Suitability Claims Expected to Rise as Market Meltdown Continues
Significant drops in the stock market in recent days are likely to reveal a number of suitability abuses by brokerage firms as customers experience losses. While such abuses are sometimes hidden by a rising market, a falling market invites scrutiny that often reveals unsuitable recommendations by brokers.
The law imposes a duty upon securities brokers only to recommend securities that the broker reasonably believes are suitable for the customer. The broker's belief must be based upon a reasonable inquiry concerning the customer's investment objectives, financial situation and needs, tax status, other security holdings, and any other relevant information known by the broker. This suitability duty is based on a "homely truth about investing -- that investment decisions can be made only in light of the goals and needs of the person for whom they are made."
Despite this, unsuitable recommendations of securities are among the most common violations in the brokerage industry. Perhaps the clearest example of a suitability violation occurs where a broker recommends speculative securities to a customer whose financial situation clearly calls for conservative investments (for example, a retired person who needs the income from his investments for his living expenses and who has no reasonable expectation of being able to replace any substantial trading losses).
An unsuitable recommendation of securities constitutes a dishonest, unethical and fraudulent business practice. If such an unsuitable recommendation results in financial loss, the customer has a right to recover that loss from the brokerage firm.
Broadly speaking, there are three primary benchmarks for determining whether an investment or investment portfolio is suitable: (1) investment objective(s), (2) time horizon, and (3) risk tolerance. Brokerage firms should carefully evaluate each of these factors in making recommendations. Failure to do so gives rise to suitability claims.
Most experts agree that the overall portfolio of an investor with an objective of asset preservation and/or income should contain a substantial allocation to money market, and/or investment-grade short-term fixed income investments. If that investor has a longer time horizon and requires some growth in order to not outlive his or her assets, a reasonable allocation to dividend-paying stocks may be appropriate as well. A portfolio comprised substantially of non-dividend-paying growth stocks might be suitable for a younger investor saving for retirement, but not for someone in need of income from investments. A longer time horizon militates in favor of a greater allocation to stocks, and vice versa.
A designation of "speculation" as an investment objective or a level of risk tolerance should be regarded with extreme suspicion. Based on our experience, it is an indicator that the broker may intend to use an investor’s account as a vehicle to generate excessive commissions. Investors should communicate their true investment objectives and risk tolerance in writing to the compliance officer of a brokerage firm.
A broker cannot have a reasonable basis for recommending an investment or investment strategy without knowing the risk of the particular investment or investment strategy being recommended, and explaining that risk to the customer. A broker cannot know the risk of a particular investment or investment strategy, and properly explain it to the customer, without measuring the risk.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing institutional and individual investors with investment problems. For further information, please contact us.
