuitable recommendations, can be held responsible for losses in a Financial Industry Regulatory Authority (FINRA) arbitration claim.
FINRA rule 2111 describes three separate suitability obligations:
(1) Reasonable Basis – firms must have a reasonable basis to believe, based on adequate due diligence, that a recommendation is suitable at least for some investors; The broker must have knowledge of the risks associated with the security or investment strategy. Since most investment opportunities are suitable for at least some investors, firms need to understand the potential risks of the investment.
(2) Customer Specific – firms must have reasonable grounds to believe a recommendation is suitable for the specific investor; including investment experience, retirement goals, investment time horizon, liquidity needs, risk tolerance and financial situation.
(3) Quantitative – firms must have a reasonable basis to believe the number of recommended transactions within a certain period is not excessive (i.e., that the investor’s account is not being churned).
Suitability Profile must be considered before making Investment Recommendations
The following must be considered by the broker before making investment recommendations:
Age of the Investor – An investor’s age may be an important part of the profile – what may be a suitable investment for a 25-year-old may not be appropriate for someone nearing retirement age.
Investment Objectives – When an investor begins their relationship with a new broker, they will be asked to choose one of the following: Preservation of Capital; Current Income; Growth and Income; Capital Appreciation; and Aggressive Growth. According to FINRA rules, the investment recommendations must follow the investor’s objective. For example, if an investor’s objective was preservation of capital, a portfolio of high-risk stocks may be considered unsuitable investments.
Other Investments – It is important for a broker to understand what other investments are in the mix prior to making an investment recommendation. Diversification could protect the investor from fluctuations in the market. As the adage says, don’t put all of your eggs in one basket.
Tax Status – Financial advisors must consider tax implications of any investment before recommending the investment. For example, some financial professionals may improperly recommend that a customer switch or trade variable annuities in order to generate a commission. While variable annuity switching is not illegal, and is often not in the client’s best interest, and it could have negative tax consequences as well and could be considered unsuitable.
Financial Situation and Needs – This refers to the investor’s current and future financial situation including account assets, such as wealth and income, set off against liabilities, such as debt and dependents.
Investment Experience – Certain investments may only be suitable for experienced or sophisticated investors, such as high-risk, high-reward investments in unregistered securities.
Liquidity Needs – Liquidity is the degree to which an asset or security can be quickly bought or sold in the market at a fair price. Highly illiquid Investments such as non-traded REITs, or private placement investments may be considered unsuitable for an investor if they are planning to retire soon.
Risk Tolerance – Possibly the most important factor in making investment recommendations, risk tolerance describes how much an investor can afford to lose.
Free Consultation with Unsuitable Investment Lawyers
Brokers have a fiduciary duty to make investment recommendations that are consistent with the clients’ net worth, investment experience and objectives. Risk tolerance, age, and liquidity needs also need to be considered.
When brokers violate securities laws, such as making unsuitable investments, the brokerage firm they are working with may be liable for investment losses through FINRA Arbitration.
If you have suffered investment losses and would like to speak with a unsuitable investment lawyer regarding your recovery options, please call the White Law Group at 888-637-5510 for a free consultation.
The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm dedicated to the representation of investors in FINRA arbitration claims against brokerage firms throughout the United States.
The White Law Group’s FINRA arbitration attorneys have handled over 700 FINRA arbitration claims involving unauthorized trading, unsuitable investments, fraud, negligence, churning/excessive trading, and improper use of margin.
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