Brokers have a duty to provide advice and recommend investments that are in their customers’ best interests and are consistent with the goals and risk tolerances the customer has expressed. “Unsuitability” is a term used to describe recommendations and trades that are inappropriate for the customer and inconsistent with his or her goals. When recommending an investment, brokers are required to take the time to fully understand an investor’s particular financial situation, investment goals, and ability to tolerate risk. A broker should analyze each investment and trading strategy and recommend only those that are suitable and consistent with the customer’s individual investment needs and objectives. If an investor suffers financial losses as a result of an unsuitable recommendation, the broker’s firm may be liable for such losses. If you have questions about how your stockbroker or financial advisor handled your account, contact us today to speak with our experienced stock lawyer.
Current Investigation: Emerson Equity is currently being investigated for the sales of GWG Holdings L Bonds. Misrepresentation and unsuitability are among the allegations, so contact us to learn more.
What is the “Know Your Customer” Rule for Advisors and Brokers?
New York Stock Exchange Rule 405 requires that stockbrokers and financial advisors make suitable investment recommendations to their clients. This rule is called the “know your customer” rule. Unfortunately, many investment advisors broke this rule when advising conservative investors to purchase oil and gas investment stocks.
Investment advisors advised retirees and others looking for low risk, high-yield investment income that they should invest in energy stocks with little or no risk because energy companies had business models that would generate steady cash flow regardless of the volatility of oil prices. Unfortunately, investments in oil and gas have fallen 50 percent or more in a short period of time. Experienced investors understand the risks associated with such investments. However, less sophisticated investors who were misled by their financial advisors have options for recovering their losses.
Financial professionals who violated the “know your customer” rule can be held accountable for the bad investment advice they provided to those who invested in oil, gas and energy stocks, master limited partnerships, or funds that were heavily concentrated in oil and gas stocks. You can make an unsuitability claim to recover all or a portion of your losses with the help of a financial fraud attorney at Zamansky LLC.
3 Types of Suitability
To comply with FINRA’s Rules, brokerage firms must conduct three separate suitability analyses. All three analyses are required in every case. If a brokerage fails to perform any one suitability analysis—or performs any suitability analysis incorrectly—this can potentially give rise to a claim for investor fraud.
The three types of suitability analysis brokerage firms must perform are: (i) reasonable-basis suitability, (ii) customer-specific suitability, and (iii) quantitative suitability.
1. Reasonable-Basis Suitability
Prior to recommending a security, a brokerage must perform research to determine if the security would be suitable to at least some investors. This analysis focuses on the security itself rather than any one customer’s investment goals or risk tolerance. If a security is suitable to recommend generally, then the brokerage can (and must) proceed to the other two suitability analyses before recommending the security to any specific customer.
The purpose of this analysis is to determine if the brokerage firm has a reasonable basis for making the investment recommendation. Is the company offering the security legitimate? Is the company financially sound? Is the company facing litigation or an investigation? If the security is a structured product, does the structure make sense, and are the risks reasonable for at least some (i.e. sophisticated and high-net-worth) investors? These are just some of the questions brokerage firms must address in order to determine whether their brokers should sell a particular security.
2. Customer-Specific Suitability
If a brokerage firm determines that it has a reasonable basis to offer a security generally, it must then perform a customer-specific suitability analysis before offering the security to any customer. This analysis must take into consideration factors including (but not limited to):
- The value of the customer’s portfolio
- The securities in the customer’s portfolio
- The customer’s investment preferences and risk profile
- The customer’s financial circumstances
- The customer’s age
- The tax consequences of investing in the security
- The customer’s ability to understand the security
If any one or more of these factors (or any other relevant factors) suggest that the security is not suitable for a particular customer, then the brokerage must not recommend the security to that customer. Likewise, if a brokerage firm does not have the information it needs to assess all relevant factors, then it cannot perform an adequate customer-specific suitability analysis, and it is therefore incapable of determining whether it is making a suitable investment recommendation.
