An investment suitability analysis is required – by industry rules and by law – before a stockbroker makes a recommendation to his or her client. Stockbrokers are obligated to recommend an investment only if they have first determined the recommendation to be suitable for the client based upon that client’s individual needs.

As attorneys who represent investors in arbitration claims against broker-dealers, we have too often seen instances of unscrupulous brokers who generated huge commissions for themselves by selling high-risk and/or illiquid investments (like REITs and variable annuities) to a large percentage of their client base, even if some of those clients could not afford the risks, needed quick access to their investment principle, or did not need to be locked into a long term investment with a contingent deferred sales charge (early withdrawal penalty).

Investment Suitability Is Required When A Stockbroker Solicits An Investment

The financial industry and state securities regulators impose legal obligations on brokers to know the important facts about their clients and to recommend investments only if the recommendation is suitable based on the customer’s profile.

For example, FINRA Rule 2111 requires that:

A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A 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, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.

Likewise, the Alabama Administrative Code declares it fraudulent and dishonest to recommend:

the purchase, sale or exchange of any security without reasonable grounds to believe that the recommendation is suitable for the client on the basis of information furnished by the client after reasonable inquiry concerning the client’s investment objectives, financial situation and needs, and any other information known or acquired by the adviser after reasonable examination of the client’s financial records.

Investment Suitability and the Senior Investor

FINRA issued further guidance to brokerage firms and their stockbrokers regarding heightened considerations when dealing with senior investors. In Regulatory Notice 07-43, FINRA highlighted investment suitability for senior investors as an area of “particular concern,” noting that a customer’s age and life state are “important factors to consider in performing a suitability analysis.” The Notice warns that firms are required to “fully understand the products recommended by their registered representatives, to give their customers a fair and balanced picture of the risks, costs and benefits associated with the products or transactions they recommend and recommend only those products that are suitable in light of the customer’s financial goals and needs.”

Investment Suitability is Not Automatic Just Because a Client is Willing to Speculate

Arbitrators have imposed on stockbrokers an obligation not to rely solely on a client’s desire for aggressive trading as a justification for making otherwise unsuitable recommendations; investment suitability is not met just because a client seeks to engage in aggressive trading. In the case of Department of Enforcement v. James B. Chase, August 15, 2001, a stockbroker argued that the speculative investment recommended by the broker was suitable because the customer had changed her investment objectives from “income” to “growth” and “speculation.”  (Id. at 8.)  In ruling against the broker, the arbitrators noted:

A customer’s investment objectives, however, are but one factor to consider in determining whether the broker’s recommendations were suitable for the customer.  Furthermore, a broker cannot rely upon a customer’s investment objectives to justify a series of unsuitable recommendations that may comport with the customer’s stated investment objectives but are nonetheless not suitable for the customer, given the customer’s financial profile.  Thus, even where a customer seeks to engage in highly speculative or otherwise aggressive trading, a broker has a duty to refrain from making recommendations that are incompatible with the customer’s financial situation and needs.  . . .  [The broker’s] recommendations therefore were not automatically made suitable by the alleged change in [the customer’s] investment objectives, when [the customer’s] financial situation and needs remained unchanged.

Unsuitable Investments May Give Rise to Legal Claims

Despite these requirements, many investors are unaware that they have a legal recourse when their broker recommends an unsuitable investment that causes financial harm. Each investor’s needs are unique, and stockbrokers must act accordingly. If your stockbroker caused you to lose money by recommending an investment that did not align with factors such as your:

• Age
• Investment objectives
• Risk tolerance
• Level of investment knowledge and experience
• Income
• Net worth
• Tax status
• Investment time horizon, or
• Liquidity Needs,

you may be able to recoup your losses via arbitration or the court system.