Investing would be easy if a single strategy was right for everyone. In reality, each investor has a distinct circumstance in terms of their assets and resources, financial goals, needs, and risk tolerance. Investments that are appropriate for an unmarried 25-year-old may not be suitable for a 50-year-old with kids in college or for a retiree who depends on investment income.
Working with a financial professional, such as a stockbroker or financial advisor, is one way to avoid a one-size-fits-all approach to investing. These professionals have a duty to fully understand their clients’ financial circumstances and to recommend only suitable financial products or trading strategies. Unfortunately, brokers don’t always follow the rules when it comes to advising their clients about investments.
When a financial professional recommends an unsuitable investment to their clients or one that is not in their client’s best interests, they may be held financially responsible when their advice results in major losses. A skilled securities arbitration lawyer can help victims of stockbroker misconduct recover compensation for their losses.
What Obligations Do Brokers Have to Their Clients?
In the United States, brokers, financial advisors, investment advisors, and other financial professionals are subject to the rules and regulations of the Financial Industry Regulatory Authority (FINRA). FINRA is a not for profit organization that is authorized by Congress to protect American investors by regulating the broker-dealer industry. Financial advisors and brokers must also follow federal law and are required to register with the Securities and Exchange Commission (SEC).
Historically, there were two primary rules that brokers and financial advisors must follow when it comes to recommending investments and investment strategy: (1) FINRA Rule 2111, Suitability; and (2) FINRA Rule 2090, Know Your Customer. Recently, however, the SEC enacted what’s commonly called Regulation Best Interest (“B.I.”). Reg BI is new, long, detailed and yet untested by judges or arbitrators. It purports, however, to require that a broker’s recommendation be made in their client’s best interest. Together, these rules work to protect customers from brokers who may recommend investments or strategies that are not designed to meet their needs.
Under FINRA’s former Suitability rule, brokerage firms and brokers “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.” This profile may include factors such as the customer’s age, financial situation and needs, other investments, tax status, investment experience, liquidity needs, risk tolerance, investment objectives, and investment time horizon (i.e., the need to make short term or long term investments).
The suitability of a particular investment or strategy must be based on the investor’s customer profile, which includes an evaluation of their ability to understand and assume the risks that are associated with the recommended course of action. Pursuant to this rule, brokerage firms and financial advisors are only permitted to recommend investments or strategies that are deemed suitable for a particular customer. We expect that the imposition of Reg BI will only serve to strengthen the former “suitability” standard and set a higher standard for the quality of a broker’s recommendations.
Importantly, the rules are not limited to the suitability of a particular investment or transaction. Instead, stockbrokers must ensure that a recommended series of transactions are not just suitable in isolation, but in the aggregate. In other words, even if a particular investment is suitable when viewed by itself, if it is unsuitable when considered as part of a broader context, the broker may have violated FINRA Rule 2111 and by extension, Reg BI.
The Know Your Customer rule works in tandem with other rules and regulations to protect potential customers from unsuitable investment advice. Specifically, this rule requires each broker or financial advisor to use reasonable diligence in opening and maintaining a brokerage account to know and retain the essential facts concerning their customers, as well as the authority of each person acting on their behalf. As defined by this rule, “essential facts” include those facts that are necessary to effectively service the account, act in accordance with special handling instructions, understand the authority of each person acting on behalf of the customer, and to comply with applicable laws, regulations, and rules.
Under this rule, brokers and financial advisors must ask the right questions and obtain the necessary documentation before opening an account. They should also continue to be diligent when it comes to knowing their customers while offering services. Taking these steps can ensure that a broker truly understands their customers’ needs so that they can make suitable recommendations.
What Happens When a Broker Makes an Unsuitable or Inappropriate Recommendation?
In an ideal world, brokers would make investment recommendations that are appropriately matched to a customer’s needs. Too often, brokers don’t live up to this goal. The unsuitability is a leading cause of disputes, according to FINRA data, with 1,580 arbitration claims for suitability filed in 2019 alone.
When a broker fails to take all of the facts and circumstances into account when recommending an investment strategy or transaction, it can lead to significant stock market losses. Financial advisors or brokers must fully understand the customer’s needs, and analyze them against the investment and the customer’s investment portfolio as a whole before making a recommendation.
If a broker or financial advisor fails to perform the due diligence necessary to make a proper recommendation, then their clients may be able to recover for their losses. Brokerage firms typically require customers to sign an agreement with a mandatory arbitration provision. This limits the ability of customers to engage in securities litigation. Instead, complaints will be handled through the FINRA arbitration process.
In these situations, it is vital to work with a law firm that has significant experience in all aspects of securities fraud. The rules governing securities are complex and multi-faceted. An attorney who understands these laws and regulations can use their knowledge and negotiating skills to win an arbitration claim.
In a FINRA arbitration, the customer who suffered an investment loss may recover their actual monetary damage and interest. They may also request specific performance, where the broker or brokerage firm is required to perform its contractual obligation as closely as possible. The majority of FINRA arbitration cases (69%) are resolved by settlement, while 18% of claims go to arbitration and result in an award.
Did Your Broker Recommend a Bad Investment? We Can Help.
If you have suffered financial loss due to an inappropriate recommendation from a broker or financial advisor, you may be able to recover money for your losses. The lawyers of McCarthy, Lebit, Crystal & Liffman have more than 20 years of experience in securities law matters, including unsuitability claims involving:
- IRA and ERISA-covered Retirement Accounts like 401k, Profit Sharing, and Pension Plans
- Margin trading
- Variable annuities
- Variable Universal Life Insurance
- Outside Money Managers
- Options Trading
Our lawyers are dedicated to helping victims of financial misconduct recover their investment losses. We may be able to help you get your money back through the securities arbitration process.
Based in Cleveland, we represent clients throughout the United States, from New York City to Los Angeles. To learn more about how we can help, contact our law firm today with a phone call to (866) 932-1295, or fill out the contact form on our website.