• September 27, 2024
• Unsuitable Investments

The market offers different investment opportunities for investors with diverse goals and risk appetites. Given this variety, it is important to understand what investment suitability means for an investor. While we generally rely on investment advisors to guide us through the most appropriate options, some financial professionals use their position to self-profit by recommending unsuitable investments. They may do this by disregarding the suitability standards for their clients, or failing to conduct due diligence on the recommended investments.

If you have been taken advantage of by a financial advisor or broker who has recommended unsuitable investments, contact an investment lawyer today with Wolper Law Firm. If we find that your advisor has not met the standard of suitability, we may be able to recover some of your lost funds.

What Is Suitability?

While the Securities & Exchange Commission (“SEC”) has yet to adopt a formal suitability rule, the Financial Industry Regulatory Authority (“FINRA”) that governs investment advisors and professionals does offer some guidance. According to an IA/BD study, “advisers owe their clients the duty to provide only suitable investment advice.” This means that investment advisors have a duty of care towards their clients to only recommend investments that are aligned with their actual needs, goals, and abilities. Only these kinds of investments can be considered “suitable”. Suitability also prevents brokers from making recommendations geared exclusively towards earning them commissions, a practice known as “churning“.

Suitability vs. Fiduciary

It is important to realize that suitability and fiduciary duties are different, and are not enforceable in the same way. A fiduciary duty is a legal standard that binds some professionals, such as trustees, financial advisors, and money managers. Fiduciaries are bound to execute the role of financial management to the best of their abilities, put their clients’ interests before their own, and disclose any conflicts of interest.

On the other hand, suitability refers to performing “reasonable diligence” to understand a client’s needs and acting accordingly. Suitability is not a legal standard, but a professional one. However, you may be able to file a FINRA complaint to recover some of your lost or defrauded funds due to unsuitable investments.

Suitability vs. Best Interest

June of 2020 saw FINRA adopting Regulation BI, an addition to Rule 2111. Accordingly, “a broker-dealer that meets the best interest standard would necessarily meet the suitability standard.” This more closely intertwines the concepts of suitability and best interest. However, the two are not precisely the same. Acting in a client’s best interest is more closely aligned with a fiduciary understanding, whereas suitability is associated with acting with a reasonable level of insight into a client’s needs.

What Is the Regulatory Framework Governing Investment Suitability?

All broker-dealers must register with FINRA. Suing for unsuitable investments is less common than filing a FINRA complaint, which can see brokers being disciplined, fined, and even facing expulsion from their professional licensing.

FINRA’s Suitability Rule

FINRA’s suitability standard is, at its heart, a consumer protection rule. FINRA’s Rule 2111 replaced Rule 2310, to state that a broker-dealer must have a “reasonable basis” to recommend an investment. The full text reads:

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.

FINRA standards recognize that customers rely upon their broker-dealer’s expertise and specialized knowledge in the field, and that this position of power must be wielded responsibly. Accordingly, there are three primary suitability obligations:

Reasonable-basis Suitability

At its core, suitability relies upon reasonableness. An investor must conduct due diligence into an investment to ensure that it has an opportunity to generate a profit for their client. They must look into an investment opportunity’s legitimacy, history, and profitability. An investment must have some likelihood to produce returns for their customer, i.e., it must be reasonable for someone in order to be considered at all.

Customer-specific Suitability

Your broker-dealer should ideally gather crucial information about you and your goals to better understand you as a customer. They should be offering customized recommendations, not simply one-size-fits-all solutions. Customer-specific suitability may mean inquiring about factors like:

• Age
• Education
• Objectives and goals as an investor
• Risk tolerance
• Daily or monthly expenses and liquidity needs
• Any prior investing experience and knowledge
• Income
• Net worth
• Marital and tax status
• Investment time horizon

All of these factors must be combined to create a customer portfolio.

Quantitative Suitability

Quantitative suitability is in place to prevent churning, the practice by which broker-dealers over-recommend investments or create artificial action to generate high fees and commissions. For example, even if a series of investments alone might each be considered reasonable to recommend to a client, creating a string of purchases solely to generate a higher level of commissions for the broker would be an example of quantitative unsuitability. Another example might be a broker-dealer that consistently recommends higher fee options to their clients, when lower fee or less expensive options also exist. Under FINRA regulations, if two options exist with equal benefits, your broker must choose the one with a lower cost to you, even if it results in a lower commission for them.

What Is the Institutional-Customer Exemption?

Institutional investors are expected to have a more in-depth ability to examine their own investment risks. Because of this, a broker or broker-dealer is only expected to have a reasonable belief that their institutional customer is capable of evaluating their investment risks independently. Such customer must also affirm that they are exercising independent judgment in regard to their investment portfolio.

However, no customer can waive their right to suitability. Institutional customers are only expected to operate under a higher amount of know-how than the average layperson. As such, they operate with fewer protections from suitability guidelines.

Best Practices To Help Ensure Investment Suitability

The reason why FINRA regulates suitability is because it is understood that investment advisors, money managers, and broker-dealers are supposed to be the experts in the room. Therefore, they also have the capacity to easily mislead their clients and take advantage of their trust for their self-interests.

