May 30, 2017
The bulk of claims by investors are premised upon the fact that the product recommended by the broker or investment adviser were not suitable for the investor. As an investor, you should understand how suitability is determined.
Financial Industry Regulatory Authority (“FINRA”) Rule 2111(a) provides that a broker must have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer based on the information obtained through reasonable diligence of the customer’s investment profile, which includes 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 related by the customer.
This suitability rule contemplates three components: First, the broker must believe, based on reasonable diligence, that the investment is suitable for at least some customers. Thus, the broker must have a reasonable understanding of the risks and rewards of the investment. If the broker doesn’t understand the investment, he or she cannot make a determination as to whether it is suitable for any particular customer. This portion of the test comes into play most often when the product is complex, such as reverse convertible notes or alternative investments created by the broker-dealer. Second, the broker must have a reasonable basis to believe that the investment is suitable for the particular customer he or she is recommending it to. While emerging market equities are suitable for some investors, they may not be suitable for a retiree who is dependent upon income and can’t afford to lose principal.
Essentially, the broker’s responsibility is to “match” the investment product or strategy with the customer. To do this, the broker must know not only the customer, but the product.
As an investor, you can aid in making sure you get suitable products by clearly explaining to your broker your investment objectives and risk tolerances, and asking your broker how the recommendation fits with your needs.