Unsuitable Investment Advice

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“financial advisors must consider client needs before recommending investments”

Brokerage firms and its financial advisors must only recommend suitable investments to their customers. Unsuitable investment advice is an investment recommendation that is not consistent with an investor’s investment objectives, risk tolerance and investment time horizon. Each customer should have its own specific determination of suitability based on its particular circumstances. For these reasons the securities industry established the “know your customer” rule to govern investment recommendations.

FINRA “Know Your Customer” Rule

The Financial Industry Regulatory Authority (FINRA”) “know-your-customer” Rule begins with the opening of the customer account and the requirement to gather through “reasonable due diligence” all of the “essential facts” concerning every customer of the brokerage firm. The essential facts are considered those required to:

  • Provide effective service to customer accounts;
  • Follow special customer instructions;
  • Act on behalf of customer; and
  • Comply with securities laws, rules and regulations.

What is Suitable Investment Advice?

FINRA established a “suitability” rule which requires brokerage firms and its financial advisors to have a “reasonable basis” for recommending investments or investment strategies, as suitable based on a customer’s investment profile. The rule requires “reasonable diligence” to gather all necessary information to formulate a basis for recommendations based on the following customer investment profile information:

  • age;
  • other investments;
  • employment status;
  • tax status;
  • investment objectives;
  • financial situation and needs;
  • investment experience;
  • investment time horizon;
  • liquidity needs;
  • risk tolerance, and
  • any other information disclosed by customer in connection with recommendation.

The FINRA suitability rule applies to a financial advisor’s investment advice whether it is a buy, sell or hold recommendation. The rule applies a flexible approach to the “facts and circumstance” of a particular customer recommendation. A recommendation does not rely upon a transaction or the generation of compensation for its existence. A recommendation can result from financial advisor communication directed to facilitate a transaction or refrain from any transactions regarding a security or investment strategy in a customer account. The financial advisor must have a firm understanding of both the investment and the customer. Failure to supervise a financial advisor’s understanding of how a particular investment works or what a specific client needs is at a minimum the basis for a negligence claim as another violation of the FINRA sales practice rules and regulations.

KlaymanToskes can help you determine whether an investment loss is the result of unsuitable investment advice. Investors who suffer losses as a result of unsuitable investment advice may be able recover their losses in a FINRA arbitration claim.

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