Arbitration claims based on “suitability” are some of the most common claims made by customers. In short, a stockbroker’s recommendation must be consistent with the customers “best interest.” Suitability claims arise from a stockbroker’s obligation -- before any recommendation is made -- to have a firm understanding of both the needs of his customer and the risks of the proposed security (or strategy) . There is thus both a “customer” and “product” component to a stockbroker’s or investment advisor’s suitability obligation.
In evaluating your needs as a customer, your stockbroker must consider your: age, other investments, financial situation, tax status, investment objectives, investment experience, investment time horizon, liquidity needs and risk tolerance. Depending upon the facts, failure to consider any of these factors could make the recommendation of an otherwise legitimate security unsuitable. A security or strategy that is suitable for one customer may be entirely unsuitable for another. Thus the sale of a variable annuity or a non-traded REIT to a customer who needs reasonable access to their money would be unsuitable and could constitute investment fraud or investment negligence. Likewise, the use of margin, or the purchase of options or high-yield bonds for a conservative investor could be unsuitable. So too would be a recommendation that would result in an over-concentration in a particular market sector – whether the securities were held at the stockbroker’s firm or elsewhere.
Suitability also requires stockbrokers to thoroughly understand the proposed product or strategy. A financial advisor must undertake sufficient due diligence to understand the potential risks and rewards associated with the recommended security or strategy. As the securities regulators state, “The lack of such an understanding when recommending a security or strategy violates the suitability rule.” FINRA Rule 2111.05 (a).
In 2012, the suitability rule was extended to apply for the first time to the “strategies” your stockbroker recommends. The term “strategy” is broadly defined and includes a recommendation to invest in high dividend companies, a particular market sector, use of a bond ladder, use of margin, day-trading, buying the “Dogs of the Dow” and the use of home-equity to purchase securities, among potentially many others. Significantly, FINRA also definitively states that a recommendation to “hold” a security constitutes an investment strategy.
The expansion of the suitability rule to strategies is significant in a number of ways. First, it requires your stockbroker to have a reasonable basis for the recommended strategy. This requires your stockbroker to have conducted adequate due diligence on the risks and mechanics of the investment strategy before recommending it, as well as to have considered whether these risks are appropriate for you given your investor profile. This extends liability for unsuitable recommendations beyond just the point-of-purchase. Previously, the suitability of a securities recommendation was judged by evaluating it at the time the security was purchased. Because a strategy can be recommended at any time – and can even cover securities not purchased at the firm – a suitability obligation is much broader and can now arise even after the time of purchase.
If you have lost money because the securities or strategies recommended by your stockbroker were inconsistent with your investment objectives, we would like to help.
Contact The Prosser Law Firm for a free, informative consultation at 901-820-4433.