Suitability Claims In Securities Litigation or Securities Arbitration
Suitability, or, really, unsuitability, is probably the most common claim investors file against broker-dealers and registered representatives* in arbitration or court. These claims are based on the Financial Industry Regulatory Authority (“FINRA”) general suitability rule, Rule 2111(a) of the FINRA rules governing the relationships of the industry with its individual (non-institutional) customers.** Here is the text of the rule:
A member [broker-dealer] or an associated person [another term for registered representative] must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile. A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
The Suitability Rule applies only when the stockbroker makes a “recommendation” to a customer. When a recommendation becomes an “order” to purchase or sell, the trade ticket, or confirmation, must be marked “solicited,” indicating that the transaction was recommended by the stockbroker and triggering the suitability rule. If the trade was the customer’s idea, the ticket should be marked “unsolicited.” Failure to mark trade tickets appropriately can sometimes become a point of contention in a FINRA arbitration or lawsuit. Notice, though, that the language in the current role is broad enough to include a recommendation to “hold” a security (“or investment strategy”) as well as to buy or sell.
When suitability is alleged, the information on the “New Account Form” or “New Account Card” becomes a significant item of evidence in the arbitration or court case. For this reason, investors should make sure that their “New Account Form” accurately reflects their experience, knowledge, risk tolerance, and investment strategy. Sometimes these forms are completed by the broker, and in many suitability cases, the New Account Card may indicate that the investor’s risk tolerance is greater than the customer’s actual appetite for risk. For example, the risk tolerance may use the term Speculative when the investor actually seeks Long-Term Growth. If that is the case, the broker-dealer will use this information defensively to argue that the speculative recommendations were suitable for that customer.
For these reasons, a suitability claim often turns on the credibility and demeanor of the witnesses and on the arbitrators’ ability to assess all the circumstances in evidence, not necessarily the documents alone. Thorough preparation of the investor’s presentation and expert testimony are essential.
*”Registered representative” is FINRA’s term for stockbroker or financial consultant or account executive, or any other name a broker-dealer decides to give its registered representatives. Most clients think of this person as their stockbroker.
**Rule 2111(b) applies only to institutional customers.