Investment professionals must make suitable investment recommendations based on the client’s particular needs. Investments that do not align with a customer’s needs are considered unsuitable and could be grounds for a legal claim to recover lost money.
The “Know Your Customer” Rule
Brokerage firms and financial advisers are required to have a reasonable basis for believing a transaction or investment strategy is suitable for the customer. This reasonable basis must be based on knowledge of the customer’s investment profile.
The Financial Industry Regulatory Authority (FINRA) outlines customer information that financial advisers should obtain before recommending suitable investments, including a customer’s:
- Financial state
- Reasons for investing
- Investment goals
- Risk tolerance
- Investment experience
- Tax considerations
- Age and investment horizon
Not only should financial advisers get to know their customers, they should also adequately research an investment before recommending it.
Since suitability can change based on a client’s needs and an investment’s status, a responsible broker continuously evaluates both.
Broker Misconduct
If a broker recommends an unsuitable investment, he or she may be liable for broker misconduct.
Picking a bad investment, however, isn’t the same as picking an unsuitable investment. A broker cannot be certain how an investment will perform. The issue is whether the adviser has a reasonable basis for recommending the investment.
If an adviser recommends a stock that is not reasonably based on a customer’s investment profile (for example, the stock does not meet the customer’s risk appetite, time horizon, or tax considerations), or that is not based on adequate research, the investment could be considered unsuitable and the broker (and ultimately, the brokerage firm) may be liable for any losses the investment causes.
Misconduct can also occur if the broker does not sufficiently explain the risks and rewards of an investment to a client (a problem known as misrepresentation).
Suspected unsuitable investments should be discussed with an attorney.
