By Timothy Guilmette, Spring 2014 Student Intern
Investors today have more choices than ever before, and many investors feel more comfortable developing investment strategies with assistance from a licensed brokerage firm. Brokerage firms have associated persons (commonly referred to as brokers) who buy and sell securities on behalf of investors and make recommendations based on the investor’s individual investment profile. Brokerage firms and their associated persons, are required to gather specific information from a client before making recommendations.
Financial Industry Regulatory Agency (FINRA) Rule 2111, Suitability, places a duty on brokerage firms and their associated persons to “. . . 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 [firm] or associated person to ascertain the customer’s investment profile.” Let’s break that down and learn more about the Suitability Rule.
Investors should endeavor to provide as much information about themselves to their investment professional as possible. Doing so enables financial professionals to make sound financial recommendations, which are better suited to the individual investor’s needs. Your investment profile encompasses risk tolerance, age, tax status, current and future financial needs, investment timeline, and other relevant information. FINRA’s, Suitability: What Investors Need to Know highlights the type of information that should be gathered before a recommendation is made. Firms are required to use “reasonable efforts” to gather this information, and although the firm or associated person is required to ask for this information, investors are not bound to provide it. It is in your best interest to talk about your position so the advice you receive is tailored to you.
Recourse for Unsuitable Investments
In some cases investors find themselves in an investment that ultimately proves unsuitable. For example, if a 75 year old retiree on social security, who has no significant assets, is steered towards a portfolio entirely composed of risky tech stocks, the investor might not have been placed in a suitable investment. This oversimplified example is clearly unsuitable given the person’s age and financial needs. Had a suitability analysis occurred, we would focus on the investor’s goals. The brokerage firm in our example should have asked the investor questions about her risk tolerance, age, tax status, investment time horizon, income, financial needs, investment experience, and liquidity needs to determine her investment profile. The answers to these questions should have alerted the firm that a risky tech stock portfolio, for a 75 year old retiree on social security, would be unsuitable given her financial needs and investment time horizon.
An investor in this position needs to conserve capital because she will likely need to draw from that investment in the near future. Additionally, the investor should be in a less volatile portfolio because riskier positions have the potential for large losses over a relatively short period of time and this investor does not have the luxury of waiting for the market to rebound. If the brokerage firm nevertheless made this recommendation, it might be held liable for any related losses stemming from the unsuitable recommendation.
Investors placed in unsuitable investments by a broker or brokerage firm may be able to bring a claim against the firm through FINRA’s dispute resolution process. Suitability is a fact specific inquiry, and investors who feel they may have been placed in an unsuitable investment should speak with a licensed attorney, or one of the several Investor Advocacy Clinics around the country.