Matching Investment Strategies With Investor Goals Is Required Under FINRA Rules

In every broker-investor relationship, the broker must “know your customer” and assess what the investor’s goals are, as well as his or her risk tolerance. This assessment is based on a number of key factors, including the investor’s stated objectives, risk tolerance, financial condition and tax status. It is the broker’s responsibility to only pursue investments suitable for that investor based on these factors. Brokers must always make suitable recommendations to their clients and abide by the FINRA “Suitability Rule,” which states: 

2111.  Suitability

(a) 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.

The phrase “investment strategy involving a security or securities” used in this Rule is interpreted broadly and obviously includes all recommendations to purchase and sell securities but also an explicit recommendation to hold a security or securities. The “Suitability Rule” includes recommendations to engage in a particular investment strategy, such as using options or margin or day trading strategies. 

A broker can be liable for unsuitable investment recommendations when he or she recommends the over-concentration of a client’s account in a single type of asset or sector.  A broker’s good faith is immaterial in a case involving over-concentration of assets in a single class of securities or sector. Even if the broker were to assert that the investor agreed to over-concentrate their holdings, a broker’s suitability obligations are not absolved.  The U.S. Securities and Exchange Commission (SEC) concluded:

the test is not whether [the clients] considered the transactions in their account suitable, but whether [the broker] fulfilled the obligation he assumed when he undertook to counsel [them], of making only such recommendations as would be consistent with [their] financial situation and needs. 

The SEC has also stated that a customer’s sophistication does not allow a financial advisor to disregard the customer’s investment objectives in recommending investments. It has also concluded that the mere disclosure of risks did not satisfy the suitability duty: “[n]ot only must the customer be sufficiently sophisticated to fully understand the risks involved with the investment, the customer also must be able to bear those risks.”

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