Select a topic below:
( Green: Current Location)

• Introduction
• Background
• Fraud by Conduct
   • Churning
   • Switching
   • Twisting
   • Other
• Fraudulent Acts   and Practices
• Suitability
• Unregistered
  Securities
• Conclusion

Suitability

The failure to make suitable recommendations is the most common basis for claims against a broker dealer and its’ representatives.

A broker/dealer and its representatives have a duty to exercise the utmost good faith and to act in the customer’s best interest in connection with the purchase and sale of securities in the customer’s account. This duty includes having a reasonable basis for recommending that an investment strategy and/or a particular transaction and/or a particular investment decision is suitable for the customer based upon the clients age, financial status and resources, investment horizon, income, investment objectives, tax status, risk tolerance and financial needs.

The basis for this duty is found in the antifraud provisions of the federal and state securities laws, numerous cases, the NYSE’s Know Your Customer Rule and the NASD’s Suitability and Fair Dealing with Customer Rules.

Examples of transactions and/or trading strategies that may be unsuitable include, but are not limited to, the following:

1. Recommendations to purchase a high risk stock, mutual fund, or variable annuity portfolio to the following investors:

   1. A person whose investment objective does not include high risk or speculative investments, including wealthy clients. (A wealthy person has as much a right to suitable recommendations as anyone else.) A customer may have different investment objectives for different accounts or investments and the customer’s particular investment objective must be followed in making recommendations for each account and/or investment;

   2. A person who does not have the ability to recover from a substantial loss, which may include:

      1. A retired person;

      2. A person with limited income;

      3. A person with limited assets; and

      4. A person who needs the money in a short time (limited investment horizon);

   3. A person with a low risk tolerance;

   4. A person whose investment objective is asset preservation and/or growth;

   5. A person who can not afford to lose the money; and

   6. A person who has been a CD investor and does not understand the risk.

2. Recommending the purchase of a variable annuity in an IRA or other tax deferred account (there may be an acceptable reason, but it would be an exception);

3. Trading in mutual fund shares (mutual funds are not normally proper trading vehicles, therefore such activity on its face may raise questions of propriety);

4. Recommending the use of a high level of margin to a customer who does not have the capacity to meet margin calls;

5. Recommending the use of margin in accounts where the objective is long-term, investment, asset preservation, and/or income;

6. Recommending a trading account to a person who does not have the knowledge and/or the time to participate in the investment decisions on a constant basis;

7. Recommending a high yield bond fund (junk bond fund) and or junk bonds to an investor whose objective is asset preservation;

8. Recommending municipal bonds to persons who have little or no taxable income;

9. Recommending tax shelters to persons who have little or no taxable income;

10. Recommending the purchase of illiquid investments (i.e., limited partnerships, investment trusts and restricted securities) to persons who need access to their money; and

11. Recommending a trading strategy that has elements of churning except the customer participated in investment decisions (i.e., even though it is not churning, it may be an unsuitable strategy that benefits only the salesperson and the broker/dealer).

Next topic: Unregistered Securities