Federal and state laws prohibit stockbrokers and brokerage firms from advising you to purchase unsuitable investments. Unsuitability is when a stockbroker recommends or purchases investments that don’t fit with your objectives and needs.
In some cases, stockbrokers give unsuitable advice on purpose for their own profit and gain. In other cases, bad investment advice happens out of negligence when a stockbroker fails to consider the needs of his client.
Regardless of whether your broker committed negligence or willful deception, if you lost money from unsuitable advice or transactions, you can seek financial compensation to try and get your money back.
A Hotly Debated Issue
Unsuitability is one of the biggest problems on Wall Street and one of the most common complaints made by investors. However, the law supporting unsuitability is vague, making it a hotly debated and often misunderstood issue.
In the simplest of terms, your broker must have a sound reason for recommending an investment to you, i.e., he must have a reason for believing that the recommendation fits your objectives and needs. If that “reason” was for his own profit and gain, for example, or if there was no reason at all, then a claim for unsuitability can often be made.
How Unsuitability Happens
Unsuitability violations usually involve one or more of the following:
- An investor doesn’t fully understand the potential risks of an investment: Most investors don’t have the expertise required to evaluate risk, let alone identify the best securities for their needs. Maybe you’re a highly skilled math teacher, carpenter, doctor or engineer, but when it comes to knowing the difference between a vested and unvested stock option, you’re lost. This is why most unsuitable investment advice doesn’t usually get discovered by until it’s too late.
- An investor doesn’t have the financial resources to afford the potential risks of an investment: Every investor is different and requires a unique strategy to fit his circumstances. Orphans, charities, and persons with disabilities, for example, can’t usually afford risky investments, nor would it be moral to put them at risk. The same is true for a retiree with limited assets available.
- An investor states his objectives, but his broker acts in a way that contradicts those objectives: Your investment advisor has a duty to “know his customer.” That means he has to ask you questions about investment objectives and needs, then consider your answers before giving advice. If you tell him you only want conservative investments, and he recommends a portfolio of junk bonds, then your broker’s actions have contradicted your objectives.
Here are some factors an investment advisor must consider before making a reasoned and suitable recommendation:
- Net Worth
- Tax Status
- Investment Goals
- Need for Liquidity
- Retirement Status
- Employment Status
- Total Invested Assets
- Investment Experience
- Desire for Safety vs. Risk
Bringing Unsuitability into Perspective
The clearest cases of unsuitability occur when an inexperienced investor needs safe investments but his advisor recommends risky ones. However, most claims are not so clear.
In cases where the suitability of a broker’s actions is less obvious, regulators, arbitration panels, and judges sometimes split the responsibility between the investor and the brokerage firm. In other words, an award or settlement for damages could be reduced or denied in light of the customer’s participation.
However, sometimes an unsuitability claim is warranted even if it seems like you signed off on or requested the inappropriate investments yourself. This is where a highly competent and experienced stock fraud lawyer can help. Your lawyer will evaluate the feasibility of your claim for damages and the likelihood of its success. He can then advocate on your behalf to obtain the highest possible award or settlement.
Something Stockbrokers and Doctors Have in Common
Just as you ask a doctor for the best medical advice to stay physically fit, you ask your broker for the best investment advice to stay financially fit. And just as your doctor must put your interests ahead of his own, so must your investment advisor. The problem is, not all brokers are honest and not all brokers conduct their business with the due diligence necessary to give you the best advice.
For example, imagine your doctor recommends a very risky surgery to you, but it’s completely unnecessary. And what if the only reason he recommended the surgery was to generate more income for himself? If the surgery goes wrong and you are injured as a result, the unneeded surgery was unsuitable for your needs and it was your doctor’s negligence or greed which led to the injury. You should be made whole.
Stockbrokers working for the most powerful brokerages on Wall Street participate in this kind of fraud every single day, resulting in millions of dollars in damages. Indeed, there’s no limit to the financial destruction that bad financial advice can cause. What’s worse is that most victims never even realize they’ve been wronged.
Discovering Unsuitability Fraud
One way to better understand the issue of unsuitability is to look at some clear examples of the offense. For instance, it would be unconscionable to recommend $5,000 of junk bonds to a 75-year-old man if his net worth was only $5,000. On the other hand, the same recommendation might be suitable if his net worth were $10 million.