3. Quantitative Suitability
The quantitative suitability analysis addresses the overall impact of an investment strategy or series of transactions on a customer’s portfolio. Even if a single transaction is suitable when viewed in isolation, engaging in multiple transactions could involve excessive cumulative risk, thus making the strategy unsuitable. Overconcentrating a customer’s portfolio in a single security or asset class is another form of unsuitability that can occur when a brokerage firm fails to conduct (or ignores the results of) a quantitative suitability analysis. Excessive trading, a poor cost-equity ratio, and a high turnover rate are all factors that will frequently be indicative of an inadequate quantitative suitability analysis as well.
Making a Claim with an Experienced Stock Lawyer
When providing advice to investors, stock brokers and financial advisors should consider the following factors:
- The current financial state of the investor;
- The investor’s goals for investing and what the investor hopes to achieve;
- The future financial needs of the investor; and
- The investor’s tolerance for risk.
When financial advisors fail to take these four factors into account and recommend investments that are not suitable for a particular investor, the advisor is may be liable in an unsuitability claim alleging stockbroker misconduct. Oil and gas investment funds, energy stocks, master limited partnerships, and other investments tied to the price of oil are high-risk investments that are not suitable for conservative investors.
Despite assurances that gas and oil securities are not affected by the volatility of oil prices, these investments have experienced significant declines as the price of oil has plummeted. Conservative investors who placed their trust in financial advisors and who believed that these were safe investments can bring an action for unsuitability.
To prove an unsuitability claim, you must establish that:
- A transaction took place;
- You sustained damages (lost money); and
- The broker was aware of your financial situation and your need for safe investments.
Zamansky LLC’s experienced unsuitability attorneys have more than six decades of collective experience representing investors nationwide. We have taken on some of the biggest brokerage houses in the business and have made it our focus to seek recovery of investment losses due to the negligence or fraud of financial professionals.
FINRA Rule 2111: Suitability
Financial Industry Regulatory Authority (FINRA) Rule 2111 addresses the unsuitability of brokerages’ investment advice. Rule 2111 requires brokers and brokerages to use “reasonable diligence” to investigate a customer’s investment profile when recommending a securities transaction or investment strategy. Under the FINRA Rule, a customer’s investment profile consists of a wide range of individual characteristics, including the customer’s:
- Financial situation and needs
- Tax status
- Investment objectives
- Investment experience
- Risk tolerance.
The FINRA suitability rule further imposes on brokers and brokerages the responsibility to deal fairly with the public: FINRA Rule 2111 is “fundamental to fair dealing and is intended to promote ethical sales practices and high standards of professional conduct.”
Class Action Litigation Portal
Zamansky LLC represents investors in securities class action lawsuits and employees in ERISA class action cases.Get Started
An Experienced Stock Lawyer Can Help
Far too often investors discover that their investments are unsuitable for them. For example, suppose a broker recommends that an elderly, inexperienced customer with a low risk tolerance invest in a risky hedge fund or complicated structured product. If the customer does not understand the risks associated with the investment or does not have the financial ability to absorb losses, the customer may bring an unsuitability claim against the brokerage firm to recover losses that resulted from the investment.
Zamansky LLC has represented hundreds of investors across the country from all walks of life. We know that all investors are different and their risk tolerances are specific to them. Each securities arbitration lawyer at our firm is well-versed in suitability claims. When investigating a suitability claim, our attorneys carefully examine a client’s investment profile, taking into consideration unique financial and investment characteristics. We will aggressively prepare and pursue claims against the brokerage firm to recoup any financial losses a client suffered as a result of the unsuitable recommendation.
Contact a Stock Lawyer Zamansky LLC Today
To determine whether you may be able to recover a loss due to a broker or brokerage’s unsuitable recommendation, contact a stock lawyer. Contact us today at 212-742-1414 or complete our contact form. Zamansky LLC responds to all inquiries within 24 hours and offers free, no-obligation initial consultations.