A stockbroker or registered representative’s knowing recommendation of an unsuitable security supports a claim for securities fraud. In addition, FINRA’s suitability rules, and the former suitability rules of the New York Stock Exchange have long been regarded as the standard to which all brokers are held.
FINRA Conduct Rule 2111 provides that:
(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.
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 to the member or associated person in connection with such recommendation.
Types of Suitability
1. Product specific suitability
2. Customer specific suitability.
Prior to the recommendation of any security, the broker must first understand the risk and characteristics of the securities being recommended, and whether that security is suitable for any customer. The second step, in connection with the recommendation to recommend a particular investment or investment strategy is whether the transaction is suitable for that particular customer.
Suitability determinations are a two-step process: the first step is reasonable diligence as to the risks associated with a particular security to determine if the product is suitable at all; the second step is to determine whether it is suitable for a specific client given their overall financial condition and expressed investment objectives.
As the US Securities & Exchange Commission, in its approval of the consolidated FINRA Suitability Rule observed:
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.
In general, what constitutes reasonable diligence will vary depending upon, among other things, the complexity of and risks associated with the security or investment strategy and the firm’s or associated person’s familiarity with the security or investment strategy.
A firm’s or associated person’s reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy.
See Securities Exchange Act Release No. 63325 (November 17, 2010)(emphasis added).
FINRA Rule 2111 specifically provides that:
(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:
(1) the customer’s financial status;
(2) the customer’s tax status;
(3) the customer’s investment objectives; and
(4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
FINRA Manual, FINRA Rule 2111 (emphasis added).
In addition, FINRA has consistently stated that “whether a security is recommended does not necessarily depend on the member’s classification of the security as ‘solicited or unsolicited.’” In particular, a transaction will be considered to be recommended when the member brings the specific security to the attention of the customer through any means, including, but not limited to direct telephone communication, the delivery of promotional material through the mail, or the transmission of electronic messages.” NASD Notice to Members 96-60.
With respect to retired persons, FINRA has consistently reminded its members that:
Firms should carefully consider the risk of a product with the age and retirement status of the customer in mind, including its market, inflation and issuer credit risk. Investment involves varying degrees of risk and reward. For many investors who are at or nearing retirement, there can be a temptation to reach for yield to maximize retirement income without the appreciation of the concomitant risk.
Moreover, it can be difficult for some investors to fully appreciate the risks of certain products or strategies, particularly if they are concerned about running out of money. Yet, especially when investments involve retirement accounts or lump-sum pension plan payments, taking undue risks with funds needed to last a lifetime can be financially disastrous.
(See FINRA Regulatory Notice 07-43)(Emphasis added).
The violation of these rules supports a claim for securities fraud. See Kirkland v. E.F. Hutton & Co., 564 F. Supp. 427, 443 (E.D. Mich. 1983) (SRO rules may be considered as evidence in support of securities fraud claim); Mihara v. Dean Witter & Co. 619 F.2d 814, 824 (9th Cir. 1980)(suitability rules of the Exchange and the NASD have long been regarded as the standard to which all brokers are held, the violation of which is tantamount to fraud);
Miley v. Oppenheimer, 637 F.2d 318, 333 (5th Cir. 1981); Keenan v. D.H. Blair & Co., Inc., 838 F. Supp. 82, 86-87 (S.D.N.Y. 1993); Kirkland v. E.F. Hutton & Co., 564 F. Supp. 427, 443 (E.D. Mich. 1983) (SRO rules may be considered as evidence in support of securities fraud claim); See, e.g., Cohen, The Suitablity Doctrine: Defining Stockbrokers’ Professional Responsibilities, 1978 J. Corp. L. 533 (1978); In re Philips & Co., 37 S.E.C. at 70 (representative’s knowing recommendation of unsuitable security not excused by customer’s belief that security was suitable); In re Powell & McGowan, Inc., 41 S.E.C. 933 (1969)(registrant had obligation not to recommend to a course of action even if he fully disclosed all risks to customer whose financial and physical condition made the recommendations unsuitable).
In re Harold R. Fenocchio, ‘34 Act Release No. 12194 (given the advanced age of customer, representative had a duty “to make a serious inquiry into the situation of the customer’s investments and to prevent the dissipation of the customer’s capital by excessive turnover”); In Board of Trustees v. Chicago Corp., No. 88-C-3855 (N.D. Ill. 1988) (1988 U.S. Dist. LEXIS 14031)( the court held that a broker had a duty to monitor a client’s investment decisions, which were effected by client’s 
trustee, and to advise client of soundness of the trustee’s decisions); Duffy v. Cavalier, 215 Cal. App. 3d 1517, 264 Cal. Rep. 3d 740 (1989) (court held that as a fiduciary, the broker had a duty to tell a client that the client’s investment objectives were improper and unsuitable and “to refrain from acting except upon the customer’s express orders”); Nobrega v. Futures Trading Group, Inc., [1999] Sec. L. Rep. (BNA) Vol. 31, No. 28, p. 950 (CFTC 1999)(broker sanctioned for failing to correct client’s “erroneous beliefs” about safety of commodities trading and failing to stop client from continued trading once aware of these erroneous beliefs).
Guiliano Law Group, P.C.
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