What Does Lack of Suitability Mean in Investments?
When you work with a broker, your broker is obligated to make investment recommendations that align with your investment objectives and risk profile. While this is commonly referred to as the “know your customer” rule, it is formally known as the concept of “suitability.”
All brokers have an obligation to make suitable investment recommendations. This means that they must make recommendations that are customer-specific, and they must not put their own financial interests ahead of those of their customers. When brokers make investment recommendations that lack suitability, they can be held liable for their customers’ losses in FINRA arbitration.
Understanding Brokers’ Duty to Make Suitable Investment Recommendations
The Financial Industry Regulatory Authority (FINRA) regulates brokers and brokerage firms in the United States. All brokers must comply with FINRA’s Rules—which address everything from recordkeeping to conflicts of interest.
They also address suitability.
Specifically, the concept of suitability is addressed in FINRA Rule 2111. This Rule states, in part:
“A [broker] 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 . . . 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 . . . .”
Later portions of FINRA Rule 2111 go on to describe this as a “customer-specific suitability obligation,” clarifying the fact that an investment recommendation that is suitable for one investor won’t necessarily be suitable for another.
When Does a Broker’s Investment Recommendation Lack Suitability?
So, when does a broker’s investment recommendation lack suitability? There are several circumstances in which an investment recommendation can be deemed “unsuitable” under FINRA Rule 2111. Some examples of factors that may be indicative of unsuitability include:
- Failing to Gather Information About the Customer – Making suitable investment recommendations necessarily involves gathering information about the customer. As FINRA notes in its Rule 2111 FAQs, a broker must “exercise ‘reasonable diligence’ to ascertain the customer’s investment profile.” Failure to exercise reasonable diligence can justify a claim for unsuitability if this failure leads to investment losses.
- Overconcentrating an Investor’s Portfolio – Investment recommendations can lack suitability if they result in overconcentration of an investor’s portfolio. Diversification is one of the keys to effective risk management when investing, and overconcentrating an investor’s portfolio results in lack of diversification—which can lead to substantial losses.
- Making Recommendations that Don’t Align with a Customer’s Investment Objectives or Risk Tolerance – The customer-specific nature of the suitability requirement means that brokers must make investment recommendations that reflect individual customers’ investment objectives and risk tolerances. Failure to consider a customer’s investment objectives or risk tolerance is a common factor in unsuitability cases.
- Failing to Consider a Customer’s Investment Experience – FINRA Rule 2111 also requires brokers to consider their customers’ “investment experience.” As a result, recommending structured investment products and other complex investments to casual investors who may not understand the risks involved is also considered to be a form of unsuitability.
- Knowingly Making Unsuitable Investment Recommendations – While brokers can make unsuitable investment recommendations as a result of failing to exercise reasonable diligence or give due consideration to customer-specific information, they can also make recommendations that lack suitability intentionally. Typically, these scenarios involve conflicts of interest. A broker may choose to make unsuitable recommendations because certain investment products offer higher fees, or the broker may make unsuitable recommendations in order to “churn” a customer’s account and generate excessive commissions.
Again, these are just examples. Unsuitability can take many other forms as well; and, as an investor, it is important to consult with a lawyer if you have any reason to suspect that your broker’s investment recommendations were not suited to your investor profile.
What Are Your Rights If Your Broker Makes an Unsuitable Investment Recommendation?
What are your rights if your broker makes investment recommendations that lack suitability? If you have suffered investment losses as a result of these recommendations, you may be entitled to recover your losses through FINRA arbitration. Arbitration provides a forum for defrauded investors to recover their losses without going to court. All registered brokers are required to submit to FINRA arbitration for the resolution of customer disputes, and FINRA arbitrators can award damages including lost principal and the gains customers would have achieved with a well-managed portfolio.
Do you have concerns about the suitability of the investment recommendations you received from your broker? If so, we encourage you to contact us for more information. To arrange a FREE and confidential consultation with an investment fraud attorney at Colling Gilbert Wright, please call (888) 513-3010 or contact us online today.