Unsuitability
A suitability claim is one of the most common customer claims made to a panel of securities arbitrators.
In order to meet their duty to recommend suitable investments a brokerage firm must “Know Their Customer.” New York Stock Exchange Rule 405 requires a firm to perform due diligence to learn the essential facts and background of the customer. The suitability rule is codified in NASD Rule 2310 which states:
- (a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
- (b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
- The customer's financial status;
- The customer's tax status;
- The customer's investment objectives; and
- Such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
Brokerage firms record suitability information on new account forms and customer questionnaires and periodically update the information as a customer may experience changes in their risk profile during their lifetime. This information is usually entered into the firm's computer and maintained in a manner that permits supervisors to ensure that brokers at the firm comply with the suitability rules. Each and every investment must be suitable in its own right and also as measured in the context of the overall investment portfolio.
The suitability of the overall mix of investments in a portfolio is determined by asset allocation. Asset allocation is the split of investment products between cash, fixed income, equities or other non-traditional asset classes.
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