Most investors know that their financial advisor cannot misrepresent the risks and rewards of investments. However, many investors do not realize that all brokers have an obligation to deal fairly with investors by only recommending suitable investments or investment strategies. All sales efforts are judged by the ethical standards of Financial Industry Regulatory Authority (FINRA) that sets industry wide investment standards. The “suitability rule” contains three primary obligations: reasonable-basis, customer-specific, and quantitative suitability.
Reasonable-basis suitability means that the broker must believe, based on appropriate research and due diligence, that the product or strategy being recommended is suitable for at least some investors. Thus, FINRA recognizes that there are some investment products and strategies that are so risky and likely to fail that they would be inappropriate for all investors. Other investments may contain risks characteristics that are only appropriate for a very small group of investors or for specialized purposes.
Customer-specific suitability requires the broker to believe that the recommended investment strategy is suitable for that particular customer. The advisor must take into consideration the customer’s risk tolerance, investment objectives, age, financial circumstances, other investment holdings, experience, and other information provided to the broker.
Finally, quantitative suitability requires that all advisors recommending a series of transactions to ensure that the investments taken as a whole to be suitable and not excessive for the customer in light of the customer’s objectives. Thus, while a small investment in a particular product or sector may be suitable for the investor, a large concentration may be unsuitable for the same investor.
These suitability principles were recently enforced in a FINRA action against broker Aaron Hurst (Hurst) of Edward Jones. FINRA alleged that Hurst’s clients were an elderly couple with an aggregate account value of approximately $300,000.00. The husband was 73 and a retired building maintenance supervisor. The wife was 69 and was employed as a part-time teacher’s aide. The couple had a net worth of $350,000 and their joint income was approximately $40,000 per year from social security payments, the wife’s part-time income, and monthly interest on their investment accounts. Both husband and wife had limited investment experience and knowledge.
The couple’s primary investment objective was income. According to FINRA, on or about July 16, 2008, Hurst recommended that the couple invest in growth equity based mutual funds. FINRA found that Hurst’s recommendations led to the couple having more than 50 percent of their liquid net worth invested in equity-based mutual funds. FINRA found that Hurst made the recommendations without reasonable grounds to believe that the recommendations were suitable for the couple in light of the customers’ age, net worth, income, retirement status, risk tolerance, and primary investment objective of income.
The attorneys at Gana Weinstein LLP are experienced in investigating claims concerning the unsuitable sale of securities. Our consultations are free of charge and the firm is only compensated if you recover.