- posted: Feb. 04, 2020
All brokerage firms require specific customer information to be inputted in what is generically called new account information. The purpose of this information is required by regulators as a first step to "know the customer." Net-worth, liquid net-worth, investment objectives, risk tolerance, years investing are some required mandatory information. Both stockbrokers and investors share a common interest to guarantee the proffered information is truthful and accurate.
Brokerage firms and customers have an interest in the firm knowing the customer's objectives and risk tolerance so the firm could implement appropriate investment strategies. Unfortunately, the standard New Account Document ("NAD") is insufficient to accomplish this goal. For example, a generic NAD may have a box to answer the number of years a customer has been investing in stocks. What does this question actually mean? Does it mean the number of years a customer has actively been investing in equities? Or does it mean when the first time a customer held an equity position? Many parents purchase Disney stock for their children. Is this included in the calculation? Or what about a bar/bat mitzvah child receiving stock as a gift? Is this taken into account, or more importantly, should it be?
NAD may ask whether a customer seeks "capital preservation," "income," "growth," "moderately aggressive," "aggressive growth," and "speculation." Each person may have a different definition of these investment objectives. A customer may have a hybrid investment objective of income and growth. However, this fails to articulate and educate the parties of the true investment objectives. For example, what increases the chance for both the brokerage firm and the customer being on the same page? 1) income and growth, or 2) Customer is seeking $3,000 a month in income. Once the monthly income needs are metthe balance of the portfolio should be invested in growth-oriented equities generating a three percent return after inflation. However, because the customer is retired the principal is irreplaceable and therefore does not want to expose the portfolio to any significant risk of loss.
Obviously, number 2 in the above paragraph gives a starting basis on the brokerage relationship between the firm and the customer. Number 1, taken by itself, will likely lead to failure since "income and growth" could mean so many different things. Unfortunately, NAD typically does not have a place to elaborate on information and provide a detail response.
Because the NAD information may not be an accurate and complete description of a customer's investment objectives and risk tolerance lawsuits may occur when losses manifest in a customer's account. This is not good for either the brokerage firm or customer. A brokerage firm may rely on NAD information as justification for the trading strategy in the customer's account. The customer may allege fraud because the NAD information was inaccurate and the brokerage firm relied on this information not only to supervise the stockbroker but to implement a suitable investment strategy. In addition to legal action, a brokerage firm must report a customer's alleged sales practice violations against the stockbroker if specific conditions are met.
What can one do to ensure accurate information on the NAD and maximize the possibility of investment success for both the brokerage firm and the customer? A customer should ask for a copy of the completed NAD and review it for accuracy. One will be surprised at how many questions are incomplete and/or wrong. The customer should provide a detailed accounting of all relevant factors: education, work experience, source of assets and liabilities; personal and financial goals; detailed investment objectives and risk tolerance; time horizon, etc. The customer should provide this accounting to the brokerage firm in a traceable manner to confirm receipt. Lastly, because life is not static, the brokerage firm and customer should agree on an annual date to update all pertinent information and realign any investment strategies.
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