Failure To Conduct Due Diligence
On many occasions securities brokers fail to conduct product specific due diligence as to the risks or characteristics of structured products, inverse or leveraged ETF funds, reverse convertible debentures, hedge funds and alternative investments, or in the case of certain Real State Investment Trusts or REITs, selectively ignore the due diligence they are provided.
We refer to this as a lack of product specific due diligence, in that if a broker does not understand a product, there can be no good faith basis for its recommendation to customers. It is well settled that a securities dealer must have an adequate and reasonable basis in order to recommend a security. Hanly v. Securities and Exchange Comm’n, 415 F.2d 589, 596-7 (2nd Cir.1969). In connection with recommendations, securities dealers “owe a special duty of fair dealing to their clients.” Securities and Exchange Comm’n v. Hasho, 784 F.Supp. 1059, 1107 (S.D.N.Y.1992)(quoting, Hanly v. Securities and Exchange Comm’n, 415 F.2d 589, 596 (2d Cir.1969)( the Second Circuit articulated the duties which inhere in this “special relationship” where a dealer “implicitly represents he has an adequate basis for the opinions he renders.”). A stockbroker cannot recommend a security unless there is an adequate and reasonable basis for such recommendation. Keenan v. D.H. Blair & Co., Inc., 838 F.Supp. 82, 89 (S.D.N.Y. 1993). These duties have been described as” implicit warranties of the soundness of the stock, in terms of value, earning capacity, and the like.” Kahn v. Securities and Exchange Comm’n, 297 F.2d 112, 115 (2d Cir.1961) (Clark, J., concurring)(failure to disclose information in contravention of the warranty is tantamount to an omission of a material fact).
It is well settled that “where the salesman lacks essential information about a security, he should disclose this as well as the risks which arise from his lack of information.” Keenan v. D.H. Blair & Co., Inc., 838 F.Supp. 82, 89 (S.D.N.Y. 1993); Alexander Reid & Co., Inc., 40 S.E.C. 986, 990 (1962)(“A broker dealer cannot avoid responsibility for unfounded statements of a deceptive nature, recklessly made, merely by characterizing them as opinions or predictions or by presenting them in the guise of a probability or possibility.”); Berko v. SEC, 316 F.2d 137, 139 n. 3 (2d Cir. 1963)(where the prospective buyer is not informed of known or readily ascertainable adverse information; he is not cautioned about the risks inherent in purchasing a speculative security; and he is left with a deliberately created expectation of gain without risk).
FINRA Conduct Rule 2111 requires a member or an associated person must have a reasonable basis to believe that a recommended investment strategy involving a security or securities is suitable for the customer, the first part of this determination is “reasonable-basis suitability.”
According to FINRA:
- Reasonable-basis suitability requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.
- In general, what constitutes reasonable diligence will vary depending on, among other things, the complexity of and risks associated with the security or investment strategy and the firm’s or associated person’s familiarity with the security or investment strategy.
- A firm’s or associated person’s reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy.
See Securities Exchange Act Release No. 63325 (November 17, 2010).
If you believe you have been the victim of your broker’s failure to conduct due diligence with respect to a particular investment product or investment strategy, contact us for a free, confidential evaluation of your claims.
AboutNicholas Guiliano, Esq.
Nicholas J. Guiliano has more than 25 years of securities related experience, and has represented more than 1,000 public customers in claims against brokerage firms for fraud in connection with the sale of securities principally in arbitration before the Financial Industry Regulatory Authority (“FINRA”) Dispute Resolution, Inc. (formerly known as The National Association of Securities Dealers (“NASD”) Dispute Resolution, and the New York Stock Exchange (“NYSE”) Department of Arbitration.LEARN MORE