Suitability: One Size Does Not Fit All

At Cold Spring Advisory Group, one of the more blatant forms of stockbroker abuse we see is the flagrant disregard for FINRA’s Suitability Rule (Rule 2111). The purpose of the Rule is to ensure brokerage firms and brokers deal with their clients fairly, ethically and professionally. The Rule obligates the firms and their brokers to provide reasonably based, quantitatively suitable, and customer specific recommendations based on the client’s investment profile, and to act in the best interest of the client. Critical elements of an investor’s profile include age, financial situation, investment objectives and time horizon, liquidity needs, investment experience and risk tolerance. Simply put, the recommended investment must be appropriate for the investor, which generally depends on each investor’s unique situation. For example, an executive with considerable investment experience and significant net worth may be confortable with options, futures and other high-risk, speculative investments, while these same investments would be extremely unsuitable for a 90 year old widow on a fixed income. We have identified a number of “low-tier”, or “transactional” brokerage firms that put their clients in the same handful of high-risk, speculative positions regardless of the person’s age, time horizon, risk tolerance or investment experience. These firms intentionally ignore the client’s true investment objective by pre-selecting “maximum risk” and “speculation” on new account forms even on IRAs and retirement accounts. Cold Spring Advisory has clients who crossed out the pre-checked box for “speculation” and wrote “no speculation” on their new account forms. Their brokers told them that “speculation” or “maximum risk” had to be checked in order for him to realize maximum gains. Another told us that despite him writing “NO SPECULATION” on his forms, “they steamrolled over it anyhow” and put him in positions even a highly experienced investor would avoid. In scenario we see all the time, the new client transfers conservative, oftentimes blue chip stocks and funds into the new account. Over the following few months, those conservative positions are sold and replaced with highly-traded, volatile, speculative stocks guaranteed by the broker to be “home runs.” Within a year or less, the account is decimated through churning with markups and markdowns and excessive margin abuse. Despite the Rule’s requirement that the broker-dealer and broker do the necessary due diligence to obtain the information that comprises an investor’s profile, these firms instead manipulate their clients and convince them that the investment objective on the forms isn’t important and doesn’t matter; yet when the brokers find themselves in an arbitration, they run to the new account form and point out that the client agreed to the maximum risk objective. These broker-dealers somehow believe they are protected from all liability by having a new account form with “speculation” pre-selected. For example, in a recent arbitration, our client lost $640,000 and paid $504,000 in commissions. The broker’s defense was that the client’s new account form showed “maximum risk” and he was “happy” with that investment strategy. The most painfully obvious cases of suitability abuse occur with senior investors – those investors over 70 years old. With rare exception, senior investors’ objective is capital preservation. Transactional broker-dealers have zero interest in designing portfolios that would meet conservative objectives because it is in direct opposition to the way they make money. They want their clients in stocks they can buy and sell and hype. The senior investor’s new account forms will be marked for speculation/maximum risk and rolled into the fold with all of their other investors, to meet the firm’s true objective: to fill their own pockets with the investor’s money through excessive trading and excessive margin. Investors, if you are with one of these small, transactional broker-dealers, look closely at your statements and confirms. If the investment objective stated on your paperwork is not consistent with your investment strategy, email the chief compliance officer at your brokerage and request a change. To learn more or to have your account analyzed for suitability abuse at no charge, please contact us at (212) 566-6060 or www.coldspringadvisory.com.