Investor Information
July 15 2008
Will Wall Street's recent downturn cause investors to question their brokers' conduct and stock recommendations? If hedge funds continue to falter, will public customers and pension fund beneficiaries start to ask how they wound up in such risky investments?
Investors have a knack for ignoring the warning signs and riding the wave of a rising market. After all, when stocks are moving higher, there is little cause to question the judgment of a stockbroker. Even if the investments were a bit too risky, or the portfolio was filled with speculative stocks, why rock the boat when values are up – or so the logic goes.
That logic falls apart, of course, when shares begin to descend – sometimes precipitously. Speculative investments can be volatile, rising dramatically in a hot market and plunging even more quickly when markets retreat. When portfolios shrink investors start to ask more questions – often with good reason.
As they look at shrunken portfolios, investors often ask whether their stockbroker or investment advisor had recommended inappropriate investments in the first place. This is the issue of suitability, and a common source of customer complaints.
Investors pursue suitability claims when they believe a broker recommended investments that did not reflect the customer's investment goals or were inappropriate in view of the customer's age, financial wherewithal or experience. Although many accounts include unsuitable investments, customers do not typically complain – or even recognize a potential problem – until losses have occurred.
Unsuitability claims are extremely fact-sensitive. An investment that is not suitable for an older investor living on a fixed-income could be perfectly appropriate for an investment banker with a high six figure salary. Hedge funds are likely to pose a particular problem. Small investors may have money tied up in risky hedge funds - and not even know it. Pension plans and other institutional investors reportedly have placed billions of dollars in hedge funds. If hedge funds founder, individual beneficiaries of those pensions may question the suitability of such investments.
An investor may be entitled to make an unsuitability claim years after the initial investment. Even if the customer was fully informed of the risks involved, the broker could be found liable if the investments fell outside the parameters of suitability for that customer.
In order to determine suitability, a stockbroker is obligated by industry rules and established standards to "know" his or her customer. That means a broker must obtain sufficient information about the customer at the time the account is opened, including age, financial condition, investment experience and goals. NYSE Rule 405 requires a brokerage firm to use due diligence and make necessary inquiries to gather this information. Similarly, the NASD Rules of Fair Practice provide that a member firm must have a reasonable basis for believing a recommendation is suitable, based upon the customer's prior investments, financial condition and goals.
A broker who ignores a customer's investment objectives, or who routinely recommends inappropriately speculative securities, may be liable for the investor's losses. Failure to diversify or over-concentration in speculative or illiquid securities raises the specter of unsuitability. Results are not the issue where suitability is concerned. The broker is not vindicated simply because some of the inappropriate transactions prove to be profitable.
To judge suitability it is important to look at the entire account. A recommendation that could be proper as a small portion of a balanced portfolio is more likely to be unsuitable if it would be a large percentage of the investor's holdings. Tech investors know the feeling. When tech was hot, some brokers recommended a high percentage of dot com stock. After the dot com crash, investors suddenly questioned the suitability of tech stock recommendations that accounted for virtually all of their portfolio.
What can an investor do when a broker recommends unsuitable securities? In most instances the customer is required to arbitrate claims against the broker and firm. See, Know Your Broker – Investors Can Fight Back.
If you believe your broker has recommended unsuitable investments, please let us know. We would be interested in hearing your story.
July 15 2008
Will Wall Street's recent downturn cause investors to question their brokers' conduct and stock recommendations? If hedge funds continue to falter, will public customers and pension fund beneficiaries start to ask how they wound up in such risky investments?
Investors have a knack for ignoring the warning signs and riding the wave of a rising market. After all, when stocks are moving higher, there is little cause to question the judgment of a stockbroker. Even if the investments were a bit too risky, or the portfolio was filled with speculative stocks, why rock the boat when values are up – or so the logic goes.
That logic falls apart, of course, when shares begin to descend – sometimes precipitously. Speculative investments can be volatile, rising dramatically in a hot market and plunging even more quickly when markets retreat. When portfolios shrink investors start to ask more questions – often with good reason.
As they look at shrunken portfolios, investors often ask whether their stockbroker or investment advisor had recommended inappropriate investments in the first place. This is the issue of suitability, and a common source of customer complaints.
Investors pursue suitability claims when they believe a broker recommended investments that did not reflect the customer's investment goals or were inappropriate in view of the customer's age, financial wherewithal or experience. Although many accounts include unsuitable investments, customers do not typically complain – or even recognize a potential problem – until losses have occurred.
Unsuitability claims are extremely fact-sensitive. An investment that is not suitable for an older investor living on a fixed-income could be perfectly appropriate for an investment banker with a high six figure salary. Hedge funds are likely to pose a particular problem. Small investors may have money tied up in risky hedge funds - and not even know it. Pension plans and other institutional investors reportedly have placed billions of dollars in hedge funds. If hedge funds founder, individual beneficiaries of those pensions may question the suitability of such investments.
An investor may be entitled to make an unsuitability claim years after the initial investment. Even if the customer was fully informed of the risks involved, the broker could be found liable if the investments fell outside the parameters of suitability for that customer.
In order to determine suitability, a stockbroker is obligated by industry rules and established standards to "know" his or her customer. That means a broker must obtain sufficient information about the customer at the time the account is opened, including age, financial condition, investment experience and goals. NYSE Rule 405 requires a brokerage firm to use due diligence and make necessary inquiries to gather this information. Similarly, the NASD Rules of Fair Practice provide that a member firm must have a reasonable basis for believing a recommendation is suitable, based upon the customer's prior investments, financial condition and goals.
A broker who ignores a customer's investment objectives, or who routinely recommends inappropriately speculative securities, may be liable for the investor's losses. Failure to diversify or over-concentration in speculative or illiquid securities raises the specter of unsuitability. Results are not the issue where suitability is concerned. The broker is not vindicated simply because some of the inappropriate transactions prove to be profitable.
To judge suitability it is important to look at the entire account. A recommendation that could be proper as a small portion of a balanced portfolio is more likely to be unsuitable if it would be a large percentage of the investor's holdings. Tech investors know the feeling. When tech was hot, some brokers recommended a high percentage of dot com stock. After the dot com crash, investors suddenly questioned the suitability of tech stock recommendations that accounted for virtually all of their portfolio.
What can an investor do when a broker recommends unsuitable securities? In most instances the customer is required to arbitrate claims against the broker and firm. See, Know Your Broker – Investors Can Fight Back.
If you believe your broker has recommended unsuitable investments, please let us know. We would be interested in hearing your story.
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