Below are some classic examples of unsuitable investment advice, which a stock fraud lawyer would likely recognize as unsuitable:
- A recently widowed, 80-year-old retiree, with no investment experience, inherits $100,000:
The money is all she has, but her new investment advisor invests all of it into risky stocks and other volatile securities.
Why it’s unsuitable: An 80-year-old widow can’t afford to gamble her money on the ups and downs of the stock market. She requires a conservative portfolio of safe, income-generating investments she can depend on.
- A disabled veteran owns $500,000 in municipal bonds that are about to mature:
He needs the bond income for living expenses and he wants to reinvest in something equally safe and income producing. His broker implements a speculative options trading strategy instead. The veteran loses everything as a result.
Why it’s unsuitable: A disabled person needs his money to last because he won’t be earning more. The veteran expressed a goal of safety, but the broker’s actions contradicted this request, and it was completely incongruent with his highly conservative investment background.
- A 70-year-old retired couple has $30,000 cash:
Their stockbroker recommends a 20-year variable annuity, but only because the broker will receive a $2,000 commission for the sale. The broker invests the annuity into very risky mutual funds and the annuity loses 50% of its value.
Why it’s unsuitable: The biggest problem is that the annuity agreement lasts for longer than the couple’s life expectancy. Their money will be locked away for the rest of their lives. Secondly, retirees need safe investments that protect them from the ups and downs of the stock market and the stock-based mutual fund exposed them directly to stock market volatility.
- A 60-year-old investor tells his advisor he wants risky stocks:
The investor wants to grow his money because he retires in 5 years. His total net worth is only $30,000. The broker recommends and purchases the riskiest stocks available and the investor loses 60% of his life savings.
Why it’s unsuitable: Due to the investor’s wish for risky stocks, this unsuitability claims is probably not going to be very strong. However, your broker must evaluate how much risk you can afford. Like a doctor, he is obligated to advise and act in your best interest. If he knowingly assists in your financial suicide (especially if he benefited financially as a result), then his actions might be considered unsuitable.
When an investor wants to purchase risky investments or engage in risky strategies, a brokerage firm will require him to sign paperwork that discloses the risks involved. Investors are often misled into signing these kinds of agreements when they don’t have the capacity to understand them. Laws exist to protect you from this kind of fraud. If you signed an agreement like this, you may still have the right to a recovery.
Know Your Rights
The Financial Industry Regulatory Authority (FINRA) governs and regulates the actions of its members. Your stockbroker and his employing firm are members of FINRA and must abide by its laws. If your stockbroker breaks those laws, the firm that supervises his actions should compensate you for his negligence and/or fraud.
According to FINRA Rule 2111 (Suitability):
(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy…is suitable for the customer, based on the information obtained through the reasonable diligence…to ascertain the customer’s investment profile…
FINRA Rule 2111 also states that:
…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…
Regarding investors who seemingly ratified the unsuitable actions of their stockbroker, FINRA says the following:
Rule 2111 prohibits a member or associated person from recommending a transaction or investment strategy…unless [there is] a reasonable basis to believe that the customer has the financial ability to meet such a commitment.
FINRA Rule 2090 (Know Your Customer) also applies:
Every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer…
In addition to the above, there are federal laws, state laws and case law that support claims for unsuitability. Unsuitability claims generally involve a breach of fiduciary duty, breach of contract, negligence, omission, misrepresentation and other violations as well.
Whether or not an unsuitability violation has happened depends on the unique circumstances of your individual case. If you suspect that you were a victim, contact a stock fraud lawyer immediately.
Try and Get Your Money Back
If you suffered investment declines due to the unsuitable actions of your stockbroker, you deserve financial compensation. Victims may qualify for a full or partial refund of the original amount invested, in addition to other compensation.
While financial damages can be economically crippling, the realization you were lied to and played for a ‘sucker’ can be emotionally devastating. If you have fallen victim to stock fraud, it’s important to remember this is not your fault!
Pursuing a stock fraud claim will teach Wall Street brokerage firms that it is unacceptable to prey upon innocent consumers. Your claim may even prevent others from suffering as you have by forcing Wall Street brokerage firms to conduct business with honesty and integrity.
You may be eligible to receive compensation regardless of whether you sold or continue to hold the securities at issue. Contact us today to set up a free consultation. We will listen to your story, answer any questions you may have and discuss your legal rights and options.