Obligations of a Stockbroker

Many people have no idea that they may have legal recourse against a stockbroker for mismanagement of their assets.  Individuals inaccurately believe that when they give money to a stockbroker, they are at the whim of chance.  This is far from the truth.

The reality is stockbrokers have legal obligations to recommend suitable investments for a customer.  This is why it is so important for a customer and stockbroker to know the customer’s investment objectives and risk tolerance.

Stockbrokers are regulated by a Securities and Exchange Commission approved entity called the Financial Industry Regulatory Authority (“FINRA”). FINRA Rule 2111 requires that a licensed stockbroker have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer. This is based on the information obtained through the reasonable diligence of the brokerage firm or stockbroker to ascertain the customer’s investment profile.

The rule states that the 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 [and] risk tolerance,” among other information. A stockbroker’s “recommendation,” which is based on the facts and circumstances of a particular case, is the triggering event for application of the rule.

Stockbrokers must have a firm understanding of both the product and the customer, according to Rule 2111. The lack of such an understanding itself violates the suitability rule.

Suitability Obligations

Rule 2111 lists the three main suitability obligations for firms and stockbrokers.

  • 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. Reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards of the recommended security or strategy.
  • Customer-specific suitability requires that a broker, based on a particular customer’s investment profile, has a reasonable basis to believe that the recommendation is suitable for that customer. The broker must attempt to obtain and analyze a broad array of customer-specific factors to support this determination.
  • Quantitative suitability requires a broker with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.

So, the next time a stockbroker recommends a security or investment strategy, make sure to discuss the appropriateness of the recommendation.

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