You can’t always know whether or not you are being taken advantage of by a fraudulent or negligent advisor. However, you can keep the following best practices in mind to mitigate your risks:

• Conducting your due diligence to vet a financial advisor: Always research your financial advisor before entrusting them with your portfolio. You must verify whether your broker-dealer was disciplined for suitability concerns or for other inappropriate actions.
• Understanding how risk tolerance is assessed: Risk tolerance is assessed based on a combination of personalized factors such as age, expenses, investment time horizon, liquidity needs, and more. It makes sense to understand if you are in the category who should be marketed more complex financial products to begin with, or if any advisor who suggests riskier and newer investments like cryptocurrency or structured products may be taking you for a ride.
• Clearly communicating goals and risk tolerance: Keep a record of all correspondence with your advisor, particularly where you have communicated your risk appetite and financial goals.
• Asking questions about recommended investments and regular updates: You have the right to receive regular communications from your broker-dealer about how your portfolio is performing. If you cannot get in touch with your financial advisor, this may be a red flag indicating that they are not acting honestly.
• Review and diversify your portfolio: Understanding what comprises your portfolio can help you know what kinds of risks are being taken, and if they are appropriate for your goals. If you feel you are not getting a straight answer from your advisor, contact an investment fraud lawyer for help and guidance.
• Documenting issues in case of any red flags: Print out statements and emails from your broker-dealer. Ask for copies of any paperwork you have signed, especially when opening your accounts, and if you have waived certain rights to litigate.

How To Understand Your Risk Tolerance

All investments carry some degree of risk. Risk in investing means that you may lose some or all of your money due to unexpected economic events, poor investment choices, or market volatility. There is no such thing as a sure thing in the market, and anyone who promises guaranteed returns is most likely selling you a scam.

However, it is very reasonable to have different risk appetite. Just because an investment is riskier does not mean that it is unsuitable for every portfolio. For instance, someone with a high net worth might be more likely to take on an investment with more of their principal at risk, in exchange for the chance to earn higher returns or simply because they believe in the venture and wish to support it. Someone with high monthly expenses, for instance – regular alimony and child support payments, may want more liquidity from their investments and be able to move their money around and access cash if needed. It is important to understand your unique circumstances so you can make informed decisions about the level of risk you’re comfortable assuming in an investment.

What Are the Unsuitability Red Flags To Watch Out For?

Some common red flags for unsuitable investments include:

• Aggressive sales tactics
• Insisting clients act immediately, or limiting time for reflection
• Only contacting clients over the phone and failing to provide written documentation
• Insufficient research
• Affiliation with known scam artists or unlicensed brokers
• Making exaggerated claims, like “this can’t lose” or promising a certain level of returns

Investment suitability can also vary based on the kind of product. For example, structured notes are known to be higher risk because of their increased expense, complex formula structure, difficulty to resell, as well as highly illiquid nature. Recommending this kind of product to a client should only be done after an in-depth assessment of their needs and goals. If your financial advisor is pushing certain kinds of investment products onto you, it is a sign they may not be acting in your best interests.

Additionally, an investor’s circumstances, experience, and other elements of their personality should be taken into account when recommending stocks and securities. For instance, retirees and senior citizens, small business owners, and those with more at stake in the market often need to be more mindful of their portfolios and how much of their net worth is tied up in investments. Wolper Law Firm recommends taking the following steps before opening an account:

• Qualification of the investment advisor: Conduct a BrokerCheck to research the expertise of your broker as well as their investment firm. It is a free and fairly intuitive process that will take a few minutes but save you time and money later.
• Certifications of the investment advisor: Before investing in more complex products like cryptocurrency, real estate, leveraged ETFs, high-yield bonds, IPOs, and any alternative investments, make sure that your financial professional is qualified to offer guidance in these more specialized fields.
• Understanding how to evaluate an investment professional’s recommendations: When in doubt about a broker or advisor, contact an investment loss attorney. If you are experiencing consistent losses in your portfolio, have difficulty speaking to your broker, or are finding all of your available funds are tied up in their accounts, contact Wolper Law Firm today for help filing a claim so you may recover some of what you have lost.

How Has FINRA Disciplined Brokers For Unsuitable Investment Advice?

FINRA has brought several disciplinary actions including fines, fees, and suspensions against brokers for fraudulent or negligent conduct. It takes appropriate actions against such parties based on investigations into complaints showing strong evidence of fraud or negligence. A FINRA attorney who understands the process can help you file a claim against a broker who provided unsuitable investment advice that led to the loss of money.

At Wolper Law Firm, our attorneys have helped many of our clients recover funds from broker-dealers and financial advisors who have taken advantage of them. We are former industry insiders who leverage our knowledge to protect our clients. If you believe you’ve been a victim of investment fraud, contact Wolper Law Firm to help file a FINRA claim.

Can I Challenge an Unsuitable Investment?

The concept of “suitability” is not static – what is suitable for someone today may be unsuitable later due to a change in circumstances. For example, say a young investor has in the past shown interest in taking on riskier ventures with less security to seek higher returns. However, this same person may want to later move their portfolio into more stable investments due to a change in their circumstances. If their broker continues to recommend “risky” options to this client, they may be acting outside of their interests.

You can challenge an unsuitable investment with the help of a FINRA arbitration lawyer. A FINRA complaint can help you recover lost funds and protect your future financial health.

Concerned About Investment Suitability? Set Up a Free Consultation With an Investment Loss Attorney

At Wolper Law Firm, we take a customized approach to addressing each of our client’s needs. We help novice investors as well as experts who spot issues in their accounts recover missing or stolen funds. We take your trust seriously, and we work hard to rebuild it throughout the course of your investment loss claim.

Working with Wolper Law Firm can help you get back not only your money, but also your confidence in the market. If you need help with unsuitable investment loss, contact us today for a consultation.