The federal securities laws and self-regulatory rules require investment professionals and stockbrokers to make appropriate or suitable recommendations to their customers, based on, among other things, the customers’ overall financial condition and stated tolerance for risk.
While even wealthy investors are allowed to be conservative investors, the sale of unsuitable or otherwise excessively risky investments is a form of stockbroker fraud and stockbroker misconduct. Suitability is based on a customer’s age, income, net worth, education, stated investment objectives and prior investment experience.
Based upon the New York Stock Exchange “Know your Customer Rule,” FINRA Conduct Rules require that in recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to their other security holdings and as to their financial situation and needs.
Despite the temptation to realize excessive returns in the stock market, investors should be aware of risk. Those seeking to double their money in the stock market ought to be prepared to lose it all.
The willfully disregard of a customer’s stated investment objectives and tolerance for risk through the sale of excessively speculative or volatile securities is a form of stockbroker fraud or misconduct, which is actionable under the federal securities laws.
The sale of unsuitable investments also includes the failure to properly diversify a customer’s investment portfolio, or the over concentration of that portfolio in volatile, or speculative technology, telecommunication or other securities, including the securities of troubled financial institutions, junk bonds, illiquid real estate investments or private placements, and structured products.
The most common examples of unsuitable recommendations by a stockbroker or investment advisor relate to:
The recommendation of a risky investment to a customer who is seeking more conservative investments or cannot afford significant losses is a form of stockbroker fraud or misconduct.
The recommendation or failure to diversify a portfolio that is over-concentrated in a small number of stocks or one asset class is a form of stockbroker fraud or misconduct.
The sale of securities that are illiquid or for which no recognized market exists such as limited partnerships or restricted securities is a form of stockbroker fraud or misconduct.
Lack of Diversification
The construction of an investment portfolio that is not properly diversified among economic industry sectors or sub-sectors, or that is not properly allocated among bonds or fixed income securities and equity based investments, including investment company shares or mutual funds.
Improper Recommendation to Outside Investment Managers
Stockbrokers and investment professionals also have a duty of suitability with respect to the recommendation of outside investment managers, and to conduct due diligence as to the investment style of any outside investment manager to determine if that style is suitable or not overly aggressive and is otherwise consistent with the customers’ overall financial condition and stated investment objectives.